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Home Builder Valuations

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September 24, 2013 – Comments (0) | RELATED TICKERS: LEN

While I was hunting around for something interesting to read on the internet yesterday or the day before I came across a M.F. video report that included a segment warning about home builder bulls potentially missing something in the basic selling point for the sector. The long term 50+ year average of home starts/ year in the U.S. is ~1.5M. We were at record low levels of ~0.5M/ year for several years until a big bounce back to ~0.9M/ year pace currently. The basic home builder bull case is that we still have 50% upside in home starts just to get back to the long term historical average (and home formation demand). The point the analyst in the video made was that while this is true home builder valuations may already be pricing this in. They cited some sort of analysis or report that sounded to me like a comparison of historical PE's for home builders to their current PE's noting right now they are beyond their historic levels.

I'm a home builder bull and have done exceedingly well buying them during the downturn and sticking with them through the recovery but over valuation is something I considered as my stocks have rocketed upward. Assuming historical PE is the point of the analyst in the video I think there are some very simple explanations why they deserve higher PE's today. Public Builders have not been around very long so most of their history is the past decade. I bought some Centex probably 2004 or so on an M* recommendation well before I had much of a clue about valuation. I remember fretting on a message board about how a company with such stunning growth could be trading for a single digit PE. Some one on the board pointed out that the home builders were cyclical and that we were clearly in a housing bubble and thus Centex's earnings were not sustainable and it's true PE should be the average of it's earnings throughout cycles.

I own LEN and a quick check of it's TTM earnings puts it's TTM PE at 20. M* puts it's forward PE at 14.5. Assuming the industry in general get's back to it's historic norm in starts over the next couple of years (if not sooner) of ~1.5M/ year we're looking at ~50% increase in sales just to get back to normalized healthy starts and sales levels. In 1999 we were at the historical average of ~1.5M starts. At the high point of the bubble we hit ~2.25M starts and averaged ~2M in the bubble years or ~33% more than average. The large public home builders on the other hand had revenues increase ~300%-400% over the same period. While some of this outperformance can be attributed to price increases clearly they were also taking large market share from traditional smaller regional builders. This is a point I don't see other home builder bulls make. So in addition to a potential ~50% increase in sales industry wide there is a high probability that the large public builders significantly outpace the rest of the industry. Particularly given they survived the downturn while a large chunk of their competition didn't and they have access to financing and terms their competition doesn't have. Given this the potential upside to sales and profits just getting back to a sustainable industry average sales level from here; I think a P/E of 15-20 is cheap and comparing it to a P/E at the height of a historic bubble that shareholders at the time clearly knew about and were accounting for is not appropriate analysis IMO.

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