2024-01-14 23:46:07 ET
Summary
- D.R. Horton, a homebuilding company, has experienced significant growth in revenues and EPS over the past decade.
- The company has a strong track record of dividend payments and share buybacks, indicating financial stability.
- DHI stock has identified growth opportunities in affordable housing, operational efficiency, and rental operations.
Introduction
The consumer discretionary sector is exciting during this time. Investors prefer investing in companies with less volatility and cyclicity when business uncertainty increases. Therefore, consumer discretionary companies are not among the top picks as investors fear the end of the economic cycle. That's when high-quality companies shine, as sometimes their shares are attractive due to sell-offs while the company is in good shape.
One interesting company is D.R. Horton ( DHI ), which has been building homes in the United States for over four decades. The company operates in a market affected by higher rates, which impacted mortgage rates. Therefore, the share price almost has not moved from the beginning of 2023 until November. Since the Fed announced its intention to pivot, the share price has increased significantly, and it is time to see if the company is attractive.
Seeking Alpha's company overview shows that:
D.R. Horton operates as a homebuilding company in the United States East, North, Southeast, South Central, Southwest, and Northwest regions. It engages in the acquisition and development of land and the construction and sale of residential homes in 118 markets across 33 states under the names of D.R. Horton, America's Builder, Express Homes, Emerald Homes, and Freedom Homes. The company constructs and sells single-family detached and attached homes like townhomes, duplexes, and triplexes. In addition, the company develops, constructs, owns, leases, and sells multi-family and single-family rental properties.
Fundamentals
The revenues of D.R. Horton have increased by 409%, meaning they are five times higher than just a decade ago. This results from the company's execution and the recovery we have seen in the real estate market. The company grows organically by building more homes annually and through acquisitions as it acquires peers, such as acquiring most of the shares of Forestar ( FOR ). In the future, as seen on Seeking Alpha, the analyst consensus expects D.R. Horton to keep growing sales at an annual rate of ~6% in the medium term.
The company's EPS (earnings per share) has increased even faster during that decade. The 812% increase in EPS equates to a nine times increase. The faster EPS increase is the result of much higher margins. Operating margins have increased from 11% in 2014 to 18% in 2023, resulting in a significant EPS increase. In the future, as seen on Seeking Alpha, the analyst consensus expects D.R. Horton to keep growing EPS at an annual rate of ~7.5% in the medium term.
D.R. Horton has paid a dividend without reducing it for the last 14 years since the financial and real estate crisis. Over the last decade, the company has increased its dividend annually, including a 20% increase for fiscal year 2024, announced in November. The dividend is extremely likely safe, with the payout ratio at 7.2%. However, the other side of the equation is that the current dividend yield is low at 0.68%, making the company less suitable for income investors.
In addition to the dividends, the company returns a significant amount of cash to shareholders via buybacks. Share repurchase plans support EPS growth by lowering the number of outstanding shares. Over the last decade, the number of shares of D.R. Horton increased by 3%. The acquisition of Forestar in 2017 increased the number of shares. Since then, the company has also repurchased all the issued shares. In 2023, it acquired $1.2B worth of shares, decreasing the share count by 3%, and it intends to buy back shares worth $1.5B in 2024.
Valuation
The company's P/E (price to earnings) ratio based on the 2024 EPS estimates stands at 11. This is the highest P/E ratio we have seen over the last twelve months, and it represents the great run the company has enjoyed over the previous year. Despite the great run, the company still shows decent growth, and the valuation is still attractive. I believe paying 11 times earnings for a company growing at 7.5% annually is decent, even in cyclical sectors.
The graph below from Fast Graphs also shows that the shares of D.R. Horton are fairly valued. The average P/E ratio of the company is 10.77, which aligns with the current P/E ratio of 11. The average annual growth rate of the company stands at 9.6%, which is slightly higher than the current forecasted growth rate of 7.5%. If interest rates go down, we may see a boost to the current EPS forecasts. However, I don't take it for granted. Thus, I believe that the current valuation is fair.
