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Investments

Sterne Agee analyst neutral on two homebuilders

Investors should look past cold-weather effects

Construction
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Builders in key areas were battered by the cold weather in the first months of 2014, but investors should look past the effects and at the bigger picture, says Sterne Agee analyst Jay McCanless.

McCanless reiterated his neutral rating on Lennar Corp. (LEN) and KB Homes (KBH) ahead of the two companies releasing earnings next week.

“We estimate approximately 14% of KBH's communities and 26.8% of LEN's communities are located in metropolitan statistical areas affected by the unseasonably cold weather and ice storms from December to February,” he wrote. “Based on the community count growth we expect, we estimate orders declined 15% year-over-year for KBH and increased 15% for Lennar. Also we expect F1Q14E earnings per share from KBH of $0.10 versus $0.16 last year, and we estimate LEN's F1Q14E EPS of $0.19 versus $0.26 last year.”

McCanless said he views the two homebuilders as test cases for the firm’s new Federal Housing Administration lending outlook.

In our note dated 3/11, we discussed the reduction in mortgage loan limits by the FHA that was effective on 1/1/14, and we indicated our belief that investors should look through the loan limit reductions,” McCanless said. “Since we estimate KBH and LEN obtain more than 50% of unit closings from entry-level consumers and since entry-level buyers are typically heavy users of FHA financing, we anticipate these companies are the best test for our thesis. Based on KBH's and LEN's websites, we estimate 43.5% of LEN's communities are located in areas with newly lowered FHA limits, and we believe KBH's exposure is 44.8% of communities at February 24, 2014.

“However, we estimate, based on listed prices, only 10% to 20% of each builder's communities in an affected city could lose sales due to customer financing issues. Consequently, we are effectively in line with the consensus revenue forecast for each company,” he said.

McCanless said the weather issues in the first quarter are well known, and he anticipates investors are willing to look through them.

“If order growth is below our expectations for F1Q14 and the management teams do not have some encouraging commentary about March, then we believe each company's stock price could come under pressure,” he said.

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