Federal Reserve chief Ben Bernanke lifted the mood of the markets as he said the end of the quantitative easing is still some time away in the future. This clearly acted as a sentiment booster for the interest rate sensitive sectors such as housing which fell some time ago when markets assumed the central bank was to wind up the stimulus program. Included among the prominent gainers are NVR, Inc. (NYSE:NVR), D.R. Horton, Inc. (NYSE:DHI), and Toll Brothers Inc (NYSE:TOL). However, there is more to these stocks than just sensitivity to interest rates:
NVR Posting Strong Growth
Virginia based homebuilder NVR, Inc. (NYSE:NVR) has dropped more than 10 percent over the last three months but has started looking up after Bernanke’s comments. In line with the general recovery in the housing market, the company has been posting strong growth in sales and profits – a trend that continued in the first quarter ended March 31. In terms of trading valuations, it is available at an attractive forward price earnings ratio of 12.8 while a price by sales ratio of 1.37 indicates the stock is reasonably priced.
Up-and-Coming Small- and Mid-cap Portfolio Managers #MICUS (Morningstar Conference)
Notes from Laird Bieger of Baron Capital, Mark Wynegar of Tributary Capital Management, and Amy Zhang of Alger Funds' presentation from the 2020 Monringstar Investment Conference. Q2 2020 hedge fund letters, conferences and more Up-and-Coming Small- and Mid-cap Portfolio Managers Our manager research team has been publishing its semiannual Morningstar Prospects report for several years. Read More
A high interest rate regime is certainly not so conducive for homebuilders but NVR has got an ace up its sleeves in terms of a debt equity ratio of just 0.39. For a capital intensive business such as contracting houses, anything less than 1 is the cherry on the cake. This low reliance on debt allows the company to better navigate in a high interest environment.
Captive Mortgages Financing Units Beef Up the Fortress
Similarly, D.R. Horton, Inc. (NYSE:DHI) is a homebuilding company whose stock saw a sharp correction towards the end of June before gathering some momentum after the latest assurances that the central bank will keep printing money. Still, the stock remains down 9 percent over the last three months. Fundamentally, the company continues to do well and that’s the reason most analysts have positive calls on the stock with target prices close to $30 – reflecting potential upside of 33 percent from current levels.
It trades at a forward price earnings ratio of 12.4 and has a debt equity ratio of just 0.87. At the same time, price by sales ratio sits comfortably at 1.3. Another positive with the company is a well functioning mortgage unit. D.R. Horton’s captive business through D.R. Horton, Inc. (NYSE:DHI) Mortgage increased to 86 percent in the latest quarter, up from 82 percent in the same period last year. A dedicated mortgage unit acts as an effective tool to lessen the burden of high interest rates by passing on the additional costs to buyers.
Toll Brothers Best Place to Deal With Interest Rates
Toll Brothers Inc (NYSE:TOL) is probably best placed in terms of capability of dealing with interest rates. The company has a strong focus on constructing luxury homes – a segment which has proven to be resilient to interest rate cycles. Its annual performance is up nearly 20 percent but still trades at a 13 percent discount to its 52 week high scaled in May. Like other stocks mentioned here, Toll Brothers also has an advantage of a lean capital structure as debt comprises only 78 percent of its equity.
In the year ended October 31, 2012, the company recorded a growth of 27.6 percent in sales but profits grew manifold from $39.8 million to $487 million. This momentum continued in the latest quarter and going by the fundamentals in place, there is no reason to believe it wouldn’t in future. As the economy continues to recover, Toll Brothers Inc (NYSE:TOL) is expected to be in the front row of strong performers.
In a nutshell, these companies are fundamentally strong players and offer some immunity to surging interest rates. Even though high interest rates eventually translate into reduced demand for homes, companies with lower dependence on debt have one factor less to worry about.