Monday, December 17, 2012

The US Housing Market and the Stocks to Buy

An overweight position has helped me outperform this year, and I see no reason to reduce it right now. In fact, the fundamentals look like they are getting better. A host of anecdotal evidence and commentary from housing related stocks has been suggesting better days ahead. In this article, I want to focus on the fundamental data. Investors should be discerning and not afraid to research things thoroughly. After all, it’s your hard earned money that you are investing.

Housing Data Looking Better

The first exhibit is the Architectural Billings Index from the American Institute of Architects...

…which has perked up lately. This is usually a pretty accurate barometer of future housing market conditions, but the picture has been distorted this year with the pull forward of activity in housing due to the unseasonably warm winter in the US. So is this another optical trick with housing?

I happen to think it isn’t.

Firstly, homeowner vacancy rates (US Census Bureau) have fallen every consecutive quarter since Q4 2010 and are now not far away from historical levels.

Of course homeowner vacancy rates are one thing, but the key is to see some traction in the demand situation.  I think we are seeing that now. For example, here is how the monthly supply of new single family homes is trending.

Again we are approaching historically favorable conditions. Now the last time I looked at an Economics 101 text book, it told me that Demand>Supply=Pricing^ -- so is this happening now?

It looks like pricing is back too.

In summary, all the data is pointing towards a more meaningful pick up in housing and the supplementary information is supporting what the Architectural Billings Index is suggesting. With that said, it’s time to drill down and look at possible beneficiaries. I want to try to keep this as broad as possible because I realize that investors will have different opinions as to which stocks are attractive.

Which Stocks to Buy in a Housing Recovery?

As ever, you can start with the home builders, and despite the fall after DR Horton’s (NYSE: DHI) and Beazer Homes'  numbers, I think the sector is still doing well. Beazer missed estimates and isn’t the best way to play the sector, while DR Horton’s numbers were a little light relative to upbeat expectations. Nevertheless, its order backlog was up nearly 50% and sales demand remains strong. This is hardly the stuff of a weak housing market. However, I would encourage investors to look elsewhere. The house building sector has had a huge run up in anticipation of a better economy.

I think there is further room to grow at Home Depot and that the stock belongs in the high 60’s, but Lowe’s (NYSE: LOW) will interest those looking for a company trying to make operational adjustments and play catch up. The stock isn’t expensive, but it needs to execute better. The good news is that it’s always easier to do this with favorable end markets, so it’s down to its management to get its merchandising right. From my perspective, I like purer exposure to macro calls and am sticking with Home Depot for now.

Home Spending Stocks

Increased construction activity should help something like Fastenal, and others might find good value here, but it’s a case of ‘love the company but hate the evaluation’ for me. I’ve discussed it in more detail here, and it’s a similar story with Pier 1 Imports in an article here. Just to prove that my misery knows no bounds, I’ve also decided to take a pass on buying into Bed, Bath and Beyond (NASDAQ: BBBY) as discussed here. The company faces competitors encroaching on its core market place and seems to be paying for top line growth at the expense of margins. Meanwhile, it doesn’t appear to be managing its cost base particularly well this year.  Much will depend on performance at the new store rollouts.

Before you conclude that I am a complete pessimist, I should point out a relatively positive discussion of Whirlpool (NYSE: WHR), which I think has managed a restructuring very well. I’m a bit concerned with its exposure to Brazil and think investors should watch what other companies are saying about conditions there. It may even have a bottom in its results in Europe -- more details here.  A company with similar kinds of exposure is Masco (NYSE: MAS), although this stock is higher risk. Its debt levels are significant in relation to its market cap, and it has significant overseas operations. In other words, it is not ideally placed to deal with an unexpected slowdown. Nevertheless, those looking for a bit more risk/return will want to take a closer look.

On a more positive note, I think Acuity Brands is worth holding. Its main exposure is to commercial and industrial lighting solutions, but spending on commercial construction tends to follow residential spending in a cyclical fashion. In addition, there is the longer term secular growth driver of LED lighting to look forward to. Lastly, the timber companies, like Weyerhauser and Plum Creek Timber, are also well worth a look, as they will have good housing exposure.


I think that the macro data is suggesting better times ahead, and this is a sector that investors should be trying to get more exposure to, at least on a relative evaluation basis. It’s been a long time coming, but the US housing market does look like it's back this year.

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