BOSTON (Dow Jones) -- Splintered home-builder stocks are looking to some
analysts like bargains for buyers brave enough to weather more storms in the
housing market.
In particular, a diversified exchange-traded fund that tracks housing stocks
is winning plaudits from investment researcher Morningstar Inc.
The ETF, iShares Dow Jones U.S. Home Construction (ITB) , is an "opportunistic
play" for long-term investors to consider, analyst Sonya Morris wrote in
Morningstar's recently launched ETF investment newsletter.
"For patient investors who don't get rattled easily, I think this is an
intriguing way to gain exposure to a beaten-down sector," Morris noted.
The home-builder portfolio joined a small group of other ETFs that Morningstar
sees as attractively valued: Diamonds Trust (DIA) , Industrials SPDR (XLI) and
Vanguard InfoTech ETF (VGT) .
This non-core portion of Morningstar's model ETF portfolio consists of more
volatile, sector offerings that can quickly drop off the buy list as valuations
change.
Morris isn't recommending loading up on home-builder stocks or calling a
bottom for this troubled sector, saying the home construction ETF should
represent no more than about 3% of the portfolio. She cautioned there could be
more pain ahead for housing stocks that could test investors' resolve.
Morningstar takes a long-term investment view and even the opportunistic plays
require a two- to three-year horizon, or longer, Morris said in a telephone
interview about the home construction fund.
"This ETF is only for long-term, risk-tolerant investors, and even they should
keep it to a tiny portion of their portfolios," the analyst explained in the
newsletter. "If you prefer a smoother rise, skip this one altogether."
Underscoring the volatility, many CEOs of home-building companies are warning
they haven't yet sighted a nadir in the housing market.
Broken dream homes
The dramatic pullback in the U.S. housing market and its corrosive effect on
builder stocks has been well-documented. While shares of public home builders
have climbed since the summer, the Dow Jones U.S. Home Construction Index (DJ_
3728) as of the market close on Nov. 16 was off about 25% from its 52-week high
set in mid-January.
The housing slump has been more pronounced than those in the "soft landing"
camp had expected. Adding to the gloom, a government report late last week
showed housing starts plunged 14.6% in October to the lowest level in more than
six years. Building permits fell 6.3%, the largest percentage decline in seven
years.
Ian Shepherdson, High Frequency Economics' chief U.S. economist, called
October's 15% decline in housing starts "a sharp poke in the eye for those who
argued that September's jump in starts was a signal that the housing crunch is
coming to an end."
Home builders have seen orders plunge and many buyers are canceling contracts.
Cancellations are being driven by fears of price declines and because buyers are
experiencing difficulty selling their own homes.
"We see further downside potential in home-building stocks as deteriorating
housing demand, moderating price appreciation and higher costs should erode
home-builders' [profit] margins," wrote Banc of America Securities analyst
Daniel Oppenheim in a report to clients last week.
"We believe there are likely two more quarters of slop for all builders before
we are out of the woods," added analyst Stephen East at Susquehanna Financial
Group, in a research note.
Home-builder CEOs who are veterans of housing's boom-bust cycle say this
downturn is unique because it wasn't sparked by an economic recession or a spike
in interest rates. Rather, the current slump was triggered mainly by oversupply,
they say.
Inventories of unsold homes have soared, and speculators who had been eager
home buyers are now among the sellers, adding to the supply glut.
Home builders are also seeing profits hit by charges being taken on land that
has depreciated in value, and on land options the companies are not exercising.
Morningstar's stock analysts covering home builders, Eric Landry and Arthur
Oduma, expect the write-offs to continue for at least another year, but say that
taking a charge on options isn't as damaging to the firms' balance sheets as
writing down the value of owned land.
Although there was a "land grab" the past three years to scoop up real estate
in tighter markets, the analysts said builders have generally grown more
disciplined than in previous cycles when it comes to buying and financing land.
Still, Morningstar sees profits being squeezed on lower construction activity.
"On average, we expect a 10% to 30% drop in unit volume for these companies
over the next year and a half," Landry wrote in the November ETF newsletter.
Still, he noted that long-term fundamentals for home builders are positive,
including a growing population, immigration and attractive demographics.
"If they manage to come through the current downturn relatively unscathed, the
market may finally be willing to give them some credit and reward them with
higher valuation multiples," Landry said.
Putting down stakes
This long-term view factors into Morningstar's home-builder ETF
recommendation. Of the three housing-related ETFs, Morris chose the one she said
provides targeted exposure to companies that focus exclusively on builders:
iShares Dow Jones U.S. Home Construction.
"It offers the purest exposure to home-building stocks," the analyst said.
Rivals SPDR Homebuilders (XHB) and PowerShares Dynamic Building & Construction
Portfolio (PKB) , both hold home-improvement retailers Home Depot Inc. (HD) and
Lowe's Cos. (LOW) , Morris pointed out.
Also, the SPDR includes paint manufacturer Sherwin-Williams Co. (SHW) as a top
holding, and the PowerShares fund owns construction-equipment maker Caterpillar
Inc. (CAT) and materials provider Vulcan Materials Co. (VMC) .
The iShares fund's expense ratio of 0.48% is higher than the 0.35% charged by
the SPDR Homebuilders, but below 0.6% for the PowerShares product.
"I'm willing to give up a few percentage points in expenses in order to get
more focused exposure to the sector, since that's where I think the return
potential lies," Morris said.
The analyst said she's encouraged that some respected value-oriented
investors, Bill Miller at Legg Mason Value Trust (LMVTX) and Ron Muhlenkamp of
Muhlenkamp Fund (MUHLX) , have dipped a toe into the builder group, even if the
moves look premature.
"Those fund managers are disciplined investors who are willing to endure
stretches of underperformance to achieve long-term success," Morris said.
The Bill & Melinda Gates Foundation, the Microsoft Corp. founder's charitable
organization, also recently disclosed new ownership stakes in some value-priced
builder stocks.
"You need to approach this ETF with a similar mindset," Morris added. "There
could be volatility ahead that might test your patience."
(END) Dow Jones Newswires
11-19-06 2254ET
Copyright (c) 2006 Dow Jones & Company, Inc.