Opportunities
The first growth opportunity is market share increase through a focus on affordable housing. D.R. Horton aims to consolidate market share by providing more homes at affordable prices to meet homebuyers' demand. The company plans to maximize returns and capital efficiency in each community, focusing on offering affordable product offerings. Despite challenges such as high mortgage rates and inflationary pressures, the demand for new and existing homes at affordable prices remains strong, supported by favorable demographics, making it a significant opportunity.
We are focused on consolidating market share by supplying more homes at affordable price points to meet homebuyer demand while maximizing the returns and capital efficiency in each of our communities."
- (David Auld, Vice Chairman of the Board, Q4 Conference Call)
Another growth opportunity is leveraging supply chain improvements and operational excellence to improve cycle times and housing inventory turns. The company leverages improvements in labor capacity and material availability to decrease cycle times, thereby enhancing housing inventory turns. Focusing on efficient operations, the company aims to reduce the time it takes to complete construction projects. This strategic move is expected to position D.R. Horton to respond more effectively to market conditions and improve its overall inventory management.
With improvements in both labor capacity and availability of materials, our cycle times are decreasing, positioning us to improve our housing inventory turns."
- (David Auld, Vice Chairman of the Board, Q4 Conference Call)
A third growth opportunity is the strategic focus on rental operations. The company recognizes the potential for growth in its rental operations, with significant increases in both revenues and profits. The company has experienced success in the single-family and multifamily rental markets and plans to continue expanding its rental platform across more markets. The maturation and expansion of the rental operations contribute to the company's overall growth strategy.
Our rental operations generated significant increases in both revenues and profits this year as our platform is maturing and expanding across more markets."
- (Paul Romanowski, President and CEO, Q4 Conference Call)
Risks
The first risk is the affordability challenges due to the higher rates. The company deals with the impact of high mortgage rates and changing market conditions on home affordability. To address this challenge, the company has increased its use of incentives and is adjusting the size of homes to enhance affordability for buyers. However, the expectation of continued high incentives in fiscal 2024, especially rate buydowns, poses a risk to the company's profit margins.
To adjust to changing market conditions and higher mortgage rates, we have increased our use of incentives and are reducing the size of our homes where possible to provide better affordability for our homebuyers."
- (Michael Murray, EVP and COO, Q4 2023 Conference Call)
The rate increase also hurt the company's margins due to the volatility. D.R. Horton anticipates lower gross margins in the first quarter of fiscal 2024 due to recent increases in volatility in mortgage rates. The company notes that incentive costs have risen on recent sales, which, combined with market uncertainties, is expected to impact homebuilding gross margins. The sensitivity to fluctuations in mortgage rates poses a risk to the company's profitability. Therefore, rate increases hurt not only the revenues due to smaller houses but also margins.
Due to recent increases in volatility in mortgage rates, our incentive costs have increased on recent sales, and we expect our homebuilding gross margins to be lower in the first quarter compared to the fourth quarter."
- (Bill Wheat, EVP and CFO, Q4 2023 Conference Call)
The high rates create a challenge for the rental business as well. The rise in interest rates and uncertainty in capital markets have led D.R. Horton to refrain from providing separate guidance for rental closings in fiscal 2024. While the company expects more multifamily unit closings, the uncertainties in interest rates and capital markets pose challenges for rental operations. This uncertainty may impact the company's ability to forecast and plan its rental projects effectively.
Due to the rise in interest rates and volatility and uncertainty in the capital markets, we are not providing separate guidance for our rental closings in fiscal 2024."
- (Paul Romanowski, President and CEO, Q4 2023 Conference Call)
Conclusions
To conclude, D.R. Horton is the largest homebuilder in the United States on an enormous scale. The company grows revenues and EPS extremely fast, allowing it to spend billions on dividends and buybacks. The company has several growth opportunities surrounding affordable housing and rental. It is also improving its efficiency, which will likely enhance margins.
The company's risks are mostly connected to the higher interest rates. It hurts housing affordability and changes the valuation of houses for rent. If interest rates go down, the company will benefit, but even if they stay at the same rates, it proves it can deal well. The current valuation is fair and in line with the long-term valuation. Therefore, I believe that the company is a BUY. Warren Buffett once said: "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price." D.R. Horton is a wonderful company.
For further details see:
D.R. Horton Is A Long-Term Dividend Growth Buy