Why Wedbush Sees Strong Upside for More Homebuilders

The housing market has been showing signs of renewed life over the past couple of years, but a lot of that life has been in rising prices for existing homes. These are often higher priced homes being sold as their owners are looking to move into a bigger — and usually — more expensive house.

The squeeze on moderately priced homes has kept many would-be first-time buyers out of the market, but that may be about to change. That’s probably not the first time you’ve read something like that, but the signs are multiplying that first-time buyers may be about to see homes for sale at prices they can afford.

When Lennar Corp. (NYSE: LEN) reported third-quarter results Tuesday morning, the CEO specifically noted that the company is ramping up buying land it intends to use to build homes for first-time buyers. Lennar is one of nine homebuilders on which Wedbush Securities initiated coverage Tuesday morning, with particular emphasis on companies that are most attractive to first-time buyers. That does not mean that it will be a buyer’s market any time soon, though. Sales of existing homes account for about 85% of all U.S. annual home sales, and Wedbush noted:

Inventories of existing homes for sale have fallen from just over 4.0 million at the worst of the housing crisis in 2007 to just over 2.1 million homes as of July 2016. On a months-to-sell basis, inventory has declined from a peak of 12.4 months in July 2010 to 4.7 months as of July 2016. A normal existing home market is typically 6.0 months of inventory to sell so we anticipate the current market is a seller’s market where all home sellers (new and existing) should be raising prices and buyers will have to pay full price for a home purchase.

That still makes it difficult for first-time buyers, but investors stand to see some improvements in stock prices for builders more focused on first-timers. Wedbush named the following three top picks:

D.R. Horton Inc. (NYSE: DHI) stock is rated Outperform with a price target of $36. Shares closed at $30.46 on Monday and traded down 1.2% shortly before noon Tuesday at $30.09. The consensus price target is $35.04, and at that price the implied gain to the current price is about 17%.

KB Home (NYSE: KBH) is also rated as Outperform with a price target of $22. Shares closed most recently at $15.30 and traded down about 1.1% at $15.13 Tuesday morning. At a consensus price target of $14.88, the stock is slightly overvalued based on the current price.

Century Communities Inc. (NYSE: CCS) is the third builder focused on first-time buyers rated Outperform by Wedbush. The analyst’s price target on the stock is $30, compared with a consensus 12-month target of $22.00. Based on a trading price of $19.80 Tuesday morning, the potential gain here is nearly 52%.

Wedbush named two value choices among the homebuilders as well:

TRI Pointe Group Inc. (NYSE: TPH) is rated Outperform with a price target of $17, compared with a consensus price target of $17.57. Shares traded at $12.38 Tuesday morning, indicating an implied gain of about 42%.

CalAtlantic Group Inc. (NYSE: CAA) is also rated Outperform, with a Wedbush price target of $44, compared with a consensus 12-month target of $42.13. The implied gain on the stock based on a Tuesday morning trading price of $33.50 is nearly 26% to the consensus target.

Wedbush also rated Lennar, Taylor Morrison Home Corp. (NYSE: TMHC) and WCI Communities Inc. (NYSE: WCIC) as Neutral and PulteGroup Inc. (NYSE: PHM) as Underperform.

The analysts set Lennar’s price target at $46, and shares traded down 3.5% Tuesday morning to $43.51, after closing at $45.09. At Monday’s closing price the potential upside to Lennar’s stock is just 2.2%.

Taylor Morrison’s price target is $18 and shares closed at $16.70 on Monday, for an implied gain of about 7.8%.

WCI Communities gets a target of $21 from Wedbush. The stock closed at $17.55 on Monday, for a potential gain of nearly 20%.

PulteGroup’s price target of $16 is more than 20% below Monday’s closing price of $19.87. The analyst noted that if the company were to abandon its value-creation strategy for a new strategy, “the new strategy may present new opportunities for revenue and income growth that are not represented in our current model or price target.”

Here is Wedbush’s investment thesis:

We believe the upward trend in the housing cycle remains intact. Job growth, alternative measures of consumer confidence, rising household formations, and loosening mortgage underwriting standards are the potential catalysts that support our view. As investors begin thinking about the upcoming spring season, the seasonal hope trade could result in higher stock prices versus current levels for our homebuilding coverage.