US Homebuilders – more analyst upgrades to come?

There is a good chance for plenty of analyst upgrades of US homebuilders already this year. Why? They have been holding back on upgrades but now the market situation seems to support the revisiting of their estimates. Housing starts are seen continuing on the path to normalisation during the coming years, as pointed out in my recent theme US Housing Market Dynamics.

In this theme I outlined my view on the housing overhang and what I expect for the US housing market during 2012-2014. Based on this I am confident that housing starts will trend higher as per chart 1. Housing Starts are much lower than the lows seen over the last 55 years and my expectation is for starts to reach the lower end of the historical range during the coming years.

Such normalisation would entail a fairly high growth rate during 2012-2014 as a result of the bottom of the market being so dire. A rise from the low in 2009 to the projection in 2014 would constitute a total rise of almost 100 percent!
 
Reflection on homebuilder’s expected revenue
The housing market appears to have turned the corner and this has finally changed the thinking of analysts about US homebuilders’ sales expectations. The light blue line in chart 2 represents expected revenue in 2012 which has been trending downwards until recently whereas expectations for 2013 (grey line) began to rise several months before. This indicates some positive belief in the long run but perhaps a lack of confidence in analysts’ abilities to call the bottom of the market.

In chart 2 the broken lines are the projections from summer 2011. There has been no reason to change them as things are going according to plan. From this I still see room for surprises in revenues in 2012 though as it is precisely on this item that analysts right now seem less convinced of the potential.

What we will probably experience is the normal analyst trick of incrementally changing estimates over time as things pan out instead of revealing their hand in terms of where things are really headed.

Net Income
Overall revenue for US Home Builders stabilised late in 2011 but for the year as a whole there was generally a decline in revenue. This took its toll on earnings as they declined throughout 2011 and ended in negative territory yet again, see chart 3. (When revenue declines fixed costs quickly eat profits as businesses can’t easily shed such expenses.)

But looking at 2012-14 analysts expect better net income ahead (see chart 3) and this is quite reasonable as revenues are now moving up and therefore have the added benefit of operational leverage.



I see some opportunity for analysts to increase their margin expectations for 2012 (see chart 4). Margins could substantially improve when the market turns but consensus net income margins are expected to reach only 2.8 percent in 2012 while margins for 2013-14 are 4.5 percent and 5.9 percent respectively.

We are entering at least a few years of progression towards normalisation and I would expect the consensus to change during 2012 reflecting this in income margins.
 

Conclusion
Step by step consensus is moving in the right direction but analysts are probably still shell-shocked from the last few years of havoc. I expect homebuilders’ earnings to be underpinned by higher activity with even the conservative consensus estimates on revenue and margins opening up for earnings upgrades during 2012.

Note: I have not mentioned valuation, but for some companies a good part of the improvements I refer to are already priced in. This is a helicopter view on US homebuilders’ revenues and earnings. It is not about whether individual companies are attractive or not.