Homebuilder Shares Hang In Balance As Credit-Stretched Consumers Await Rate Cuts

Shares in homebuilders fell sharply this week following fourth-quarter results from D.R. Horton Inc DHI which showed the company had to pile on the sales incentives to generate its top-line growth.

Thus, even though the biggest house builder in the U.S. generated annual revenue growth of 6.4%, net earnings and gross margins fell as the company cut deep discounts into its sales prices.

Tepid Analyst Response To D.R. Horton Results

Analysts were lukewarm on the results. While higher sales showed some buoyancy exists in the U.S. housing market, uncertainty surrounding buyer affordability remains as mortgage rates stay relatively high and the interest rate outlook becomes more clouded.

Keefe, Bruyette and Woods reduced its 2024-2025 growth estimates, but maintained an Outperform rating, saying “the backdrop remains in line with our ‘sideways’ thesis.”

Wedbush rated the stock at Neutral with a price target of $115. Analyst Jay McCanless said: “We anticipate the mortgage rate volatility and what we believe was a competitive pricing environment during the quarter may have contributed to the earnings miss.”

Since Tuesday’s earnings report, D.R. Horton’s stock has fallen more than 10%. Shares of rival homebuilders fell in response, with Lennar LEN down 5.8% and Pulte Group PHM falling 5%.

Investors were left with the question: will the environment improve in 2024?

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Consumer Credit Stretched

Much will depend on how deep homebuilders can adjust pricing and other incentives to attract buyers as evidence begins to emerge of a growth in consumer debt.

Having come through 18 months of rising interest rates and higher inflation, household finances appear to have become stretched.

The four biggest U.S. banks — JPMorgan Chase, Citigroup, Bank of America and Wells Fargo — have recently reported higher credit card spending in 2023, compared to 2022, while unpaid balances surpassed 2019 levels for the first time, according to the Wall Street Journal.

A recent guest on Benzinga’s Pre-Market Prep, Scott Shellady — the Cow Guy — believes it goes deeper.

He told Benzinga on Monday: “Consumers have moved from their pandemic savings, to their actual savings, then they went to credit cards, then to home equity lines of credit, then to their 401(k)s, and now they're doing buy-now-pay-later.”

Lower Rates, More Affordable Mortgages

The average rate of interest on a 30-year mortgage is 6.6% — down from a peak of 7.79% in late October since markets began to price in the likelihood of Federal Reserve rate cuts this year.

Once the Fed does begin to cut, interest rates on mortgages, credit card debt, bank loans and overdrafts will begin to ease.

“We expect a modest recovery in housing, given that the sector typically responds quickly to lower rates,” said Ian Shepherson, chief economist at Pantheon Macroeconomics.

He added: “The benchmark 30-year mortgage rate has now dropped by some 115bp from its peak last October, and we expect further declines over the next few months.”

Thus, mortgage applications are already tentatively turning up, said Shepherdson.

“A simple model of home purchase demand, based on our forecast for lower rates, points to applications rising by as much as 30% by the end of this year from the recent trend, and by more than 40% from last October's low.”

Much depends on how the Fed deals with interest rates. As headline consumer price inflation ticked higher in December, hopes of a March rate cut and five further cuts in 2024 faded.

The outlook for homebuilders in the coming months hangs in the balance.

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