Note: the following analysis and commentary is similar to the content I provide in my weekly short selling newsletter. To learn more follow this link: Short Seller’s Journal info
DR Horton – $DHI – is down 9% after reporting its FY 2024 Q1 earnings. The Company “beat” consensus revenues but “missed” Wall Street’s earnings forecast. While aggressive price cuts and a heavy dose of incentives enabled the Company to generate a 6.4% revenue growth YoY, operating income and net income declined. It’s like Tesla. Stimulate sales (and “pull forward” future sales into the quarter just reported) and the expense of profitability. For DHI it required price cuts, upgrade incentives, and mortgage rate buydowns. With the latter, the homebuilder either gives money to the buyer to “buy down” the mortgage rate for the first year or two or pays the mortgage directly on behalf of the homebuyer to temporarily know the rate down. This expense hammers profit margins.
Despite the fact that DHI raised its guidance for its full-year FY 2024 – which in and of itself is laughable – it has a big problem on its balance sheet. Inventory ballooned in its FY Q1. One thing about that raised guidance. Homebuilder CEOs are like Elon Musk – they’ll say anything and everything to get the stock price higher. Didn’t work this time because the share price is down 9.7% post-earnings as I write this.
Another ugly development is the jump in inventories from its FY Q4 2023. The book value of residential lots under construction is up $ $467 million from last quarter (5.2%). And the Company must have gone on a lot-buying spree because the book value of residential lots and land jumped $1 billion (9.4%) from its FY Q4 2024. At some point, as potential buyers become immune to the current level of price cuts and incentives, DHI, as well as all of the homebuilders will be forced to implement even steeper price cuts in hopes of stimulating sales volume. But, at some point, because of affordability issues (discussed below), it will be like trying to push toothpaste back into the tube. At that juncture, homebuilders will be forced to write-down the value of their bloated inventory which leads to very bloody income statements.
I not only believe that DHI will ultimately fall well short of its deliveries guidance for 2024. I also believe the stock has the potential to get cut in half from the current level. The homebuilder stocks have bubbled up to all-time high valuation levels relative to the value of their order backlogs and relative to the general outlook for the housing industry. Yes, the homebuilder sentiment index bounced quite a bit in January. But recall that I suggested there might be a dead-cat bounce in the first couple months this year in sales and sentiment. The builders are excited because mortgage rates have dropped from 8% to 6.5%. But even with that, homes are at the least affordable in history (chart source @charliebilello):
Existing home sales do not offer any hope for optimism – and new homes are considerably more expensive on average than used homes making them even less affordable. Existing homes sales for December declined 1% from November on a seasonally adjusted annualized rate basis (SAAR), much worse than the +0.3 increase projected by Wall Street. Sales were down 6.2% YoY. On a SAAR basis, the December SAAR was the lowest since 2010. But on an annual basis, it was the worst year going back to at least 1995.
To be sure, part of the problem continues to be supply. But the months’ supply in December was still slightly above the average of 2023 as well as the previous two years. Affordability is the culprit. Again, there may be a small bounce in home sales activity in the first couple of months this year. But I expect the home sales to continue grinding lower, particularly when the stock market resumes its bear market.