For 19 consecutive years, D.R. Horton (DHI 1.77%) has maintained its position atop the summit of the American homebuilding industry. Since its founding in 1978, the company has seen few environments as operationally tricky as the COVID-19 pandemic, with economic shutdowns imposing unprecedented uncertainty. The company bolstered its balance sheet in preparation for hard financial times that never came, instead delivering accelerated earnings growth. A record single-family housing shortage stands to boost the company's earnings further, representing a growth opportunity in a stock market that's at all-time highs.
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An unusual year
D.R. Horton withdrew guidance to investors after the second fiscal quarter ended March 31, 2020, citing the uncertain and unpredictable nature of the pandemic on its operations. Restrictive stay-at-home orders led to falling demand and sales cancellations in late March and early April, with the company raising $1.2 billion to shore up its financial position.
Aligned with a gradual easing of restrictions and record low interest rates, May and June delivered a powerful turnaround for D.R. Horton, with net orders for homes increasing 50% compared to the same period the previous year. The company responded with surprise, expressing further caution that the economic dynamic could shift for the worse at any time. Nevertheless, it generated $1.72 in earnings for that quarter ending in June, a 37% boost over the prior year.
These trends were not exclusive to D.R. Horton. Its closest competitor -- Lennar Corporation -- displayed similar performance over the period, but its earnings bounce-back in the June quarter was slightly weaker at 33%.
Responsibility perhaps falls less on what these companies did, and more on historical fiscal and monetary stimulus. With over $2 trillion injected into the economy through the CARES Act, and mortgage rates pulled down to record lows, it's no surprise consumers were galvanized and ready to buy homes.
Only the beginning
D.R. Horton's full fiscal year earnings and revenue displayed remarkable growth and continued acceleration:
| Metric | FY2018 | FY2019 | FY2020 |
|---|---|---|---|
| Earnings-Per-Share | $3.81 | $4.29 | $6.41 |
| Revenue (billions) | $16.1 | $17.6 | $20.3 |
Data source: Company filings
D.R. Horton attributes these results to its operational experience and geographic footprint. The company operates in 29 states, 32% more than its closest competitor, delivering a total market share of 9%. Its broader footprint across the US makes it difficult for competitors to wrestle away the coveted No. 1 spot, placing the company in a stronger position to reap the rewards of the current housing boom.
There were no signs of a slowdown in the new fiscal year. For the quarter ended Dec. 31, the company grew earnings a staggering 84% over the previous year to $2.14 a share, led by a 44% boost in home sales closed and the company's highest gross margins in three years. It's worth pointing out that these results came before the recent $1.9 trillion in new stimulus was passed, which should further bolster housing demand.
Keeping busy
During the pandemic, Freddie Mac estimated an enormous shortage in new housing, which potentially totaled 2.5 million homes. According to the Mortgage Bankers Association, this could lead to over 1 million new single-family homes built in 2021 for the first time in 14 years. More significant is their expectation that housing starts for 2022 and 2023 will also exceed 1 million -- so we could be facing the strongest stretch for homebuilders in well over a decade.
The picture for builders is not all rosy, though. After hitting an all-time low of 2.65% in January, 30-year mortgage rates have now climbed rather rapidly to 3.13%. Putting the actual number aside, it's typically the trend that matters with interest rates, and if this rise continues, it could dampen the red-hot housing market. Fresh concerns have been aired recently by analysts at UBS, that strong demand for housing is driving prices into bubble territory — so rising rates may not be a bad thing!
Ultimately, homebuilders face a maturing millennial population, of whom 52% are still living at home. As they spread their wings, demand for new housing should remain robust, and D.R. Horton remains best positioned to benefit. With the largest geographical reach, it possesses an interesting advantage as work-from-home trends in the broader economy drive more people out of major cities.
The stock currently trades at about 14 times FY 2020 earnings, which is higher than similar periods post-FY 2018 (11.5 times) and FY 2019 (12 times). However, the company rarely posts growth quite this strong, and with the addition of powerful stimulus-infused tailwinds, it's not unusual that investors are paying slightly more. Going forward, the multiple will expand further if the company continues to grow earnings, which is likely based on projected housing starts data for the next few years.
Overall, the stock represents a good value at current prices. Investors should watch for increased revenues and earnings per share driven by more homes closed, and rising gross margins as a result of demand-led higher prices.
