KB and other home builder stocks could rise as mortgage rates fall, analysts say

  • By Daren Fonda,
  • Barron's
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The outlook for home sales seems to be improving with mortgage rates down sharply from last fall. That is prompting some analysts to upgrade the stocks of home builders and lift their price targets.

J.P. Morgan analyst Michael Rehaut has been bearish on many of the builders for months. But he’s now slightly more upbeat. He upgraded shares of PulteGroup (PHM) and KB Home (KBH) to Neutral from Underweight on Wednesday. He raised his price target on Pulte to $25.50 from $24 and increased his target on KB Home to $23 from $20.50.

“We expect the sector’s recent positive momentum to continue this earnings season,” Rehaut wrote in a note, “driven by likely upside to our order growth estimates and an incrementally positive investor sentiment.”

Yet Rehaut’s price targets are still below where the stocks now trade; Pulte was at $28.95 in trading on Wednesday morning while KB Home was at $25.17. Indeed, his targets and multiples reflect an overall cautious view of the sector, implying 10% average downside potential for the group from recent stock prices.

Rather than buy and hold, Rehaut writes, “we believe a more prudent strategy is to look for profit-taking opportunities over the next several months.”

Pulte’s stock, up about 11% this year, has lagged behind the average large-cap builder by about 10.1 percentage points. The company is likely to see margin erosion and declines in earnings per share in 2019, compared with 2018, Rehaut writes. Consensus estimates are for Pulte to earn $3.16 a share this year, down from $3.55 in 2018. But the earnings slide may now be reflected in the multiple; the stock trades at about nine times consensus earnings estimates for 2020, making it one of the least expensive larger-cap builders.

Earnings look stronger for KB Home; analysts expect EPS of $2.65 in 2019, up from $1.71 in 2018. Rehaut expects order growth of 6% in 2019 and gross margins to expand by 0.4 percentage points. Moreover, the stock’s valuation looks reasonable, trading at 8.5 times his 2020 earnings.

Rehaut sees more upside in other builders, though. He rates Lennar (LEN) as Overweight, for instance. The stock trades at 8 times estimated 2020 earnings, he writes, and the company has potential to improve returns on equity over the next several years as it integrates the acquisition of builder CalAtlantic, a deal that made Lennar the largest home builder in the U.S.

He also likes Taylor Morrison Home Corp . (TMHC) and William Lyon Homes (WLH) as inexpensive small-cap stocks, expecting both to outperform.

Rehaut isn’t the only analyst taking a more positive view of the builders these days.

JMP Securities analyst Peter Martin raised his price targets on several stocks this week, including D.R. Horton , KB Home, and LGI Homes (LGIH). He maintained Outperform ratings on them all, writing that the fall in mortgage rates “has improved traffic and stabilized incentives,” such as discounts or upgrades that builders use to entice buyers.

Mortgage rates are now about 4.5% for a 30-year fixed-rate loan, Martin notes. That is well below the peak of 5.23% in November 2018, and it’s below the 4.69% average rate a year ago.

With the spring selling season now under way, we’ll soon find out if lower mortgage rates are luring buyers back to the market. If that’s the case, expect the builders’ stocks to keep moving up.

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