Time to Buy Home Builders at First Hints of Optimism?

Much data is coming out suggesting that the housing bottom may have finally been reached, and small growth is finally budding. Does this mean value investors could get some bargains in the industry? Arnold Van Den Berg of Century Management seems to think so. He is stepping out where many other investors fear to tread. This quarter he added enough to his position in Toll Brothers (NYSE:TOL) to make it his eighth largest position. Several other gurus are venturing into the space amid rising optimism.

The year commenced with several positive headlines about the housing industry. For instance, though tight mortgage restrictions have been put in place since sub-prime mortgage lending run amok precipitated the credit crisis of 2008-2009, the Federal Reserve recommended that change in order to stimulate the housing market.

In a white paper written to Congress on January 4 entitled “The U.S. Housing Market: Current Conditions and Policy Considerations,” the Federal Reserve said: “Obstacles limiting access to mortgage credit even among creditworthy borrowers contribute to weakness in housing demand, and barriers to refinancing blunt the transmission of monetary policy to the household sector. Further attention to easing some of these obstacles could contribute to the gradual recovery in housing markets and thus help speed the overall economic recovery.”

Lowered mortgages rates also could spur some growth in the housing market. The average rate on a 30-year fixed mortgage decreased to 3.91 percent this week, from 3.95 percent last week, Freddie Mac reported in its weekly mortgage rate survey.

“Fixed mortgage rates started the year a little lower this week just as recent data reports indicate the housing market and manufacturing industry are showing signs of improvement,” said Frank Nothaft, vice president and chief economist of Freddie Mac, in a news release.

Housing starts increased 15% in November from October 2011, though of that, 1.7% were single-family starts.

Some investors believe that despite the numbers, housing will not recover soon. Jeremy Grantham wrote in his third-quarter letter that home buyer caution and that the overhang of houses will remain for years. Historically, a “multi-year sustained overrun on the downside” usually follows the bursting of a large bubble like the most recent one in housing, Grantham added.

The market is responding more to the positive news, however. Toll Brothers, the nation’s leading builder of luxury homes and one of Van Den Berg’s home builders stocks, is trading 4.5% higher over the last year and 7% higher since the beginning of 2012. Van Den Berg initiated a position in Toll Brothers in the third quarter of 2007 with 242,715 shares at an average price of $23 per share. He has mostly sold small portions of shares since then, but in the third quarter of 2011, he added 541,410 shares at about $18 per share, and 589,090 shares in the fourth quarter of 2011. The stock is currently at $22 per share.

In a recent interview with GuruFocus, Van Den Berg commented on his Toll Brothers holding: “We believe that both MDC and Toll Brothers (TOL) understand their strengths and weaknesses more than most of the other publicly traded builders. While TOL is a great operator, it did not appear to have the same upside as MDC and has not traded at as large of a discount for as long as MDC. Also, both have very different operating models. TOL makes money throughout the entire construction cycle from developing raw land to building houses and does this better than most homebuilders.”

The company is facing financial challenges, namely, decreasing revenue from 2006 to 2011. Last year marked a return to profitability though in some areas. After three years of net losses, it had earnings of $40 million for 2011, and after three years of negative net margins, it increased to 2.7%. Operating margins continued to be negative for the fourth year in a row.

Van Den Berg noted that he might have to wait a few years for demand to increase and the market to adjust before seeing a return, but that he feels now is the time to take advantage of the opportunity. Gurus Charles Brandes, Chris Davis, Mario Gabelli and Arnold Schneider bought Toll stock or added to their position in the company in the third quarter of 2011.

Pulte Group Inc. (PHM), the nation’s largest home builder, shares fell just 14% over the last year, and increased 12.5% since the beginning of the year.

Pulte also had increased revenue from $4 billion in 2009 to $4.6 billion in 2010, though both years’ results were the lowest of the decade. The company has not made a profit since 2007. Free cash flow has remained positive, albeit in decline, since 2007.

Several homebuilders had lower sales overall for most of 2011, but showed improvements toward the end of the year. Pulte sold 14% fewer homes in the first nine months of 2011 than the first nine months of 2010, but 9% more homes in the third quarter than the third quarter of 2010.

KB Homes delivered 21% fewer homes in 2011 than in 2010, and in the fourth quarter delivered 4% more homes in the fourth quarter 2011 than in the fourth quarter 2010. Los Angeles-based KB Homes is one of the nation’s largest homebuilders and sells affordable, built-to-order homes. Its stock price was also elevated from the beginning of the year. Down 50% over the last year, it is trading 7.4% higher since the start of 2012. Fourth quarter revenue was far better than that of the entire year. Fourth-quarter revenue increased 6% year over year. For the year ended Nov. 30, 2011, company-wide revenues declined 17%.

David Tepper lost quite a bit of money on this stock by purchasing too soon. In the first quarter 2011, he bought 1,388,900 shares at an average price of $14. In the second quarter 2011, he sold 83,500 shares at about $11.50 per share. He then sold 426,991 shares in the third quarter of 2011 at about $7 per share. The stock trades for $7 per share on Friday. Tepper still owns shares of KB Home, Pulte Group and Beazer Homes USA Inc. (NYSE:BZH).

At the start of the fourth year after the housing market crash, it appears that value investors beginning to see some value in housing stocks. Of course, they want to buy the stocks at rock-bottom prices, before everyone recognizes their value after a recovery seems certain and the prices go up.