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Toll Brothers Inc (TOL), KB Home (KBH): Rising Mortgage Rates Spell Trouble for Homebuilders

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Investors were just getting used to the idea of a rebound in the housing market; and now, a sustained rise in mortgage rates may lead to disappointment once again.
At risk are the domestic homebuilders, a group of stocks that have advanced significantly over the past few years, but may now be vulnerable to a lapse in demand for housing.
The most well known home builders are now trading at valuations that fully account for the recent rebound in the housing market. These stocks are vulnerable to a significant decline as mortgage rates pressure the industry. I would recommend locking in any gains in the sector today, and selling these stocks before they sustain further declines.
Mortgage rates are moving higher
On Wednesday of this week, Freddie Mac announced that mortgage rates moved higher for the sixth straight week. 30-year fixed rates hit a 14-month high at 3.98% as benchmark treasury bonds continue to soften.
The underlying issue at stake is the uncertainty surrounding exactly how and when the Fed will taper its bond buying program. Artificially low interest rates — fueled by massive asset purchase programs from the Fed — have helped drive demand for new as well as existing homes.
But as the Fed winds down its operations and interest rates begin to rise, the fear is that higher funding costs for home purchases will dampen long-term demand for new homes.
Today, I will take a look at some of the most vulnerable homebuilders, in order to avoid losses as capital rotates out of this industry.
Toll Brothers Inc (NYSE:TOL)
Premium homes, premium stock price
Shares of Toll Brothers Inc (NYSE:TOL) have the highest price to earnings multiple of the group. That’s fitting, because the company builds the highest priced houses of the group as well. Shares are currently trading for about 20 times next year’s expected earnings.
Toll Brothers Inc (NYSE:TOL) currently has a debt level of $2.48 billion, which is reasonable given the company’s cash balance of $936 million and a healthy level of real estate assets as well. The majority of the company’s debt will not mature for well over five years, so there is no pressing need for capital.
Toll Brothers Inc (NYSE:TOL) will likely face less pressure from interest rates than competitors because the company’s typical client is much more financially secure. The average selling price is $573,000 versus most other public home builders who are in the mid to upper $200,000 range.
Still, with the stock trading at 20 times forward earnings, and the overall housing market likely to endure a decline in demand, the stock should have a hard time advancing much farther.
Aggressive growth, potential risk
The management team at KB Home (NYSE:KBH) has worked hard to structure the company for aggressive growth. The group currently has nearly $2 billion in debt and is actively buying up land.
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