D.R. Horton, PulteGroup Make A Solid Foundation For A Homebuilders Position

It’s a good time to be in homebuilding, according to Bank of America Merrill Lynch analyst John Lovallo II.

Lovallo reiterated Buy ratings for D.R. Horton, Inc. DHI and PulteGroup, Inc. PHM, and raised both price targets by a dollar to $42 and $30, respectively.

The analyst likes D.R. Horton because of its high volume and even-flow production strategy, which have benefitted from consistent execution by management.

PulteGroup shares come at a P/E discount compared to its large-cap peers, and Lovallo believes 2018 could see large, re-accelerated order growth as the company’s land strategy comes to fruition and it increases its active community count (see Lovallo's track record).

The housing market is expected to grow in the high-single digits the next two years. Lovallo estimates 9-percent growth year over year in 2018 single-family housing starts and new home sales and 8-percent growth year over year in 2019 — compared to the previous 6 percent growth year over year.

Also, the analyst raised homebuilder EPS estimates by about 3 percent for the next two years given the higher order growth estimates.

Homebuilding Supply, Demand

Lovallo expects housing supply to loosen up in the next few years.

He attributes this primarily to builders becoming more confident in the market’s recovery. As fears are calmed, new developments should appear at lower price points and in more speculative areas.

Potential bank regulation reforms could also increase builder lending and easing land entitlement burdens, helping to increase the supply of lots.

Lovallo also noted reports of accelerating demand this year, crediting them to “robust consumer confidence” and greater faith in the employment market.

Increased demand is also being driven by an influx of first-time homebuyers, still with low mortgage rates.

Building product companies should benefit from these factors as well, but to a lesser degree than homebuilders due to more diversified end-markets, noted Lovallo.

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