Rising household income due to an improving economic environment and an increasing employment rate once again makes housing affordable for an average American. This is evident from the increasing number of new housing units owned in the US. Although the current level is still far below the housing units owned in 2006-07, the recent increase in residential construction is a positive signal for the housing industry. In light of the expected economic recovery and a decline in the unemployment rate, this industry will inch closer to the highs achieved in the past. I analyze the three largest and most widely covered housing construction companies in the US.
The three giants
PulteGroup, Inc. (NYSE:PHM) is the largest publicly-traded residential construction company in the US in terms of market capitalization. The company has seen an improvement in all of its operating statistics in 2012, due to an increase in the number of houses sold, new orders received and backlog. The company’s backlog and new orders receipts increased by 35% and 4% respectively, year-over-year. In 2012, the company was able to generate profits for the first time in the last six years. However, the company is expected to continue reporting profits in the midst of improving market conditions.
D.R. Horton, Inc. (NYSE:DHI), the largest company in terms of revenue, has also experienced a substantial improvement in its revenues and margins. The company is expected to continue to dominate the residential construction in the future as well, as its backlog units increased by an amazing 54% in the most recent quarter. In light of a lower order cancellation rate together with a huge increase in new orders placed, the future of the company looks promising. The company has one of the highest margins in the industry. As the economy improves, I believe its margins will return to their historic levels.
The industry environment
As US economy entered recession, it saw the number of foreclosure filings increase rapidly and then more than double by mid-2008. Furthermore, the high rate of housing units nearing completion created an excess supply of homes in the US economy. The combined result of these two factors was a sharp decline in the prices of houses. Hence, residential construction companies suffered heavy losses as they were unable to sell new properties at a profit.
Now, as the economy recovers and the unemployment rate falls, US households are adopting better living standards. The improvement has led to an increased demand for new homes in the US.
Conclusion and caution
Although these are positive signs for the housing industry as a whole, the pace of recovery for single family homes is likely to be slow in the coming years. Low single digit economic growth and minimal improvements are expected in employment levels. Although the American dream seems to have gained traction in the last three to four quarters, households currently exhibit a tendency towards multi-family apartments over the much more expensive single family homes. This is evident from the high demand for multi-family apartments as well as the recent increase in investment in this particular sector of the housing industry. I believe that the single family housing demand will increase in the long term and move closer to the pre-crisis level. Thus, the residential construction industry will generate moderate returns in the short run, but in the long run these companies are expected to outperform other segments within the housing sector. Amongst the peers analyzed, I strongly believe that D.R. Horton, Inc. (NYSE:DHI) will generate superior returns for investors in terms of both dividends and price appreciation. The company has and will continue to operate at superior margins. In the light of higher revenue growth and lower debt level, the future of the company looks very promising. Hence, I will give a buy recommendation for D.R. Horton, Inc. (NYSE:DHI).
The article Housing Construction on the Rise originally appeared on Fool.com and is written by usman iftikhar.
usman iftikhar has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. usman is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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