Why Merrill Lynch Just Became Much More Excited About Homebuilders

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The housing market is one of the engines that drive the American economy. With most housing markets having fully recovered from the Great Recession, there remains at least some debate over how much more juice is left in homes. After all, housing affordability has become stretched for many Americans at the same time that an oversupply of apartments has pressured rents in many top cities around the country. And we all know that coming up with 20% down to buy a house is no simple task.

If Merrill Lynch is proven correct, some of the homebuilder stocks have even more upside ahead. The firm did have two homebuilders that it thinks investors should not be in at all, but the firm has Buy ratings and raised its target price on four top U.S. homebuilders.

Several issues were behind Tuesday’s call. The first issue on a sector basis is that the firm believes that the U.S. housing cycle is on solid ground and is possibly inflecting higher. Many of the supply constraints are easing, and builders have started to target lower price points and labor returns to get easier home sales. While this may be an inside-baseball call for investors, Merrill Lynch noted that technical analysis (i.e., the stock charts) also supports the group.

On an industrywide basis, the firm continues to forecast roughly 9% year-over-year growth in both 2017 single family housing starts to 850,000 and new home sales to 615,000. The firm actually reduced its multifamily starts estimate from 400,000 to 360,000.

In most cases, Merrill Lynch has the highest or close to the highest targets on Wall Street for its picks with Buy ratings. Additional color has been included, and the consensus analyst price targets are the mean (average) from Thomson Reuters.

D.R. Horton Inc. (NYSE: DHI) was reiterated as Buy and the price objective was raised to $42 from $41, and Merrill Lynch sees 24% upside here. This is one of the two top homebuilder picks for the firm. Merrill Lynch sees D.R. Horton being a primary beneficiary of green-shoots in the construction labor base, based on a consistent execution of its even-flow production strategy. The firm noted that Horton’s Express product remains one of the most attractive and affordable new housing offerings on the market. Buyers get some degree of customization at an average selling price of about $220,000, and the firm also noted that the D.R. Horton management team is among the industry’s best.

D.R. Horton shares were last seen trading at $33.97, and the stock has a consensus analyst target price of $36.19. Its 52-week trading range is $26.69 to $34.94.

PulteGroup Inc. (NYSE: PHM) is Merrill Lynch’s other top pick, and it also projects 24% upside to the $30 price objective. The firm sees it valued at roughly twice a valuation discount to other large cap peers on a 2018 price to earnings (P/E) basis. It also has a best-in-class return on equity over the firm’s 2019 forecast period. Pulte’s financial results have improved in recent quarters, and the firm believes that 2018 could be a year for reaccelerated order growth. Lastly, the firm appreciates Pulte’s disciplined approach to capital allocation, with share repurchases and dividend increases expected to continue.

PulteGroup’s stock was traded at $24.22 and the consensus target price was $24.67. Pulte’s 52-week range is $17.69 to $24.73.

NVR Inc. (NYSE: NVR) was reiterated as Buy at Merrill Lynch and the price objective was raised from $2,485 to $2,690, for roughly 10% upside. NVR was trading at $2442.25, and its consensus analyst target was down at $2,020 before this call.

Toll Brothers, Inc. (NYSE: TOL) was reiterated as Buy and the price target was raised from $43 to $46, implying upside of about 17%. Toll Brothers was last seen at $39.24, with a consensus analyst target price of $40.81.

Lennar Corp. (NYSE: LEN) was reiterated as Buy and the price target was maintained at $63.00. That implied upside of relatively 20% for Lennar investors. The shares were last seen up almost 0.3% at $52.60, and the consensus target price is $58.69.

Still, Merrill Lynch doesn’t believe for a minute that it’s just all rosy in the world of homebuilders. While price objectives were raised, it still sees big downside for three homebuilders:

  • Meritage Homes Corp. (NYSE: MTH) saw its target raised from $36 to $38, but that implies 7% downside for these Underperform-rated shares.
  • KB Home (NYSE: KBH) saw its price objective raised to $17 from $19, but that still implies 17% downside. This one is also rated Underperform.
  • MDC Holdings Inc. (NYSE: MDC) saw its price objective raised from $24 up to $27, which implies downside of 23%.