Home is where the heart is, but it hasn't been much of a profit center lately.
Recession and declining property values have hit home owners hard, which is bad news for investments tied to homes and property. Home builders, home improvement centers, and real estate investment trusts are left to pin their hopes on an economic revival.
Home-builder stocks, bounced around on the conflicting signals of foreclosures and rising mortgage rates versus declining inventories and pockets of recovery, are up modestly as a group this year.
"We like the home-builder stocks because there's an upside between now and the end of the year, as losses start to mediate and we see more signs that housing has stabilized," says Megan McGrath, home-builder analyst with Barclays Capital, of New York. "The time to invest in these stocks is early in the cycle."
For now, an easing in the rate of sales decline and fewer reductions in home prices are reasonable expectations, but it may take a quarter or two before the outlook can be described as truly positive, McGrath says.
"The new-home market, with sales at historic lows, is only 10 percent of the total housing market, but plummeted faster than existing home sales due to the supply of foreclosed and distressed property," McGrath says. "However, new-home sales have reached a significant low point, and we've started seeing stable numbers since the beginning of the year."
Bottoming of the new-home market represents a buying opportunity in home-builder stocks, she says.
DR Horton Inc. (DHI) and Toll Brothers Inc. (TOL) are stocks recommended by McGrath. DR Horton's long-time focus on low costs will give it a boost in an economic upturn, while luxury home builder Toll Brothers always has maintained higher profit margins than competitors, she says.
"I'm cautious on the home builders because, while sales over the next few months are going to be good since there is still some momentum, price pressure will continue to squeeze profit margins," warned David Urani, home-builder analyst with the Wall Street Strategies independent research firm, of New York. "Some of the big impairment charges these firms are taking will likely continue."
Urani doesn't expect home builders actually to revive until 2010. Nonetheless, he likes the stock of Lennar Corp. (LEN), which has boosted its capital position, had some sales improvement, and turned in a second-quarter loss smaller than analysts expected.
Ryland Group Inc. (RYL) is recommended by both McGrath and Urani based on improved sales and a strong cash position that assures it of exiting the recession in fine shape.
The two analysts also have definite dislikes. Both are steering clear of Hovnanian Enterprises Inc. (HOV) because the firm's uncertain profitability and high debt will make it difficult for it to benefit from an economic recovery. Urani would avoid Beazer Homes USA Inc. (BZH) because of a financial position that "isn't resilient" due to significant exposure to California and other problem real estate regions.
As the housing market goes, so go home improvement centers. Their stocks have managed to rally somewhat from their lows set earlier in the year.
"A major factor that benefits these retailers is that they operate in a duopolyHome Depot and Lowe'sand that really helps profit margins," says Michael Souers, home improvement retailer analyst with Standard & Poor's Equity Research, in New York. "They've kept rational pricing and strong gross margins throughout the economic decline, though they've had negative same-store sales growth."
Souers has a "buy" on stock of Lowe's Companies Inc. (LOW), down 11 percent this year, because it is trading at a lower price/earnings ratio than Home Depot and is more of a growth story. He has a "hold" on Home Depot Inc. (HD) stock, which has been flat for the year, though it is a "safer story" with a higher dividend.
It could be several years before home improvement centers see a significant pickup in remodeling and overall demand, Souers says. In the meantime, he finds it commendable that both chains own so much of their own real estateHome Depot 89 percent and Lowe's 88 percent.
Real estate investment trusts (REITs), dividend-producing investments that use the pooled capital of investors to purchase properties, have been volatile and are down about 20 percent as a group this year.
"REITs are going to be in a trading range for the rest of this year, and their eventual catalyst will be their ability to acquire assets from distressed sellers," says Chris Lucas, senior real estate analyst with Robert W. Baird & Co., of McLean, Va. "The good news for public companies in real estate is that they've been able to raise equity and a number of refinances have been done."
Corporate Office Properties Trust Inc. (OFC) is a REIT recommended by Lucas because it derives 55 percent of its earnings from government and government contractors in defense and intelligence that should experience growth.
He likes Federal Realty Investment Trust (FRT), a shopping-center REIT with locations in high-density, high-income areas in the Northeast and on the West Coast. Its high-quality properties are the places retailers find especially attractive, he says.
"REITs are often used as a defensive investment because of the dividends they pay," Lucas says. "So it wouldn't surprise me if at some point investors started to look to well-capitalized REITs as a safety play."
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