Morgan Stanley: Homebuilders At Mercy Of Rising Interest Rates, Slow Demand In Spring

Tale Of The Tape - Past Year

Lennar: Overweight, $54 PT

• Morgan Stanley noted Lennar's top notch operating platform, evidenced by "industry leading gross and operating margins as well as low teens ROE."
• Lennar has embedded growth having traded as high as 2.4x TBV multiple, the Morgan Stanley $54 PT is driven by EPS growth.
• Ancillary businesses: private equity Rialto Fund 1 has $123 million of carried interest upon liquidation; Multifamily building sales generated $8.5 million in Q3 2014, LEN expects to generate $23 million in 2015 from sale of 5 buildings; Five Points development JV for master planned communities in California, expected to ramp up sales.
• Lennar sells ~30 percent of its homes to first time buyers, and will benefit from GSE moves easing mortgage availability.

KB Home: Underweight, $14 PT

• While noting that KB Home has improved margins from its "Going on Offense" initiative, Morgan Stanley believes this ongoing transition will be a headwinds for margins in 2015.
• Morgan Stanley sees KBH's strategy of buying raw land to develop in infill markets as risky, relative to peers who have established communities.
• KB Home has the highest leverage, 58 percent (including DTA), which will make land deals and private builder acquisitions more difficult, and "warrants a discount."
• Morgan Stanley noted that the detailed guidance provided by KBH management on its Q1 earnings call helped reduce uncertainty around its FY 2015 earnings range.

Toll Brothers: Equal-weight, $39 PT

• Multiple Expansion Headwinds - "TOL's initial 2015 guidance calls for flat growth in deliveries, gross margin, and HPA" (home price appreciation).
• While noting Toll's "high gross and operating margins relative to peers," Morgan Stanley feels that Toll's large land bank creates a drag on ROE.
• While order growth has been positive 2015 YTD, Morgan Stanley still lacks visibility into 2016 sales for this luxury homebuilder.

• A slower spring selling season than is currently anticipated.
• Potential for rising interest rates reducing effective demand and absorption rates.
• Houston exposure if the price of oil results in worsening employment trends.
• LEN and KBH are at risk for slowdowns in local governmental approvals.
• TOL high-end City Living Product could see lower demand from foreign buyers due to the low price of oil and strong dollar.