Housing

Did Homebuilder Stocks Already Hit Bottom Ahead of the Recession?

Jon C. Ogg

On a day where the U.S. weekly jobless claims hit an exponential record high of almost 3.3 million, and when the ugly recession level economic news has not even really been seen at all, does it make sense that homebuilders would be rallying sharply after a big bounce already this week? That sounds like a hard scenario to sell, but add in a $2 trillion-plus stimulus and rescue package from Congress while some nimble investors and traders are trying to look through the recession storm and look deep into 2020 or even 2021.

The SPDR S&P Homebuilders ETF (NYSEArca: XHB) was up another 2.5% on Thursday, but that’s up over 30% from the low of $23.95. It’s also down from a peak value of $49.35. The iShares U.S. Home Construction ETF (NYSEArca: ITB) was up almost 25 at $31.20 late on Thursday, up more than 39% from its low of $22.39 while still being down almost 40% from its peak of $50.52.

Anyone in real estate will confirm that the rug was yanked out from under the market over the last month. Again, the question now is whether the recession will be sharp and followed by a major recovery — or whether this coronavirus lock-down and data continues to get worse. What started out as extreme lows on interest rates and dirt cheap mortgages suddenly turned into a panic mode as the Federal Reserve’s two emergency rate cuts took fed funds back down the zero-interest rate policy (ZIRP) that prevailed from 2009 through 2015. To put it mildly, recessions tend to be atrocious for the homebuilder sector.

Some investors and analysts will be worried, but Raymond James and KeyBanc Capital Markets have at least tried to look through the storm. Is it possible that the outlook for residential new construction remains strong and that the sell-off that has been seen is overdone?

KeyBanc included a note that the risk outlook in now more favorable for shares of KB Home (NYSE: KBH). The firm gave an upgrade to Overweight from Sector Weight and its $25 target is versus a drop of nearly 4% to $18.75 late on Thursday.

Raymond James has noted that KB Home and PulteGroup, Inc. (NYSE: PHM) both have enough cash that allow those builders to manage their businesses with little or no cash flow for a period years. KB Home ended 2019 with almost $455 in cash and $3.7 billion in inventory at the end of 2019. Pulte ended 2019 with more than $1.2 billion in cash and another $508 million in short-term investments and with almost $7 billion in inventory.

Meanwhile, shares of Home Depot, Inc. (NYSE: HD) were up another 4.9% at $190.93 on Thursday. It was as low as $150 earlier this week, but is still down from a $247.36 peak. Lowe’s Companies, Inc. (NYSE: LOW) was last seen up over 5% at $88.08 on Thursday, up from a panic low of $60.00 but still down from a high of $126.73.

Builders FirstSource, Inc. (NASDAQ: BLDR), which makes and sells construction materials of all sorts was last seen down 4% at $14.04. That is up from a recent panic low of $9.67 but it is still down over 50% from its high above $28.00.

KB Home reported earnings after the close of trading. KB Home also withdrew its guidance for 2020 due to the uncertainty. Jeffrey Mezger, Chairman, President and Chief Executive Officer of KB Home said:

While our performance in the first quarter was strong, with underlying market conditions that were robust, these results preceded the COVID-19 pandemic declaration, and we are now taking actions to adjust our business in this period of uncertainty… KB Home is well positioned given our strong balance sheet and over $1.2 billion in liquidity. With our Built-to-Order model, we are flexible in aligning our business to demand and building to our sales pace, mitigating inventory risk. With that foundation, we are diligently managing our operations with a focus on being both prudent and strategic with our cash resources. While we continue to close homes and generate revenues, we are also taking steps to curtail land acquisition and development until circumstances become more stabilized. We have a long-tenured, hands-on team that is experienced in navigating changing market conditions, which will help guide our actions in this challenging environment.

This seems hard to imagine that the stimulus and rescue package has added that much support considering that much of the damage has been done that will take months to recover from in the best of circumstances. Still, $2 trillion The 1,000 point gain on the Dow to 22,200 is now up from a low of 18,213.65 just a few days ago. The S&P 500 move back up to 2,600 is up from a low of just under 2,200 just a few days ago. Gains of 22% for the Dow and over 18% for the S&P 500 in a few days are not normal. Then again, it’s not normal for the S&P 500 to be down 35% and for the Dow to be down over 38% in just over a month from an all-time high.