Leading company's earnings report falls short of expectations, causing a sharp decline in the "hot sector" of the US stock market

After a strong rebound in 2023, US residential builders' profits have declined and their stocks have plummeted.

On Tuesday's closing, US residential builder stocks plummeted, with leading residential builder D.R. Horton (DHI) falling 9.2%, marking the largest single-day decline since 2020.

D.R. Horton stock price

Other US residential builders, such as Toll Brothers, PulteGroup, and KB Home, fell nearly 6%, while Lennar, Tri Pointe Homes, and Beazer Homes USA saw declines of about 5%.

ETFs were not spared either, with the SPDR S&P Homebuilders ETF falling over 3% and the iShares US Home Construction ETF falling over 5%.

The entire residential builder stock index fell 6%, marking the largest single-day decline since 2022.

D.R. Horton's price cuts disappoint investors

On Tuesday, industry leader D.R. Horton released its earnings report, showing first-quarter EPS earnings of $2.82, lower than the expected $2.87, and underperformance in areas such as quarterly orders.

The company's CFO, Bill Wheat, mentioned:

The volatility of interest rates may cause hesitation among homebuyers and reduce home sales. To maintain sales, the company must provide incentives such as price cuts, reducing the size of homes being built, and additional home decoration services.

While these incentives may increase sales volume, they also erode the company's profits, and the adverse impact will continue into the second quarter.

The company's profit margin has also been affected by the fluctuation of mortgage rates at the end of 2023. D.R. Horton originally employed hedging strategies to offer mortgage loans at rates lower than the market rate, but the sharp decline in mortgage rates at the end of the year directly impacted the company's performance.

D.R. Horton stated that it plans to lower prices and continue to provide incentives for homebuyers. This move has disappointed investors and raised concerns about the entire housing construction industry, as they had hoped that the recent decline in borrowing costs would boost market prospects.

Next week, more earnings reports will be released from the industry, including the third and fourth largest US residential builders by market value, NVR Inc. and PulteGroup Inc.

Analysts downgrade ratings for the housing construction industry

In the past two years, Seaport Research Partners analyst Kenneth Zener has been known for his accurate predictions of the US housing construction industry. In early November 2023, Zener upgraded the rating of a series of residential construction stocks to "buy", predicting a 25% upside in the short term.

In the fourth quarter of 2023, due to the increasing expectation of a rate cut by the Federal Reserve, the industry surged by nearly 35%, marking the largest quarterly gain since 2020.

However, Zener believes that this increase is too high and exceeds the typical increase in the industry after the Federal Reserve eases monetary policy. The current high stock prices already reflect expectations of moderate inflation decline, limiting further upside potential and even the possibility of a decline.

On Monday, Zener downgraded the U.S. residential construction industry, as well as the ratings of several residential construction companies, from "buy" to "neutral", including the industry leader D.R. Horton.

Zener is not the only analyst cautious about residential construction stocks. Michael Dahl from RBC Capital Markets also maintains a neutral rating on the industry.