It came as no surprise when homebuilder KB Home (NYSE:KBH) posted results for fiscal 2003 last week that shot through the roof. With bargain-basement lending rates fueling demand for housing, the homebuilding market may seem like the place to be.
The company's bottom line jumped a hefty 23% to $8.80 a share on a 16% spike in sales for the year. Expecting continued strong housing demand next year, it raised its earnings estimates from $9.50 to $10 a share on a 13% projected revenue growth.
With the stock trading at only 7 times next year's estimated earnings, it would seem that investors have little to lose. But before you rush into what seems like the next great growth story, think twice about whether these valuations are built to last.
Remember, homebuilders rise and fall with interest rates. Simply put, low interest rates translate into lower mortgage payments for consumers, allowing more of them to afford a new home. Low mortgage rates also give homebuilders pricing flexibility, meaning they can charge higher prices. This June, mortgage rates tanked to their lowest levels in 45 years, and these low rates helped spur the latest housing boom. But the boom can quickly bust, if interest rates rise as the economy begins to recover. As noted in Homebuilders Getting the Shingles?, it's likely that interest rates have bottomed out and housing activity could slow, leaving some of the homebuilders out in the cold.
Rising rates could be a triple whammy for KB Homes. As well as being the largest single-family homebuilder in California, it has another claim to fame as the provider of mortgage banking services to domestic homebuyers. What that means is that as interest rates rise, we can expect a downturn in mortgage banking profits. Worse yet, the company markets its homes to mainly first-time and first-move-up buyers, who are especially susceptible to rising mortgage rates.
So, if you're tempted to walk through the door of a homebuilder -- whether KB Home or Lennar (NYSE:LEN), D.R. Horton (NYSE:DHI), Pulte Homes (NYSE:PHM), or Centex (NYSE:CTX) -- remember these are cyclical stocks that don't weather high interest rates very well.
Carla Pasternak welcomes your feedback at [email protected].
