TOL - KeyBanc upgrades D.R. Horton Lennar Pulte others on homebuilding sector pivot

KeyBanc Capital Markets analyst Kenneth Zener upgraded seven homebuilder stocks even as higher interest rates make home purchases less affordable for many consumers.

"On balance we see fundamental and rate pressures persisting, but positive relative performance, supporting our upgrades," he wrote.

Specifically, Zener upgraded D.R. Horton ( NYSE: DHI ), Lennar ( NYSE: LEN ), PulteGroup ( NYSE: PHM ), Meritage Homes ( NYSE: MTH ), and TopBuild ( NYSE: BLD ) to Overweight and KB Homes ( NYSE: KBH ) and Toll Brothers ( NYSE: TOL ) to Sector Weight. Meanwhile, the iShares U.S. Home Construction ETF ( BATS: ITB ) has risen 2.1% in Monday morning trading.

In the quantitative report, KeyBanc analyzed 19 cycles since 1963. "What surprised us is how EARLY builders are vs. the market," Zener said.

"We think investing in high return on inventory ("ROI") builders will generate better risk-adjusted stock returns, with ROI highlighting different operating structures and structural risks as the cycle matures," he added.  The firm's quantitative approach simplifies qualitative factors (entry-level, geographic diversity, spec vs. build-to-order) to margin, turns and cash flow.

KeyBanc coverage's median ROI is 25%, with a homebuilding margin of 19%, inventory turns of 1.5x, net leverage of 21%, and inventory (percentage of book) of 142%. In terms of homebuilding inventory returns, NVR ( NYSE: NVR ) topped the list with 91.7% followed by D.R. Horton ( DHI ) at 41.8% and Lennar ( LEN ) at 32.7%.

Earlier on Monday, the NAHB Housing Market Index dropped in August for the ninth straight month as higher mortgage rates keeps more consumers on the sidelines.

SA contributor Alex Galanis sees a strong mid-term outlook for D.R. Horton ( DH ) as millennials enter their prime productivity and homebuying years.

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