It is true that mortgage rates are on the rise, and the first industry that could come in the line of fire is home building. A lot of investors may be running away from housing stocks, resulting in a drop in stock prices for a lot of them over the past month or so. But, owning housing stocks may actually be a good idea if you know which ones to pick. I am bullish on Meritage Homes Corp (NYSE:MTH), which designs and builds single-family homes. And I will tell you why.
The timing is just right
It has been four years since the recession officially ended in 2009, but there has been hardly any life infused in the construction of single-family as well as multi-family homes. Over the years people have suppressed their needs, bowing down to the economic turmoil. But now that is changing, and rapidly so.
The mortgage rates are still much lower than the peaks we have seen in the past decade. This, together with rising consumer confidence, has started unleashing significant pent up demand. The lower inventory levels of used homes for sale have fueled new housing starts and triggered a rise in property prices. In May, Commerce Department figures showed that applications for single-family home construction increased to a 622,000 rate. This is the fastest pace since May 2008.
But, even then the recovery is just in its initial stages and Meritage Homes Corp (NYSE:MTH) estimates that housing starts are still around 45% below the median levels. It would take quite a few years to match supplies with the demand, which is likely to move the needle for home builders.
While a run-up in mortgage rates can definitely mute demand, at present the prevailing sentiment among home buyers is to make their bookings before property prices and mortgage rates both climb further. Besides, the higher property prices make houses attractive assets for banks and encourage them to facilitate credit availability.
Exposure to high growth areas
What makes Meritage Homes Corp (NYSE:MTH)’s prospects more attractive is its presence in the Western and Southwestern regions where there is good demand momentum. Coupled with the strong demand, the affordability for buying new homes also remains conducive.
The company chooses its markets strategically keeping in mind their long-term prospects. The result was that 11 out of Meritage Homes Corp (NYSE:MTH)’s total 16 markets were among the country’s top 20 housing markets in 2012, and the company has been an established player for years in many of them.
During the first quarter, the number of orders in California increased by 68% and average selling price, or ASP, went up by 27%. In Florida it was a 58% increase in order count and 30% increase in ASP. In Colorado the figures were 55% and 21% respectively, while for Arizona it was a 28% increase in both number of orders and ASP. Meritage Homes Corp (NYSE:MTH) derives 62% of its revenue from these four states.
Given the strength these markets are still seeing and California having one of the lowest home inventories, we can expect similar trends when Meritage Homes Corp (NYSE:MTH) reports its second quarter results later this month.
Meritage Homes Corp (NYSE:MTH) saw a 35% increase in its order count in the first quarter and ended the same with 89% higher backlog value. Riding on this solid backlog and more home closings, the company expects a 40-45% increase in home closing revenue in each of the remaining quarters of 2013.
Meanwhile, Meritage Homes Corp (NYSE:MTH) has been able to control its commissions and selling costs, as a result of which the rise in these costs has been at a slower pace than the rise in sales. The rising prices and smaller increases in direct costs would bring about margin improvements over the coming periods. For 2013, Meritage expects a 350% to 400% rise in pretax earnings.
Among the residential construction stocks two other good picks are Standard Pacific Corp. (NYSE:SPF) and D.R. Horton, Inc. (NYSE:DHI). Like Meritage, both these companies have a good presence in the Western and Southwestern states to capitalize on the strong housing demand.
In addition, South Pacific has recently purchased from Centerline Homes around 3,000 home sites, including 30 communities that are under development. This improves the company’s land supply and active community count while positioning it well in important markets like Central and South Florida and North Carolina. The company also had 89% higher backlogs at the end of the first quarter.