Moody's Calls Bottom in Homebuilders, Sort Of (XHB, ITB, HOV)

Moody’s Investors Service has raised the bias and outlook on the U.S. homebuilder sector this morning.  Its report was titled “U.S. Homebuilding Industry Shows Signs of Stability” and the ratings agency raised the sector’s outlook to Stable from Negative.  In short, Moody’s believes or suggests that a bottom has been reached.  There are some concerns still present here that might be worth a consideration before just hoping that the key stocks in the sector or that the key ETFs tracking housing will be great buys in 2010.

The SPDR S&P Homebuilders (NYSE: XHB) is down only about 0.25% at $14.83 on the day versus a 52-week trading range of $8.00 to $16.75.  The iShares Dow Jones US Home Construction (NYSE: ITB) is down about 0.8% at $11.63 verss a 52-week trading range of $6.33 to $13.93.  Both ETFs have recovered from their lows.  Hovnanian Enterprises Inc. (NYSE: HOV) had a huge day yesterday on the heels of the housing starts data, but the after-hours and pre-market reaction to its earnings, ergo losses, was a selling of the stock.  The homebuilder posted a wider-than-expected loss and it noted a 24% cancellation rate during the quarter.  The stock was down over 10% after earnings in the after-hours session, but came up substantially off of its lows to being down 6% and we had shares trading at the similar level this morning in pre-market.  At 10:35 AM we have shares down only about 4% at $4.06 (versus 52-week trading range of $0.52 to $5.75), and part of this recovery may be due to the Moody’s report.

Moody’s synopsis is that the stable outlook expresses a view that fundamental credit conditions in the industry will neither erode nor improve materially over the next 12 to 18 months.

Moody’s has cited that housing starts, new home sales, and existing home sales have all shown positive trends, and housing affordability is at the strongest point seen in many years.  This is on the heels of a November figure showing a 8.9% rise in housing starts.

While specifics from homebuilders may be sketchy when you review the latest earnings from homebuilder stocks, Moody’s did note that operating profits of the rated homebuilders are also expected to show modest improvements in 2010.  Of course, US government support remains a critical piece of the puzzle, and any backing away from that would put the rating outlook at risk of going back to negative.

The issue to consider is here is the availability of mortgages and whether foreclosures can abate substantially in 2010.  Foreclosures are competing against new home sales and existing home sales.  If the shadow supply from the banks and lenders that was foreclosed or has been given a permanent reprieve from foreclosure come on the market, the worst case scenario for homebuilders can come back: houses will start selling for cheaper than they can be built.  That seems to be the case in Michigan now, and it was certainly the case during the Texas bust of the 1980’s.

JON C. OGG