Analyst Upgrades Homebuilders In Anticipation Of A Credit Catalyst Amid Recession Fears

Seaport analyst Kenneth Zener has upgraded the shares of KB Home KBH, M.D.C. Holdings, Inc. MDC, Meritage Homes Corporation MTH, Taylor Morrison Home Corporation TMHC and Toll Brothers, Inc. TOL to Buy from Neutral rating.

The analyst looks at 25% upside for all the above homebuilders. The analyst has listed the conclusions after looking at 10 past rate inversion periods since 1957, and applying past stock performance.

The conclusions are: 9 of 10 cycles led to a recession, sector out-performance versus S&P and housing activity inflects 2-months post de-inversion.

The analyst says buying builders at 1x book and selling at 2x is the multi-decade, generalist PM's playbook and should not be dismissed.

The more complex pitch for higher multiple builders, justified by higher returns on capital, cash flow matching EPS, or lower leverage, are secondary to book value heuristics, for now, writes the analyst.

The monetary trajectory, slope of rates, and fiscal spending and funding, amid Treasury Yellen's uncertainty as to the cause of bond volatility remain looming clouds into an election year, writes the analyst.

The analyst has upgraded the homebuilder outlook, using past interest rate inversion cycles (2 versus 10-year bond rate), supporting sector upgrade and specifically those builders with a low Book valuation of ~1.0x book.

The analyst says builders traditionally outperform the market amid rising economic headwinds resulting in recession 9 of 10 cycles while delivering attractive risk-to-return prospects.

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