DR Horton: Key Developments Moving Forward

Homebuilder DR Horton's (NYSE: DHI  ) shares have dropped 10% in the last 12 months amid uncertainty in the real estate market. But a few upcoming catalysts could propel this stock to satisfying returns.

Breaking down the revenue
DR Horton is the biggest name in the residential construction market, ranking No. 1 among all homebuilders for the last two years in a row, with $4.7 billion in revenue and almost 20,000 total closings. The homebuilding segment is its  main source of revenue, accounting for 97% of total revenue, with financial services accounting for the remaining 3%.

While Horton divides its geographical footprint into six segments, three in particular look key to the company's growth: 

 Segment

2013 Average Selling Home Price

2012 Average Selling Home Price

% Change

East

$277,900

$268,400

4%

Midwest

$342,600

$312,100

10%

Southeast

$242,600

$205,600

18%

South Central

$214,900

$191,600

12%

Southwest

$204,700

$189,100

8%

West

$404,000

$312,600

29%

Source:DR Horton Quarterly Report Period Ended June 30, 2013.

The Southeast, South Central, and West segments not only posted the highest year-over-year increases, but also generate more than 75% of DR Horton's total revenue. By commanding higher selling prices, they provide the company with fatter margins, too. Clearly, the success of future projects in these three segments will be crucial to DR Horton's revenue growth going forward.

With that in mind, let's review each of those segments, to see what kind of economic conditions exist in the specific areas where new communities are under way.

Welcome to the neighborhoods 
The Southeast, comprising of Alabama, Florida, Georgia, Mississippi and Tennessee, experienced a 75% increase in number of homes in backlog year over year, as of June 30, 2012. Birmingham, Alabama stands out as a preferred destination for development, with DR Horton expected to build 10 new communities here in the near future. The city has several strong economic indicators in its favor, with a 5.6% unemployment rate, well below the national average, as well as 3.5% growth in construction employment in the last 12 months.

Moving on, the South Central segment -- consisting of Louisiana, New Mexico, Oklahoma, and Texas -- saw a 29% increase in backlog orders and 47% backlog value appreciation year over year in the latest quarter.

Dallas and Oklahoma City are two of the biggest markets DR Horton's targeting for new communities. Texas overall has been steady throughout the economic downturn, with much less volatility in home prices. The Case-Shiller index for Dallas, which measures the value of the city's residential real estate market, is at an all-time high, surpassing its pre-recession level. In comparison, the nationwide Case-Shiller Index remains 22% lower than its pre-recession peak. Oklahoma City is also a ripe place for real estate; its 4.8% unemployment rate suggests a strong local economy.

The West segment consists of California, Hawaii, Nevada and Oregon, Utah, and Washington. There are a total of 25 communities coming soon in this segment, including 14 in California alone.

Historically, California has seen strong home value depreciation, but it is currently offering one of the strongest rebounding real estate markets. Most communities are being developed in the proximity of San Jose, where the median home sales price increased by 28.5% year over year.

If California represents DR Horton's biggest bet in this region, Hawaii seems to be its most exclusive. The company plans four upcoming communities here, with prices around $3 million per property, compared to the average home price of $316,900 in the company's Western segment.

According to CEO Donald Tomnitz, DR Horton aims to appeal more to move-up home buyers:

We're also offering homes in some markets targeted to second time move-up and luxury buyers. 3.4% of our homes closed this quarter at a sales price greater than $500,000, up from 2.5% a year ago. The dollars associated with these closings increased to 9.4% of home sales revenues from 7% a year ago.

These luxurious homes can further boost profit margins, as Tomnitz's data suggests. Moreover, Hawaii enjoys a lower-than-average unemployment rate at 4.3%, which makes it an overall solid place for investment. 

What about the company itself?
Its Hawaiian homes may be lavishly priced, but DR Horton's own valuations suggest that the company's shares could represent a good deal. Its EPS is expected to grow by 25% in the next year, fueled by the development of those upcoming communities.

The current P/E ratio is at 16, compared to an industry average of 18. It also has the lowest current and forward P/E values among the top three homebuilders:

Company P/E Forward P/E
DR Horton 15 12.2
Pulte Group 21.3 12.8
Lennar 17.5 15.6

Source: S&P Capital IQ as of 10/21/13.

Based on these comparisons, DR Horton looks like a better value than its peers in the homebuilding industry.

Takeaway

DR Horton seems to have picked communities with favorable economic conditions in all three of these crucial, revenue-driving markets. But Fools should keep a close eye on interest rates as well. If rates rise, consumer demand falls, and average home prices' growth slows down, it might crimp -- or crush -- the company's hopes for growth in these areas.


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