2 Stocks To Play The Gloomy Homebuilding Outlook

Perhaps there's no sector that can feel the negative impact of higher interest rates more than the housing sector. Therefore, it’s hard to be bullish on the sector in the current environment.

With that being said, Jay McCanless, Senior Vice President of Equity Research at Wedbush Securities, covers the homebuilders and building products sector with his outlook under gloomy circumstances.

Magnitude Of Increase In Rates: McCanless acknowledged the negative correlation between rising interest rates and the housing sector. He emphasized the recent rapid increase of 250 basis points for mortgage rates over the last four months is a rarity.

“This has been the biggest increase in rates since the 1980s, however, it has not yet translated into the field," he said.

From the builders he has spoken with, the buyers are still out there, but just not as many are interested in the same property. For example, whereas the builders had 12 prospects for one property in the past, now they may have only six but more serious buyers.

Large Cap Pick: In the large cap space, McCandless favors D.R. Horton DHI for a few different reasons and has a $97 price target.

First of all, it has the best balance sheet in the names in his area of coverage, with the debt cap just under 20%. More importantly, “they have a size and scale advantage in order to preserve their gross margins, that other builders just do not have.”

The company has initiated a stock buyback program, which is something it has not done in years.

Small-Cap Pick: McCandless favors Meritage Homes Corporation MTH in the small-cap space for different reasons and has a $144 price target.

First of all, 85-95% of its customers are first-time buyers that are looking for more modestly priced homes. To make the homes more affordable, the company is “very focused on energy efficiency, which is key to maintaining lower price points for first-time buyers.”

The company is focused on the "smile states” (from California down to Texas, Florida snd back to the Carolinas). In his opinion, this company has “benefited the most from Covid, work from home migration.”

The company has plans to move into the “build for rent communities,” which has been growing in popularity in recent years.