Wedbush on Tuesday downgraded five homebuilder stocks, citing seasonal headwinds during what it called the most “normal” year for housing trends since 2019.
The company downgraded all five stocks to underperform from neutral, lowering the price target for Century Communities (CCS) to $82 from $92, LGI Homes (LGIH) to $74 from $88, and Meritage Homes Corporation (MTH). to $148 from $155, maintaining its rating. Price targets for DR Horton (DHI) and Lennar (LEN) shares were unchanged.
“No year in homebuilding follows a set timeline of exactly high demand in the spring followed by a natural, seasonal decline in demand in the summer,” Wedush analyst Jay McCanlies wrote.
“However, 2024 was the most 'normal' year we have seen in the homebuilding industry since 2019 in terms of normal seasonality. Therefore, we believe these names could see a normal seasonal decline in stock prices in the summer especially after the seasonal trade. The window closes in April/May.”
In particular, the company kept earnings estimates unchanged for all five stocks.
The bearish call comes as all five names, except Lennar, have underperformed the iShares US Home Construction ETF (ITB) year-to-date.
“We believe this poor performance may worsen if land acquisition and development costs continue to rise and lumber prices continue to rise,” McCanles wrote.
Higher interest rates for a longer period and a tight housing supply have allowed builders to focus their attention on the underserved sector – the entry-level buyer. Construction companies offered price reductions and incentives to increase volume. But this strategy negatively reduced gross margins.
McCanless expects the same story will play out in the second quarter of this year as mortgage rates remain near their highest levels in the cycle. The 30-year loan rate fell to 6.79% from 6.87% the previous week. According to Freddie Mac.
Many housing experts believe mortgage interest rates will likely fall in the back half of the year as the Federal Reserve lowers interest rates. But McCanles doesn't think the move will be so mechanical.
“We believe this is still the consensus view in the market, but we take the opposite view on this front because we believe mortgage originators (banks and non-banks) are unwilling to take on prepayment risk without compensating them for that risk,” he noted. .
McCanless also points out that the spread between a 30-year mortgage and a 10-year Treasury is “artificially wide” today to account for refinancing risks.
