The U.S. housing market is just getting over the hump of a recent scare. According to data from the Intercontinental Exchange Inc., most homeowners currently hold mortgages at rates of around 3.2%, and only a few are willing to let go of this generational low financing rate.
On the buyer side, few would-be homeowners are willing to finance a new property at today's mortgage rates, which hover around 7.3%. The average home price rose by as much as 31% since the COVID-19 pandemic to a $492,300 price range.
Suppose no one wants to sell their cheaply financed property, and few can afford a much more expensive home at high rates. In that case, the only way to get out of this stagnant market is to build a way out of the freeze with new inventory.
Stocks like D.R. Horton Inc. and PulteGroup Inc. broke to new all-time highs and have been flirting with these levels since. However, their P/E valuations reached levels above the residential construction industry average multiples, making Taylor Morrison Home Co. (NYSE: TMHC) and its current valuation the only sensible value play left in the construction sector.
Buffett Got It Right Again
After buying into D.R. Horton and other stocks in the homebuilding space, Warren Buffett let the rest of the market know that a residential construction boom may be coming.
So far, he's been proven right, as U.S. building permits have sustained their uptrend for the past quarter. These permits will eventually turn into housing units, helping to untie the current housing market. These homebuilders could be setting up for a blockbuster quarter ahead, as the preparation window is now closing.
According to the CME FedWatch tool, traders have now priced in the Fed's potential rate cuts for May or June 2024. With less than a few months worth of preparation, investors could save a lot of time by finding the gap that needs to be filled by Taylor Morrison. Lower interest rates could help mortgage rates decline, giving investors near-perfect timing for new housing units to hit the market as the Fed gets ready to cut financing rates.
Taylor Morrison Is Fundamentally Driven
Taking the most wishful thinking outside of this potential opportunity, investors can focus on what really matters for homebuilding stocks: net new orders. New orders are the industry's key performance indicator (KPI) and how Wall Street decides which stock to reward.
For Taylor Morrison, the 2023 fourth-quarter financial results show a jump of 30% in net orders. What's more, home closing revenue came in at $7.2 billion, comprised of 11,495 closings at an average price of $623,000.
A booming or busting economy doesn't make a difference at this price range, which is above the national average. Buyers looking to be in the property market at these price levels aren't apprehensive about the business cycle. Still, lower rates definitely won't hurt demand.
While D.R. Horton's new orders rose by 35% and PulteGroup's by 57%, besting Taylor Morrison's, revenues remain the focal point. D.R. Horton generated $7.7 billion, on par with Taylor Morrison. PulteGroup's $4.2 billion revenue shows that quantity isn't much without quality. As Taylor Morrison's sales quality is higher (as seen in the superior revenue figures despite the lower order growth), its price-to-sales (P/S) multiple should be exceptional, yet it isn't.
Wall Street Likes the Taylor Morrison Story
At a valuation of 0.9x P/S, the market may have overlooked Taylor Morrison due to its $6.6 billion market capitalization. Willing to pay a much higher valuation of 1.5x P/S, investors may have found safety in D.R. Horton's $54.6 billion size. The same goes for PulteGroup's 1.6x valuation; a market cap of $25.5 billion called the shots there.
Yet, there must be a reason why Royal Bank of Canada analysts boosted their price targets for Taylor Morrison stock up to $61 a share, calling for a 5% upside from today's price. Analysts at Barclays think that the stock could reach $60 as well. Because these targets were assigned in February 2024, they have yet to reflect the current state and trend that potential interest rate cuts could have on the company's financials.
