Earnings Reports Could Shed Light on Home Building Sector

By Chris Kirkham 

Shares of U.S. home builders have trailed the broader market in recent months amid growing concerns over rising land and labor costs and a housing recovery that has been slower and weaker than expected.

Investors will get fresh insight into the sector next week as builders Toll Brothers Inc. and Hovnanian Enterprises Inc. report earnings results.

The two companies are in starkly different positions nearly a decade after the housing bust. Toll Brothers has one of the strongest balance sheets in the industry, while Hovnanian has struggled under a massive debt load from land purchases and acquisitions made during the boom years.

Investors also will be looking for signs of the impact that rising mortgage rates might have on home purchases in the wake of Donald Trump's presidential election victory. Rates have jumped about half a percentage point since the election.

National home prices reached a record high in September, according to the latest reading by the S&P CoreLogic Case-Shiller index. But home building remains far below historical levels typically associated with recovering markets.

As a luxury builder, Toll Brothers has faced concerns this year about its exposure to high-end markets that are softening, including in New York City. Last quarter the company cut its guidance on gross profit margin for the year, citing lower margins in its high-end condo division in New York due to delays in delivering units.

New York City represents less than 10% of the company's revenue, but in recent years it has played a big role in boosting the company's margins. As the housing recovery progresses and more first-time buyers enter the market, some analysts are concerned there may be less overall demand for higher-end product than in recent years.

"We think most of the growth is at the lower end of the market. That's where the pent-up demand is," said Peter Martin, an analyst at JMP Securities who follows the home-building industry. "If you're a wealthy individual, you really don't have a ton of incentive now to switch your housing choice. You probably got a great price during the downturn, so why would you want to buy another house and raise your taxes?"

Despite the lower guidance on margins and worries about a slowdown in New York, Toll Brothers has seen significant growth in other profitable markets such as California. The company has authorized $400 million in share repurchases over the past year in an effort to boost returns.

Company executives recently announced plans to introduce a slightly less expensive line of homes in the $400,000 to $500,000 range geared toward affluent first-time millennial buyers who have waited to make their first purchases.

Chief Executive Douglas Yearley said at an investor conference last month the goal is to target younger buyers who "can afford a little more and can aspire for their first home to be a 3 series BMW."

Hovnanian Enterprises has been challenged throughout the recovery by its debt, and it stock price has mostly hovered below $2 a share since mid-2015.

Because of Hovnanian's low credit rating, it has been difficult to refinance, meaning the company has had to dip in to cash to pay off $320 million in debt over the past year. Without access to capital, growth prospects are difficult.

Hovnanian has started pulling back from Minnesota, North Carolina, Tampa, Fla., and the Bay Area in the past year. In Northern California, company executives said they are turning more attention to the Sacramento market while in Florida they are focusing on Orlando and the southeastern Florida areas such as Palm Beach and Broward counties. It sold out of Minnesota and North Carolina entirely.

"If we kept all of our markets open, then we would have less to invest in all of our markets," Larry Sorsby, the company's chief financial officer, said at a conference in September. "So we said 'Let's rationalize our footprint'."

Write to Chris Kirkham at [e-mail]

(END) Dow Jones Newswires

December 03, 2016 07:14 ET (12:14 GMT)

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