J.P. Morgan’s Rehaut-courtesy of Big Builder Online
J.P. Morgan home building and building products company analyst Michael Rehaut asserts his outlook for 2011 breaks ranks with the consensus of his brethren when he writes, “we believe our outlook for stable to modestly improving trends, as well as for home prices to be flat to down only 3% in 2011, is materially more positive than our view of the current buyside consensus, which we believe expects home prices to decline at least another 5-10%, resulting in a resurgence in land-related charges, margin compression, and book value erosion.”
The pivot point of Rehaut’s analysis–and the unknowns for anyone in the unenviable position of having to produce an economic “outlook” for housing in 2011–is prices. The linkage of prices to demand tangibles such as job formation, consumer spending, and small business expansion, as well as to supply tangibles such as current absolute vacancies, new-home inventory, and resale months’ supply is complex enough in a good year to model out a forecast. This year, intangibles weigh heavily. Prices could swing significantly based on relative contagion of stragegic default, the Animal Spirits of “recession fatigue,” the potential innovation–after a stumbling process of elimination–of housing finance policy that actually stems the tide of homeowner distress, etc.
Rehaut’s betting that the operational drivers in home building pre-indicate a technical “comfort zone” on prices–with a fall on a national basis of 3% or less.
Here’s his sum-up of the way things look to him in early December 2010 for the year ahead. Give him credit for bravery in his conviction.
Following a 2010 that featured a striking amount of volatility due to the expiration of the federal housing tax credit, but overall reinforced our view when we upgraded the sector to positive in September 2009 that the recovery would emerge slowly and over the next 24 months, we believe 2011 will mark stabilization and modest improvement in the housing market. Critically, however, we believe our outlook for stable to modestly improving trends, as well as for home prices to be flat to down only 3% in 2011, is materially more positive than our view of the current buyside consensus, which we believe expects home prices to decline at least another 5-10%, resulting in a resurgence in land-related charges, margin compression, and book value erosion. By contrast, we believe land-related charges should continue to be minimal in 2011, while margins should expand modestly and book values should largely hold. Moreover, we estimate order growth to resume and more builders to generate positive Operating EPS in the upcoming year. Trading at 1.05x current P/B (ex-adj. FAS 109, ex-NVR), at the low end of their historical range, we believe the stocks fully reflect the more pessimistic buyside consensus. Hence, we view the sector as representing a compelling risk/reward dynamic, as we expect improving fundamentals in 2011 to result in investors anticipating a return to normalized EPS and book value growth, which in turn should drive P/B multiple expansion over the next 12 months. Using an average targeted 10% discount to the group’s 10-year P/B multiples against our 2011-end book value estimates, we slightly adjust our price targets, which now represent an average 28% return potential (previously 31%). Lastly, we round out our coverage universe by initiating on NVR (OW) and MTH (N), the former of which we add to our favored OW-rated names of LEN, KBH, and TOL.
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