We believe that the recent run in housing has been driven less by secular shifts that are brandied by the media and the industry but rather by a decrease in mortgage rates lowering the average mortgage payment and buoying consumers ability to purchase housing. With the subsequent movement in home prices we believe that this has remarked home prices to fit this change in mortgage payments. The street has misunderstood this dynamic and has modeled a structural lift in housing demand as home demand is in the process of rolling over. While we are not calling for a severe downswing in housing, we believe that estimates need to be reset and this will pressure securities tied to housing. There is a chance that the froth that has been in the housing market could make this reset more acute than the ‘18 reset but do not believe that we are close to an ’05 moment. We recommend a short on PHM as an example of a residential based security but there are other securities that could fit the thematic short as well.
Description and Background –
PHM is the second largest homebuilder in the country delivering over 24,000 homes in 2020. The average selling price of homes was 430k showing PHMs broad housing exposure. This compares to Lennar at 394k and 370k for NVR which are slightly more entry level exposed. It is important to note that as you go farther down the ASP scale you are more exposed to mortgage rates as these homes are less likely to be cash purchases.
Homes are typically bought using a mortgage. This changes the consumer from looking at a home price to viewing the purchase as a monthly payment. From 2019 the average mortgage rate has decreased from ~3.75% to 3.1% on the most recent published average 30yr fixed rate. As mortgage rates have decreased, these rates have inflated the prices of homes as consumers can afford more home with the same mortgage payment. Importantly, mortgage rates dipped as low as ~2.8% in 4Q20. We believe the current housing stock is priced closer to those rates than the current 3.1% and the ~10% increase in rates has a commensurate decrease in what consumers can afford.
Our short thesis is predicated on mortgage applications beginning to roll over and showing itself in order trends. As evidence of this the most recent MBA Purchase NSA Index was -14% yoy and +1 on a 2yoy basis. This compares to a 4Q20 average of +25% and +35% respectively and a 1Q21 average of +15 and +18% respectively. For an example of the indexes ability to predict slowdowns in the last mini-tightening of ’18 mortgage applications decelerated from +7% and +15% in 4Q17 to +1% and +8% respectively. This led to a deceleration of PHM order growth from +14% to -12% in 4Q17 and 4Q18 respectively. On a gross basis orders decelerated from +12% to -9% from 4Q17 to 4Q18. We believe this shows how correlated mortgage purchase applications are to new orders.
In the face of this deceleration the street is modeling a 41% increase in 2Q21 order growth and a 53% growth in orders per community, a 3Q21 order growth rate of 8.5% and 10% respectively, and a 4Q21 growth rate of 9% and 10% respectively. We believe these estimates are too high in the face of the current mortgage application data. The comps are progressively getting harder and run rating the current mortgage application stack through year end would show negative year over year order growth in the mid to high teens for 3Q21 and 4Q21.
Valuation –
These stocks typically trade on p/b multiples and in 3Q/4Q18 PHM rerated from close to 2x TBV per share to ~1.5x tbv to share on a more moderate deceleration in year over year order growth. A similar rerating would lead to a ~30% decrease in PHM stock or a $35 target price.
I do not hold a position with the issuer such as employment, directorship, or consultancy. I and/or others I advise do not hold a material investment in the issuer's securities.
Catalyst
Deceleration in housing
10yr moves higher or lower
Lagged cost inflation hits p+l in 2h21/1h22
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AUTHOR
DATE
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6
Fitzgerald
6/28/21 3:55PM
Re: Re: Re: Supply matters, too; supply dynamics are insanely good
5
While I agree the backlog does cushion things temporarily the problem is these stocks trade primarily on the derivative similar to other orders based businesses ex: WGO or CRO's. The street hasnt modeled the names correctly (which is shocking because SS building/prods analysts have a small group to begin with) and with that will come weakness.
If we want to talk about WFH I believe that this will be a headwind on a go forward basis as those that moved out of cities into builder created communities are going to be increasingly called back to work. Many of those that have left cities hoping for WFH forever are being forced back in at least on a part time basis creating a glut or at the very least will not be incremental builder demand.
Re: Supply matters, too; supply dynamics are insanely good
2
Supply is low because demand has been so high. Annecdotally sellers i have talked to are reticent to list their homes because they can not source the other side of the trade. If you look at the historical housing data the lowest months of supply was right before the housing market rolled over in late '05. In my view months of supply is a meaningless number that gets plenty of industry attention because it fits the narrative they want. Very similar to the "chronic underbuild over the past 10 year, look at how low starts have been vs housing formation." This datapoint is used with no mention of the incredible OVERBUILD that happened in the mid 2000s that had to be absorbed over the years where the industry talks about an "underbuild."
A great datapoint I instead look at is HOWNOWN Index or the total owned homes vs the total population. There are 82.5m homes owned as of 3/31/21, in 05 there were 76m. The census bureau estimates there are ~330m americans today and there were ~300m in '05. This works out to a 25.8% ownership rate in '05 and a 25.1% ownership rate today. This compares to the trough ownership rate of ~23.5 in late 2015 early 2016.
Now we can sectionalize this a little more fine into owner occupied data at 77.7m homes today or a 23.7% ownership rate vs a 24.8% rate in '09 and a low in 2015/2016 of 23.2% but point remains that supply is not nearly as tight as portrayed.
Historically people used p/b regressions with roe or roic, this effectively drives you to a p/e metric but the SS prefers to hide under this methodology. If we wanted to get into the land remarks we can use some sense from len transcript talking about ~100 bps of margin compression driven by lumber. over the past year margins have expanded ~200 bps so we can view that as 300 bps from land. If the land is ~30% of a home value we can imply that land is earning somewhere around 30% margins. Theres about ~4.1b of land on the books so say 1.2b of mark to market and you are talking about a 1.8-1.9x adjusted book to tbv. This is all somewhat irrelevant because what im really calling for is a move lower in forward earnings on what has been a model that the sell side straight lined
Thanks for the idea. You note P/B as a key valuation metric, but I assume that GAAP understates "B" in an upcycle, and the argument could be made that it understates it by more now than at any point in the last decade-plus (given how much home prices have shot up recently). Have you attempted to quantify this effect, and how does it affect your view of valuation?
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