Nearly a decade after the financial crisis interest rates remain at zero. Fed watchers have been arguing for years that policymakers will soon raise rates, only to see the possibility put off yet again (and again and again). While many believe Yellen and company have stuck with ZIRP due to worries about the impact of a hike on the stock market, a bigger concern might be housing.
In both 2004 and 2005 there were almost two million new homes built in America. That number dropped below 500,000 after the financial crisis. In 2016 almost one million single and multi family homes will go up. That’s good but not great, especially in light of fact that roughly 500,000 homes are torn down every year.
With rates at zero and the US housing supply reduced after years of below replacement construction, one would think housing stocks would be trading at historically high multiples of earnings and price-to-book levels. That has not happened, which continues to make select housing stocks extremely attractive.
Two favorites are Denver-based Century Communities (CCS) and Houston-based LGI Homes (LGIH). Both stocks have outperformed the group (and the market) over the last twelve months and both could easily continue to do so.
At $21/share, CCS is up 60 percent from its 52-week low, but is still below its $24 initial public offering in 2014. Century operates in five fast growing markets--Colorado, Atlanta, Las Vegas, Central Texas and Salt Lake City. Its average home price is in the mid-$300k vicinity. The company projects 2016 revenues in the $850M-$1 billion range, an estimate that will likely be tightened and probably raised after Century reports third quarter earnings in early November.
Wall Street projects Century will earn $2.50 and $3 in 2016 and 2017, so it currently trades at only 8.4x and 7x 2016/2017 earnings. Historically, Century has beaten Street guidance and I expect that trend to continue in 2016’s second half. An added bonus for Century shareholders might be the initiation of a quarterly dividend. The company already has a buyback plan, but it could easily initiate a .25 cent quarterly dividend, as it will generate over $100M in 2016 ebitda and has only 21 million shares outstanding.
LGI is growing even faster. While LGI is headquartered in Houston, last quarter over half of its 1128 home closings were in communities outside of Texas. LGI’s average home price was an industry low of $197,450 last quarter, which means most of its customers are former renters buying their first homes. LGI projects 4,000 to 4,300 home closings in 2016, vs. 3404 closings in 2015 and 2356 closings in 2014. As I’ve written about before, its gross profit margin of 26.5 percent is the highest of all publicly traded home builders. LGI should earn $3.40 a share in 2016 and $4 in 2017, which means it currently trades at only 10.2x and 8.7x 2016/2017 eps.
I have interviewed the senior managements of both companies at their headquarters in the last two months. They are both run by smart, competent people who own sizeable amounts of their own stock (the all important ‘skin in the game’). Unless the US enters an unexpected recession soon, I expect continued rapid earnings growth and inevitable multiple expansion will help both outperform in the next twelve months.
