Stock pick: D.R. Horton Inc. (DHI) rebuilds along with the U.S. housing market

Recent lull could be a good opportunity to buy in

Chart of trailing 12-month stock performance for D.R. Horton Inc.

A lot of U.S. housing stocks have skyrocketed as the American recovery has taken hold, but there are still some companies in this sector that will continue to climb. One business to watch is Fort Worth’s D.R. Horton Inc. (NYSE: DHI), the largest homebuilder in the States.

Since Sept 2011, the company’s stock has risen by 149%, but returns have since slowed — it’s down 7.2% over the last 12 months — giving investors a good opportunity to buy in.

On May 29, Robert Wetenhall, an analyst with RBC Capital Markets, upgraded D.R. Horton from a sector perform to outperform. He likes the company’s focus on first-time homebuyers, which is a segment that’s growing in the markets it’s operating in.

About 31% of its lots are in South Central America, with most of that in Texas. “The Texas market is seeing the return of the first-time homebuyer in response to strong job growth, which provides Dr. Horton with a volume tailwind,” he wrote in his latest report.

It’s also shifted its business model somewhat. Over the last few years, homebuilders made a lot of money by raising prices on homes, rather than on volume. While that has worked nicely — companies in the sector have seen gross margins expand by 16% in 2011 to 21% in 2013 — some experts think housing prices could fall in the near future.

To combat that potential problem, D.R. Horton is now putting more emphasis on buying and selling homes as quickly as possible. “They’re now aggressively pursuing land deals with short payback periods that can deliver strong operating leverage even in the absence of large gains in house price appreciation,” wrote Wetenhall. “We believe that this is an optimal strategy at this point in the cycle.”

The company is also in a good position to meet the still increasing demand for homes. From the start of 2012 to the end of last year, the company invested $2.7 billion in land — the largest investment made of any homebuilding company during that time.

It’s now holding on to 60,000 finished lots and “should be able to comfortably meet forecasted deliveries in the next two years without materially increasing land spend,” wrote Wetenhall.

Steady demand should result in sustained earnings growth this year, he said, but that growth will continue into the future to, with U.S. housing starts expected to rise from 925,000 in 2013 to 1.35 million in 2016.

If everything pans out the way Wetenhall thinks it will, D.R. Horton should see earnings per share come in at $1.80 this year, $2.06 next year and $2.33 in 2016. The stock is currently trading at $23.88, but Wetenhall predicts it will hit between $27 and $30 over the next 12 months.