Why Wells Fargo Is Bullish On KB Home, DR Horton

Wells Fargo has debuted coverage of the homebuilding companies KB Home KBH and D.R. Horton, Inc. DHI.

Thumbs Up On KB Home: Deepa Raghavan, senior equity analyst, initiated coverage of KB Home with an Overweight rating and $55 price target.

“The company is a vastly improved version vs the past few years,” the analyst said.

“KBH now holds a top 5 market share position in more than two-thirds of its markets (vs. half in 2015).”

She praised KB Homes’ combination of revenue growth, a margin expansion potential that's  “not dependent on macros” and strong return on equity expansion prospects.

The company addressed lingering issues that previously kept it from reaching a greater potential, Raghavan said. 

“KBH has also shed a lot of its legacy issues at this time, including dealing with mothballed assets, high leverage, uneven operation, etc., and is poised to reap full benefits of its scale/growth-focused strategy.”  

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Sizing Up DR Horton: Raghavan initiated coverage of D.R. Horton with an Overweight rating and$105 price target.

The analyst predicts the company could “outperform this cycle given its solid market scale, dependable execution, significant exposure to entry-level demand, and peer-leading balance sheet capacity.”

Yet she acknowledged some investors may not be entirely convinced of the stock’s viability, pointing out the company’s “heavy reliance on entry-level demand for growth and its spec-heavy business model, which tend to lead to higher inventory drag in a slowdown.”

Nonetheless, Raghavan praised the company’s scale and geographical diversification as being able to buffer against any potential housing market slowdowns, adding that it generated the largest return on equity among its peers.

“We believe DHI is well-situated medium term given the solid demand dynamics in the overall housing market,” she wrote. “But it also can leverage its market-leader position effectively (DHI holds the top 2 positions in most major markets in which it participates).”

(Photo: A KB Home property in Converse, Texas. Photo courtesy KB Home.)