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Big Builders Look Good to Wall Street Analyst
 Acknowledging that it may be a “contrarian view,” Stephen Kim, managing director at Citigroup Investment Research, told the NAHB forecast conference in Washington on April 26 that his firm has a “decidedly bullish” outlook for the stock prices of large, publicly-traded home builders.
Cushioned by higher operating margins relative to previous market downturns and built-in competitive advantages over smaller rivals in the area of land acquisition, these firms are well situated to ride out the current market correction and can expect to see healthy annualized operating margins in the 10% to 11% range in the years ahead, Kim said.
The 15%-plus operating margins recorded by the top building companies in 2005 were driven by a wave of speculative buyers aggressively bidding up home prices, he said. But “margins in 2003 had already risen to 11% before speculators came into the market, and without unusually strong pricing,” Kim said, “and we see no reason why normalized margins in the home building group will not settle back into the 10% to 11% range.”
The land supply constraints that emerged in the mid-1990s just as the industry began to see major consolidation put public builders at an advantage over the competition, Kim said, and with strong financial backing, large builders continue to sit in the driver’s seat because they:
- Have superior access to capital at lower cost
- Develop much of their own land
- Get a “first look” at lots that are made available by third-party developers
- Hold negotiating leverage by virtue of their experience with thousands of projects representing a wide range of product types, terrain and entitlement hurdles
- Enjoy lower production costs through market share consolidation
By contrast, small builders seldom have enough cash to develop their own land, often must choose from “leftover” lots that are overpriced or in difficult terrain and have a tough time finding people with strong acquisition skills, who tend to become land specialists or work for large builders.
“Our view is that the building industry has become supply-constrained,” Kim said. “The salient consideration for investors is not where demand is. The long-term dynamics is supply. Generally, the industry is more supply constrained.”
For most industries, market consolidation takes place during down cycles, but just the opposite has occurred in housing, he said, with the top-10 builders doubling their national market share to 15% of housing starts from 1998 to 2005.
“This suggests that prior to the late 1990s, there were no barriers to entry into the industry,” said Kim. “It comes down to money and land. If small builders can’t get access to land or capital, they lose market share. That’s why we think the large firms are under-valued.”
Today’s public home building firms are considerably larger, more geographically diversified, less leveraged and substantially more profitable than in prior downturns, Kim said, and they are positioned for sustained double-digit growth in their market share.
He expects major builders to see orders rise in the third quarter of this year, as cancellation rates and backlogs begin to shrink in the most troubled markets.
“People cancel when markets get weaker,” Kim said. “If markets stop getting worse, cancellation rates come down. This year, net orders will be up because the cancellation rate will come down. The bottom line: this moves stocks.”
During the next two to three months, he said that publicly-traded home building firms will be trading in “choppy waters,” but a significant re-valuation is anticipated in the next 12 to 18 months.
“Now is the time to buy at bargain basement prices,” he said.
Photo by Morris Semiatin
 Construction Forecast Conference Now Available on the Internet
The simultaneous Webcast of the Construction Forecast Conference — Spring 2007 held in Washington, D.C. on April 26 is available for purchase for the next three months.
Those interested can purchase the conference Webcast, which includes panels of nationally recognized experts discussing economic trends, government policies, developments in the housing industry and the results from NAHB's recent surveys.
Purchasers will receive unlimited access to the Webcast archive for three months, as well as electronic copies of the conference handouts and presentation material. Purchasers can watch at their own pace, rewind, fast forward and review important sections.
To Purchase the Webcast
To purchase the Webcast, visit www.nahb.org/cfcwebcast.
 Want to Know Your State’s Starts Forecast for 2008?
Find out in HousingEconomic.com’s State Starts Forecast (sample). The starts forecast includes downloadable Excel tables of total, single-family and multifamily starts by region and state.
To learn more, visit www.housingeconomics.com.
 NAHB Kit Gives Builders Back-to-Basics Tips in Cooling Market
With the current cooling of the nation’s housing market expected to persist into next year, NAHB has developed a comprehensive online toolkit geared to providing association members with information that will help them prosper in today’s changing business environment.
To access the “Back to Basics” toolkit, you must be an NAHB member and have a login to www.nahb.org. To create a login, go to www.nahb.org/login or click on the log-in button on the main menu bar.
For assistance, call the NAHB Member Service Center at 800-368-5242.
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