US real estate companies have reached their peak? "Leading" company's profits decline, and this analyst has made another accurate prediction.

Zhitong App has learned that the stock index of residential construction companies, which has been closely watched, fell 6% on Tuesday, marking the largest decline since 2022. This came after industry leader Horton announced quarterly earnings that were lower than Wall Street's expectations. The company also stated that it will continue to lower prices to stimulate buyers, which disappointed investors who had hoped that the recent decline in long-term borrowing costs over the past few months would brighten its prospects.

Just the day before, Seaport Research analyst Kenneth Zener downgraded the rating of the US residential construction sector. This analyst has made accurate predictions about the performance of US residential construction stocks over the past two years, which suggests that his latest recommendation for the industry seems to be accurate as well.

Leading real estate company Horton's Q1 earnings fall short of expectations

Horton's first-quarter earnings, which were announced earlier, were lower than analysts' average expectations, as high mortgage rates continued to put pressure on the real estate industry. In the last full week of 2023, the average interest rate for a 30-year fixed-rate mortgage in the United States was 6.61%, compared to 6.42% in the same period last year.

For the quarter ended December 31, 2023, Horton's earnings per share decreased from $4.45 in the previous quarter to $2.82, lower than the expected $2.89 but higher than the $2.76 in the same period last year. Revenue was $7.73 billion, a 6% increase compared to the same period last year, exceeding analysts' average expectation of $7.58 billion but lower than the $10.5 billion in the fourth quarter and higher than the $7.26 billion in the same period last year.

Net sales orders for residential construction in the first quarter increased to 18,069 units, valued at $6.8 billion, compared to 13,382 units and $4.9 billion in the same period last year. The cancellation rate was 19%, lower than the 20% in the previous quarter and the 27% in the same period last year. The company's residential construction business sold 19,340 homes, compared to 22,928 homes in the fourth quarter and 17,340 homes in the same period last year. As of December 31, 2023, Horton had 42,600 inventory homes, of which 28,800 were unsold. In comparison, as of September 30, there were 42,000 inventory homes, of which 27,000 were unsold.

The company also stated that the gross profit margin of home sales revenue was affected by multiple factors, including stimulus measures and price reductions to improve affordability for homebuyers, as well as the devaluation of hedging tools used by the company to provide financing to homebuyers at below-market interest rates. Therefore, the gross profit margin for the first quarter was 22.9%, a decrease of 220 basis points compared to the previous quarter.

Leasing revenue was $195.3 million, with pre-tax income of $31.3 million, compared to revenue of $1.4 billion and pre-tax income of $217.2 million in the previous quarter, and revenue of $327.5 million and pre-tax income of $110.3 million in the same period last year. 2024 Fiscal Year Guidance: The company has slightly raised the upper limit of its 2024 fiscal year comprehensive revenue guidance from $37 billion to $37.3 billion. The lower limit of this range remains at $36 billion. The average analyst forecast is $36.5 billion. The number of home sales is expected to be between 87,000 and 90,000 households, compared to the previous estimate of 86,000 to 89,000 households. The cash flow forecast for the home construction business remains at around $3 billion, and the stock repurchase guidance remains at around $1.5 billion.

Donald R. Horton, Chairman of Horton, said, "Our strong balance sheet, liquidity, and low leverage provide us with significant financial flexibility. We plan to maintain a disciplined approach to capital investment to enhance the long-term value of the company, including returning capital to shareholders through ongoing dividends and stock repurchases."

Analysts' pessimistic sentiment towards real estate developers

Just a day before Horton's business performance, Zener downgraded the sector from "buy" to "neutral." At the same time, he also downgraded the rating of the largest construction company, Horton, and other companies from "buy" to "neutral." The company experienced its largest decline since 2020 on Tuesday, closing down more than 9%.

Previously, market expectations of a rate cut by the Federal Reserve continued to strengthen, driving the sector to rise by 35% in the previous quarter, marking the largest increase since 2020. According to Zener's calculations, this increase has exceeded the typical magnitude of the industry's rise after the Fed's policy easing. He analyzed the past 18 rate-cut cycles by the Federal Reserve and found that the median return for homebuilders' stocks was around 19% six months after the rate cut began. According to the analyst's research, as the market expects the rate cut to start as early as March, the potential return of the industry has weakened.

In his report on Monday, Zener wrote, "We don't want to linger too long in the bullish forecast of early November." He was referring to when he upgraded a series of residential construction stocks to "buy," expecting a 25% increase in the near term. By the end of the year, the homebuilders index had risen 28% from that point.

This analyst accurately predicted the challenging start and rebound of residential construction stocks in 2022, as well as their strength in 2023. Zener stated in an interview on Tuesday that while the industry may have reached its peak, economic indicators such as employment data will largely guide analysts' forecasts for the future. Signs of a strong economy have raised expectations for interest rates, which will weaken stock prices, and vice versa. Zener is not the only one who is cautious about housing construction stocks. Michael Dahl, an analyst at Royal Bank of Canada Capital Markets, also has a neutral rating on the sector. In a report on Tuesday, Dahl stated that Horton's results "hardly showed any confidence in significant improvement in demand after the recent interest rate cut, which could serve as a reality check for the sector after a strong rebound."

The optimistic side this week is that Zener expects the industry's profit margins to generally bottom out as measures to stimulate customer demand are relaxed, partially offset by rising costs such as lumber and labor.

Next week, more industry earnings reports will be released. NVR Inc. (NVR.US) and PulteGroup (PHM.US), the third and fourth largest residential builders in the United States by market capitalization, will announce their fourth-quarter results.