Wedbush on Tuesday downgraded shares of five homebuilder stocks, citing climate change in what it called a more “normal” year for housing trends in 2019.
The firm downgraded all five stocks to underperform from neutral, cutting its price target on Century Communities ( CCS ) to $82 from $92, LGI Homes ( LGIH ) to $74 from $88, and Meritage Homes Corp. ( MTH ) to $148 from $155. Shares of DR Horton (DHI) and Lennar (LEN) have price targets unchanged.
“No year in housing construction follows a precise timeline of rising demand in the spring, followed by a seasonally normal decline in demand in the summer,” Wedush analyst Jay McCannless wrote.
“However, 2024 is a more 'normal' year for the housebuilding industry than 2019. As a result, we believe these names may see a normal seasonal share price decline in the summer, especially after seasonal trading. The window closes in April/May.”
The company, notably, kept earnings estimates unchanged for all five stocks.
With the exception of Lennar, all five names in the iShares US Home Construction ETF (ITB) have underperformed since the start of the year, so the bearish call comes.
“If land acquisition and development costs continue to rise and lumber prices continue to rise, we think this underperformance could worsen,” McCanless wrote.
High long-term interest rates and a lack of housing have allowed builders to focus their attention on a lower segment – the entry-level buyer. Builders have offered price reductions and incentives. But that strategy has negatively pressured gross margins.
McCanless expects the same storyline to play out in the second quarter of this year, as mortgage rates remain near cycle highs. The 30-year fixed rate loan fell to 6.79% from 6.87% a week ago. According to Freddie Mac.
Many home economists believe mortgage rates will fall later in the year as the Federal Reserve cuts interest rates. But McCannless doesn't think the move will be mechanical.
“We think this is still the market consensus, but we take the opposite view because mortgage originators (banks and non-banks) don't want to bear the risk of prepayment without being compensated for that risk,” he noted. .
McCannless also notes that the spread between a 30-year mortgage and a 10-year Treasury is “artificially wide” today to account for refinancing risk.
