With the prospect of lower interest rates ahead, housing stocks are looking up. One beneficiary has been D.R. Horton (DHI -0.84%), which recently saw its shares hit an all-time high. The largest U.S. homebuilder has enjoyed two months of momentum after impressive earnings results and encouraging macroeconomic data.
Some investors might think about selling after the recent gains, but there's still plenty to love about this homebuilder. Here's why.
The news has been good this summer
The housing stock stormed higher in July after a stronger-than-expected earnings report. The company reported 2% sales growth and 5% higher earnings relative to the prior year. D.R. Horton's new orders were relatively weak, and it reduced its full-year sales forecast. However, investors were pleased with the overall outlook thanks to low housing inventories and the prospect of interest rates falling later this year.
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The interest-rate speculation gained steam in August. Fed Chairman Powell's public commentary indicated that a rate cut is coming. Investors are hoping that lower borrowing costs will stimulate demand in the housing market, sending D.R. Horton to a new all-time high.
Marching higher across economic cycles
Homebuilding activity is highly cyclical. It's influenced by numerous factors, including interest rates, employment, consumer sentiment, and lending standards. There have been major distortions to the housing market over the past 20 years. D.R. Horton's financial results fluctuated through these macroeconomic cycles, but the company has delivered over the long term -- achieving a 6.8% compound annual sales growth rate (CASGR) since 2004.
DHI Revenue (TTM) data by YCharts.
Its bottom line has outpaced its sales growth. Net profits, earnings per share, and cash flows have all expanded at a quicker rate than revenue. Its dividends have also moved consistently higher, too. D.R. Horton isn't a dividend stock; its dividend yield is under 1%, and its payout ratio is less than 10%. However, it's important to recognize the company's improving capacity to return value to shareholders.
Competitive position
D.R. Horton operates in a highly competitive landscape. There are several homebuilding companies with national footprints. Its major competitors include:
- Lennar (NYSE: LEN)
- Pulte Group (NYSE: PHM)
- Toll Brothers (NYSE: TOL)
- NVR (NYSE: NVR)
- Taylor Morrison (NYSE: TMHC)
- Meritage (NYSE: MTH)
The industry also includes numerous smaller national or regional players along with a large number of small businesses. Homebuilding is a broad and highly fragmented market.
D.R. Horton is the industry leader based on revenue. It closed more than 24,000 units in its most recent quarter, higher than its rival Lennar. The company also diversified its revenue streams with a rental segment and financial services that offer mortgages to its home buyers. Rental operations provide more stable cash flows. The integration of mortgage services not only increases revenue but also entices customers by simplifying the buying process.
Horton gained market share in recent years, with its top line outpacing competitors. That can be attributed to several factors. Its broad geographical footprint and exposure to homes across the price spectrum mean that D.R. Horton isn't reliant on economic strength in any particular city, state, or income level.
The company's diversification offers a top-line boost along with a competitive advantage. D.R. Horton's scale also gives it negotiating leverage on pricing from suppliers and subcontractors, making it difficult for its rivals to compete based on price.
DHI Revenue (TTM) data by YCharts.
The company has also benefited from rising construction activity relative to overall home sales. Newly built houses make up roughly one-third of total residential inventory. That number was around 15% before the global financial crisis and under 10% in the years following the housing crash. D.R. Horton capitalized on that trend over the past decade, and demographic data suggests that new construction demand should remain strong.
D.R. Horton can't claim an economic moat based on proprietary technology or a network effect. As a result, some investors can feel justifiably skeptical about its ability to maintain its competitive advantages in the future. Nonetheless, it's hard to argue with results; the company has added market share while maintaining an attractive return on invested capital (ROIC). This is compelling evidence of strong competitive performance, pricing power, and operational efficiency.
Valuation
Currently, D.R. Horton's stock is somewhat expensive relative to its peers and its average historical levels, but the whole industry trades at modest valuations. The stock's forward price-to-earnings (P/E) ratio is under 13, so there's no meaningful speculation baked into the price. If the economy goes into uncertain lean times, there's less room for the stock to fall even at this relatively elevated valuation.
DHI PE Ratio (Forward) data by YCharts.
Cheap valuations often indicate operational or financial risk, but that isn't apparent for D.R. Horton. Cyclicality creates issues, but it shouldn't surprise investors or the company's management. Downturns are inevitable, and so are recoveries. D.R. Horton has ample liquidity based on its high current ratio. It also has a reasonable capital structure, so servicing debt shouldn't cripple the company during the next economic downturn. Strong financial-health metrics reduce macrorisk for long-term investors.
D.R. Horton's performance will depend on its ability to maintain its competitive position and the health of the housing sector. This isn't the cheapest stock for exposure to housing or homebuilding activity. However, it's a reasonable valuation for a market leader boasting impressive operational performance and clear macroeconomic catalysts moving forward.
