8 Home-building and Steel Stocks That Offer Substantial Value

The common denominator in both groups is that investors don’t think currently robust earnings will last. The stocks discount disastrous downturns for both industries that are unlikely to materialize. Home-building stocks have fallen 40% or more this year.

The losses in home builders’ and steel makers’ shares reflect a broad pullback in economically sensitive stocks. Yet, balance sheets have rarely been stronger for these industries, offering a financial cushion in a potential recession.

While a doubling in mortgage rates to 6% is reducing housing demand, a prolonged and deep downturn seems unlikely, given strong demographic trends and limited supply. “The home builders are pricing in an Armageddon scenario and a repeat of the great financial crisis when home prices fell 30%,” says Stephen Kim, housing analyst at Evercore ISI. “The stocks are cheap and more than compensate for the risk.”

Kim thinks they could double over the next year.

Bespoke Investment Group noted last week that the 40% decline in home-building stocks from their prior highs marked the sixth such drop in the past three decades. The average one-year gain following those declines has been 43%, with the only negative reading coming in 2006.

Home-builder profits remain at record levels, as was apparent in

Lennar
’s
(ticker: LEN) latest quarterly report. Lennar is the No. 2 U.S. home builder behind

D.R. Horton

(DHI). Lennar acknowledged that the market is softening, but Chairman Stuart Miller said land impairments, which hammered home builders during the 2008 financial crisis, were unlikely unless the market falls “an awful lot.” That reassured analysts and investors, and Lennar rallied, gaining 8%.

At around $70 a share, Lennar trades for four times projected 2022 earnings and below its book value of $74 a share. Lennar and other builders have ramped up stock buybacks and boosted dividends this year.

Wedbush analyst Jay McCanless says the stocks are trading for an average of just 80% of year-end 2022 tangible book value. Builders are benefiting from growing demand from companies that rent out single-family homes.

McCanless favors Horton, which generated an outsize 34% return on equity in the year ended in March. Horton shares, at $67, trade for four times earnings.

McCanless says high-end home builders could be more insulated from rate hikes because of their affluent customer base. He favors small-cap builder

Tri Pointe Homes

(TPH), now trading around $16, or three times 2022 earnings. The luxury leader,

Toll Brothers

(TOL), trades around $44, or four times 2022 estimated profits and below book value of $46 a share. Some 20% of Toll buyers don’t need a mortgage; they pay cash.

Steel stocks are among the most volatile. The companies generally had record first-quarter results and guided to similar performance in the current quarter.

Yet the stocks have been hammered on recession fears as steel prices, measured by hot-rolled coil steel, have fallen below $900 a ton from $1,500…