Friday April 13, 2012
by George Putnam, editor The Turnaround Letter
We are starting to see a few signs that the residential housing sector may be beginning to rebound from its long downturn – or at least signs that it may be bottoming out. As a result, many of the stocks related to homebuilding have begun to perform better.
Despite good moves in many of these stocks in recent months, we think the upturn is just beginning and there is plenty of gain potential left in these stocks.
We’re actually not that enthusiastic about the stocks of the homebuilders themselves; rather, we prefer stocks of other companies whose results will be strongly affected by a real estate upturn.
These include companies whose products are used in financing home purchases or in remodeling or furnishing homes.
Builders FirstSource (BLDR) manufactures and supplies structural building products to the residential construction industry, largely in the Southeast and Texas.
The housing collapse crushed operating results, and even today profitability is elusive. But the firm’s financials are solid, and the company is capturing market share as smaller competitors fail.
Builders should be in a good position to capitalize on the rebound in building activities. A decent level of insider ownership aligns management’s interests with shareholders.
The home furnishings business of Ethan Allen Interiors (ETH) is highly correlated with home sales and consumer confidence.
Management responded to the downturn with internal repositioning and restructuring initiatives that helped contain costs, but they also expanded manufacturing and retail operations, including in China.
The company offers a strong brand with a good quality/value proposition that should help results, which have been improving in recent quarters.
Lumber Liquidators Holdings (LL) is a specialty retailer of hardwood flooring and related products. While its same store sales have been sluggish in recent years, it has maintained top-line growth by opening new stores.
It has also gained share in the rather fragmented wood flooring market. The financials are solid and quite capable of supporting a new stock repurchase program.
Masco (MAS) derives more than half of sales from cabinets and plumbing products; brands range from KraftMaid and Merillat to Delta and Peerless. Is also makes BEHR paints as well as a range of other general building products.
A restructuring program that was completed in 2011 should help profit margins. An amended credit facility, which raised borrowing capacity to $630 million, allows the company to wait for a rebound in demand and gives it the flexibility to invest in growth opportunities.
MGIC (MTG), the nation’s largest mortgage insurer, has been facing the double-whammy of low home sales and high default rates.
Default rates are now improving, and could be further helped by recent government programs to reduce foreclosures. New business is picking up, and many smaller competitors have disappeared.
While MGIC could face serious problems if the improving default trends reverse, there is significant upside in the stock if the housing sector does indeed rebound.
Mowhawk Industries (MHK) is a leading manufacturer of floor coverings, such as carpet, tile and hardwoods.
Revenues declined from 2006 through 2010, but 2011 saw a modest bounce. Commercial markets have been a bright spot, and improvement on the residential side should give the stock a nice boost.
Owens Corning (OC) is a leading producer of insulation and roofing products, as well as other glass-fiber products. The company emerged from an asbestos-related bankruptcy in late 2006, just as housing was beginning to slump.
The company has done a good job of maintaining profitability through most of the housing downturn.
Any real estate rebound should benefit the bottom line since Owens Corning products are used in both remodeling and new construction.
Radian Group (RDN) is another large mortgage insurer. During the housing boom, it diversified into insuring mortgage-related financial instruments, many of which turned out to be toxic.
Radian has managed to settle many of the issues relating to those financial products, thereby positioning itself to profit from a recovery in housing.
Radian, like MGIC, has significant risks if there is another leg down in the housing market but powerful gain potential if that market turns up.
USG (USG) produces wallboard and other gypsum- based building products. Like Owens, it emerged from an asbestos-related bankruptcy just in time to experience the housing collapse.
USG has not been as successful as Owens in maintaining profitability in the downturn, but perhaps its rebound potential is even greater.
Warren Buffet’s Berkshire Hathaway owns roughly 16% of USG, but it has been in the stock for quite a while and has suffered losses along with everyone else.
Learn more about this financial newsletter at George Putnam's The Turnaround Letter.