Housing is back. Housing starts have climbed to the highest levels in five years, inventory is low in many areas of the country, and continued low interest rates continue to persuade potential buyers to jump into the real estate fray. The painful memories of the past five years seem to be dissipating quickly, and homebuyers guides are declaring the end of the severe reduction in home prices and construction activity that helped drive the entire country into recession.
How to turn a real estate recovery into investing profits
Rather than advocating a return to the highly risky and speculative world where everyone seemed to be a home flipper, landlord, or real estate developer, there is money to be made in the housing recovery through stocks. Sure, there are choices such as homebuilders, home improvement stores, and banks, all of which have an obvious correlation with the construction, renovation, and sale of homes. However, taking a broader view yields a wide array of candidates for investment; some of these companies have a strong investment thesis in which the housing recovery is just a single element.
The construction of an average single family home requires over 400 pounds of copper and16,000 board feet of framing lumber. With that in mind, a significant rise in new construction (and renovation) can have a profound effect on companies specializing in the creation of the raw materials that go into homes. Half of the world’s copper is used for construction, so a meaningful increase in demand will help drive the business of leading copper producers such as Freeport-McMoRan Copper & Gold Inc. (NYSE:FCX).
Despite this potential catalyst in the U.S. and emerging market growth worldwide, Freeport is hovering near its 52-week low while the stock market trades at multi-year highs. This is the result of several negative forces, including the current prices of copper and the company’s recent announcement that it will acquire two oil and gas exploration companies for $20 billion. Many on Wall Street have expressed displeasure with the move to diversify, especially at what seems to be an excessive price. However, the fact remains that Freeport-McMoRan Copper & Gold Inc. (NYSE:FCX) will be lowering the heavy correlation between its success and the prices copper, gold, and other metals. Meanwhile, pre-acquisition of Plains Exploration & Production Company (NYSE:PXP) and Mcmoran Exploration Co (NYSE:MMR), Freeport trades at just seven times next year’s earnings while rewarding shareholders with a solid 3.9% dividend yield.
In the timber business, many companies have opted for real estate investment trust (REIT) status. As a result, the industry boasts solid dividend yields similar to Freeport’s, such as Plum Creek Timber Co. Inc (NYSE:PCL) 3.2% dividend yield. The heavy correlation between Plum Creek (and the industry as a whole) and a housing recovery has been well documented, causing Plum Creek and its peers to trade near 52-week highs on expectations of faster growth. As a result, Plum Creek Timber Co. Inc (NYSE:PCL) is trading at a lofty valuation of over 30 times next year’s earnings, which is cause for some caution for investors in this slow growth (literally) industry. However, as an income investment, timber REITs can still make quite a bit of sense even at today’s prices.
While there are plenty of downstream investment ideas for products and materials that go into the actual construction or renovation of a home, it is also important to fully appreciate just how big of an impact a housing recovery will have on home furnishing providers. Whether someone is buying a first home or moving to a home with a different style, size, or number of rooms, furniture and home decor purchases are almost certainly a part of settling into a new home.
With this in mind, upscale furniture, decor, and kitchen retailer Williams-Sonoma, Inc. (NYSE:WSM) has a wide range of solutions at its Pottery Barn, West Elm, and Williams-Sonoma stores. Williams-Sonoma’s various brands feature a wide range of products for the home, including everything from kitchen utensils to large pieces of furniture. The company has found a profitable intersection of quality, style, and reasonable prices to appeal to a broad range of consumers. In addition to a recovery in housing, a largely untapped international market and a 17% growth rate in e-commerce sales in the most recent quarterly earnings add to the growth aspect of the investment thesis.
While Williams-Sonoma, Inc. (NYSE:WSM) has risen in value sharply over the past year, the valuation is still quite reasonable. The company trades at just 16 times next year’s earnings, boasts a dividend yield of 2.4%, and maintains a pristine balance sheet with virtually no debt.
A recovery in housing won’t just drive big purchases like new sofas or dressers. Much smaller household essentials are also part of the equation, and Bed Bath & Beyond Inc. (NASDAQ:BBBY) is worthy of consideration on that basis. Towels, bedding, and other home goods have helped drive sales of the company up to nearly $10 billion in the past year. Solid top line growth has translated to the bottom line, but the stock remains attractively priced. The trailing twelve month free cash flow yield is around 7% and the stock trades at just 12 times next year’s earnings despite analyst expectations of 13% annual growth over the next five years.
When considering Bed Bath & Beyond Inc. (NASDAQ:BBBY), it is important to also understand the intense competitive environment that it operates within. This competition comes from department stores, discounters such as Wal-Mart Stores, Inc. (NYSE:WMT) and Target Corporation (NYSE:TGT), online retailers such as Amazon.com, Inc. (NASDAQ:AMZN), and even companies like Williams-Sonoma, Inc. (NYSE:WSM) with respect to many products. This competition can offer some combination of lower prices, larger selection, and higher quality, so understanding the competitive environment is a critical part of any invesmtent.
Which stocks to choose?
This article only discusses four of the multitude of companies poised to benefit from a housing recovery. Of this group, Freeport-McMoRan Copper & Gold Inc. (NYSE:FCX) appears to have the most upside based on valuation, but also the greatest risk in terms of non-housing considerations such as commodity prices and acquisition integration. Plus, there is always risk of a strike or accident at a significant mine as well as government privatization, all of which can put an immediate halt to production.
For a safe bet that combines the upside of a housing recovery, a reasonable valuation, a solid dividend yield, and additional growth opportunities beyond domestic housing, Williams-Sonoma appears to be a great fit. Stay tuned for the second installment of this analysis, which will take a deeper dive into a few smaller companies that often go under the radar, but have significant housing-related opportunities.
Brian Shaw owns shares of Freeport-McMoRan Copper & Gold Inc. (NYSE:FCX) and Amazon.com, Inc. (NASDAQ:AMZN). The Motley Fool recommends Amazon.com, Bed Bath & Beyond Inc. (NASDAQ:BBBY), and Williams-Sonoma, Inc. (NYSE:WSM). The Motley Fool owns shares of Amazon.com and Freeport-McMoRan Copper & Gold.