How low will homebuilder stocks go this time? That is the top question on investors’ minds as the biggest housing market slowdown in 15 years begins to unfold. As mortgage rates soar near 7%, fewer buyers are able to qualify for loans, leaving many newly constructed homes empty even as more are nearing completion.
In fact, the housing market downturn has been so sharp that Touchstone Living Inc., a Nevada builder that had a list of 639 qualified buyers interested in one of its housing developments this time a year ago, has seen that number drop to just 30. Touchstone is not alone; homebuilders all across the country are seeing a similar situation.
However, this time around, some builders are claiming they have learned their lesson from the financial crisis and are well-prepared for the next market slowdown. They have built homes at a slower rate in recent years, leading to a steeper housing shortage, and also avoided high levels of debt.
With homebuilders shaping up to be stronger than they were in the past, investors may want to add a few homebuilder stocks to their watchlists in order to take advantage of an eventual recovery. Here are three leading undervalued homebuilder stocks with high financial strength ratings according to the GuruFocus All-in-One Screener, a Premium feature. While the near-term outlook may be dismal, the long-term outlook for the housing market is still strong, and these homebuilders have what it takes to weather the storm.
Meritage Homes
Meritage Homes Corp. (MTH, Financial) is a home construction and real estate company based in Scottsdale, Arizona. It mainly constructs single-family detached homes, active adult communities and luxury real estate in Arizona.
Meritage has an excellent GuruFocus financial strength rating of 8 out of 10, driven by a Piotroski F-Score of 5 out of 9, an Altman Z-Score of 4.41, a current ratio of 7.73 and a cash-debt ratio of 0.23.
The company expects to report a slowdown in sales in the third quarter as rapidly rising interest rates reduce customers’ ability to qualify for a mortgage. Due to the ongoing housing shortage and preference for move-in ready homes, it does hope declines will slow once more of its speculative inventory that is already in progress is completed.
“With our healthy balance sheet and ample liquidity, we believe we have flexibility for evolving market conditions. Our net debt-to-capital was 20.6% at June 30, 2022,” CEO Phillippe Lord said in the company’s second-quarter earnings report.
The chart below shows Meritage’s share price history alongside its annual cash per share and total debt per share ratios. As we can see, the stock lost 88% in the financial crisis and, as of this writing, it is down 42% from all-time highs reached in December 2021. If the company were to end up as badly off as it did in 2008, the stock has much further left to fall. However, cash per share has risen much faster than debt per share, so Meritage may yet emerge from this housing market slowdown in better shape than the last one.
NVR
Based in Reston, Virginia, NVR Inc. (NVR, Financial) operates a homebuilding and sales unit under the Ryan Homes, NVHomes and Heartland Homes brands, as well as a mortgage banking unit. The company mainly operates on the U.S. East Coast.
NVR’s GuruFocus financial strength rating is 8 out of 10 on the back of a strong cash-debt ratio of 1.5, an interest coverage ratio of 39.49, a Piotroski F-Score of 6 out of 9 and an Altman Z-Score of 10.25.
Unlike Meritage, NVR was already seeing orders decrease in the second quarter of 2022. The cancellation rate increased from 14% versus 8% in the year-ago quarter, though higher sales prices still drove revenue up.
The company helps preserve cash by not paying a dividend and limiting shareholder returns to share repurchases and capital gains.
During the financial crisis, NVR’s share price fell about 56% and, as of this writing, it is down 31% from all-time highs reached in December 2021. Both cash and debt per share have risen over time, but it is encouraging that NVR has historically managed to keep cash higher than debt in most years. This should help mitigate the effects of a housing market downturn as the company will not be forced to sell as many of its homes below break-even.
PulteGroup
PulteGroup Inc. (PHM, Financial) is based in Atlanta and is the third-largest U.S. homebuilder by volume, with operations in 23 states. The company builds under the brand names Pulte Homes, Centex, Del Webb, DiVosta and John Wieland. It also owns a subsidiary mortgage business.
PulteGroup has a GuruFocus financial strength rating of 7 out of 10. Its Piotroski F-Score of 7 out of 9 and Altman Z-Score of 3.89 are solid, as is the debt-to-revenue ratio of 0.16. The cash-debt ratio of 0.27 is in line with the historical median.
The company's second-quarter 2022 home closings were more or less on par with the prior-year quarter, reflecting housing market conditions that are more comparable to U.S. averages than the more region-specific Meritage and NVR.
“Within today’s volatile market conditions, we remain disciplined in our business practices and focused on delivering high returns on invested capital in support of building long-term shareholder value. Given PulteGroup’s efficient building practices and exceptional financial strength, I believe we are extremely well positioned to manage through today’s changing market conditions,” CEO Ryan Marshall said in the company’s second-quarter earnings release.
The stock fell 82% during the financial crisis. As of this writing, the stock is down 39% from all-time highs reached in May 2021. PulteGroup has lower debt per share and higher cash per share compared to the financial crisis era.
