Are These Overvalued Housing Ripe for a Short Despite the Recent Declines?
2024.10.30 07:05
DR Horton (NYSE:) reported its FY Q4 numbers yesterday. It missed Street consensus across the board and warned about FY 2025. The stock is currently down 12.5 but it has a long way to fall just to reset to its valuation at the peak of the first big housing bubble this century.
fell 1% in September from August and 3.5% YoY. The 3.84 million seasonally adjusted, annualized rate is the lowest since October 2010. On a not-adjusted, monthly basis, existing sales plunged 12.6% from August and 4.9% YoY. At the current SAAR the months’ supply of listings jumped to 4.3, the highest since the pandemic. First-time buyers represented 26% of the closings, which matched an all-time low.
Existing home sales are based on closings. It’s possible that existing sales in October could undergo a small bounce because the mortgage purchase index rose during September and contracts signed will show up as closings in October and part of November.
The prospects for a sustained turnaround in home sales will not improve anytime soon, however, as the weekly mortgage purchase index plunged 5.8% from the previous week. The purchase index is down 12.1% from September 27th. The purchase index had been rising since mid-August as mortgage rates declined in anticipation of the Fed rate cut. The index started to reverse sharply three weeks ago with the 10yr Treasury yield up 60 basis points and the baseline 30yr fixed mortgage rate jumping to 7.26% from 6.6%.
New home sales were said to have risen 4.1% in September from August and 6.3% YoY. August’s 8.7% decline from July was revised even lower, from a 716k SAAR to a 709k SAAR. And July’s alleged 751k SAAR, or 18.4% jump from June’s originally reported 681k SAAR. June’s number was revised down to a 672k SAAR and the July number was revised down to a 726k SAAR.
See the pattern here? The Census Bureau’s data surveying and statistical calculus is completely unreliable. are based on contracts signed. So, while the Census Bureau’s estimate is likely inaccurate, it’s entirely possible that there was an increase in new home contracts given that the mortgage purchase index rose 9.5% during September. That said, the CB does not adjust its data for canceled contracts. Given the jump in mortgage rates since mid-September, I would bet there will be a jump in contract cancellations.
I can’t say with certainty that the market will start to reprice tech or small caps anytime soon, though I think it will, I am confident that the homebuilders and related stocks will are starting to feel the gravitational pull of fundamentals-based reality. Higher rates eventually will force a hard downward valuation adjustment in the housing stocks.
Pulte Homes (NYSE:) reported its Q3 numbers on Tuesday before the open. Despite what looked like decent headline numbers, the stock plunged 7.2% and dragged the entire sector with it. This is despite the fact that PHM beat the revenue and EPS consensus. I’ll get to my rationale for the sharp sell-off in the stock shortly.
In terms of the prima facie numbers, on a YoY basis closings were up 12%, revenues rose 12% and EPS increased 16%. Gross margin declined and SG&A as a percent of sales increased. Both metrics do not surprise me because the Company no doubt had to offer huge incentives to coerce contract signings and the cost of that would be allocated both to the cost of revenues and SG&A.
Here’s where it gets interesting. To begin with, forward guidance was notably absent from the earnings press release, the earnings presentation and the conference call. Although new orders increased YoY, the dollar value of the backlog declined 5.3% YoY and roughly the same amount from Q2 2024. Despite the Fed rate cut, along with a decline in mortgage rates during July and August in anticipation of the rate cut, PHM’s cancellation rate increased in Q3 vs Q2 (it was about the same – 15% – as Q3 2023).
Here’s PHM’s comment about mortgage rates: “with mortgage rates hovering around 6.5% to begin the third quarter, buyers were generally less inclined to sign a purchase agreement.” Actually, the current baseline (20% down, 740+ FICO) 30-yr fixed mortgage rate is now 7.26%, which means buyers will be even more “less inclined” to sign a purchase agreement now. This means it will become more difficult to move inventory. In addition, the jump in mortgage rates will likely cause an increase in cancellations.
Speaking of which, Pulte management said that 43% of the homes in its inventory are “spec” homes. In all likelihood, I would bet 50% of those spec homes are from canceled contracts. I would love to ask about that on the earnings call, but corporate earnings calls are highly curated and no sycophantic Wall Street analyst would would dare ask a tough question. It’s a great bet that the percentage of spec homes in PHM’s inventory will continue to climb. I suspect the same is true for all of the homebuilders.
Here’s the money-shot. At the peak of the housing bubble in the first decade of this century, PHM peaked at a little over 2.4x the dollar value of its backlog. Currently, the stock is valued at 3.6.x the value of the backlog. On this basis, despite the big drop earlier this week, PHM is at least 50% overvalued based on market cap to backlog value.
As with the entire sector and the stock market in general, PHM has been rising relentlessly, albeit irrationally, since mid-October 2022. It was triggered by the market’s anticipation of the eventual rate cut that occurred in September. Unfortunately for the perma-bulls, the rate cut triggered a sharp increase in the and mortgage rates. In addition, new home sales home sales have been on a downward trajectory since October 2020. The phony SAAR for September is down 28.3% from October 2020 – and the numbers do not include contract cancellations.
Of the homebuilders I analyze and present in SSJ, only and PHM look like this:
While I think both TOL and PHM are fantastic shorts, the charts of , , DHI and appear have formed a top and are poised to head lower:
LGIH, along with , are my two favorite homebuilder shorts. They both report numbers on November 5th. DHI reports Tuesday (Oct 29). In my opinion, all three are shorts (or put plays) ahead of earnings.
