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Saturday, January 28, 2012

UBS Report on Homebuilding: 10 Predictions for 2012

Conditions Are Getting Better . . .
Over the past 6-12 months, macro data points, including accelerating household
formation, increasingly suggest an increased demand for housing. At the same
time, government support appears to be improving. This, in turn, has led to
increased optimism among investors for a robust improvement in fundamentals.

. . . Just Not Quickly Enough to Justify Current Valuations
In contrast, we believe a more dramatic recovery, especially relative to owner
occupied demand, faces constraints. We note that: 1) pro-cyclical underwriting is
unlikely to materialize given regulatory and macro uncertainty & 2) the transition
of foreclosures from owner to renter occupied remains gradual. Concurrently, we
expect government actions—constrained by the factious environment—to focus on
economic stimulus (i.e. mass refis) resulting in a more limited impact on housing.

...Accordingly, We’re Moving to the Sidelines
Since 8/31, the HB stocks have risen 38% and now trade at 1.3x tang BV (adjusted
for the PV of future tax benefits). In our view, the earnings power needed to justify
these levels will only be realized in a robust recovery. Said differently, we believe
housing has bottomed and that an improvement is unfolding, we just don’t believe
the rate of acceleration will be sufficient to justify upside for most of the group.
...Valuation: PTs Are Based on 1.3x Current BV
Given our view, we’re making the following changes: DHI, LEN and TOL go to
Neutral (from Buy) and KBH and MTH to Sell (from Neutral). For investors that
are more optimistic, we’d focus on higher beta names like PHM and SPF.
Prediction #1. Single family housing starts will grow by approximately 5-10%
in 2012, marking the first year in the last seven years that starts will have grown
meaningfully on a year over year basis. At the same time, multi family starts will
accelerate at a faster pace, leading total starts up 10-15% versus 2011.

Prediction #2. With community count growth ranging from 5-10% year over
year, we expect the public builders to post unit order growth of around 15-20%
when compared to 2011 levels.

Prediction #3. We’re increasingly comfortable with our forecast for flat new
home pricing in 2012. Additionally, we think distressed prices have basically
bottomed. Further, we believe that understanding distressed prices is much
more complex that it appears on the surface.

Prediction #4. More pro-cyclical underwriting will be the crucial element to
driving a more robust recovery in housing. We don’t expect loosening to
materialize until 2013 at the earliest; when it does we’d look for private
lenders—as opposed to the GSEs or the FHA—leading the way.

Prediction #5. Government support for the new home market will be slightly
better than “do no harm”. That said, we’d emphasize the word “slightly” given
the incredibly factious nature of the current political environment. Further, even
if efforts are more robust than we expect, they will be focused on the existing
home market and providing broader economic stimulus (as an example, we’d
note the likelihood for a large scale refinancing program).

Prediction #6. While many believe that record affordability should drive sales,
we continue to expect that mortgage availability will constrain owner occupied
demand over the next couple of years. Despite this, with home prices down 33%
from the peak and 30 year fixed rate mortgages at 3.9%, the opportunity for
investors to buy and rent homes is increasingly attractive. The demand
generated by this opportunity will set a floor for home prices and will eventually
lead to improved conditions. That said, the process of transitioning this supply is
likely to be long and drawn out, thereby constraining home price appreciation.

Prediction #7. With volumes growing and prices stable, we don’t forecast
significant book value erosion in 2012. Further, while some companies will lose
money, this will primarily be driven by financial leverage.

Prediction #8. Over the last two years, the homebuilding stocks have traded
between 0.7x-1.3x tangible book value (based on a 50% discounted value for
allowances against deferred tax benefits), as sentiment has swung from
anticipating accelerating impairments to faster earnings growth. Given our view
that meaningful book value erosion is unlikely (see prediction #7), we expect the
trading “range” for the stocks to reset in 2012, with the “floor” rising to
around 1.0x tangible book value. That said, visibility around a turnaround
remains limited, which should constrain potential upside for valuations to
approximately 1.4x adjusted tangible book values.

Prediction #9. We don’t expect public to public M&A activity in the coming
year, as the availability of well located lots in more attractive locations is
sufficient to meet current demand levels. Further, we wouldn’t expect any such
activity until one or more of the following variables changes: 1) land scarcity
became more acute, such that builders couldn’t reload with parcels at relatively
attractive prices; 2) a more robust recovery, driving companies to try to expand
their land holdings more quickly to grow EPS; and/or 3) differences in
valuations gave some builders more “expensive” currencies relative to peers,
allowing them to pay a premium.

Prediction #10. Although the long term trends for housing are likely positive,
we have less conviction in the near term demographic story. In fact, we believe
there are likely trends that will work against an acceleration in homeownership
in the near term.

1 comment:

  1. Really great post by delta Gypsum thanks for providing informative tips.