4 favorites for a housing rebound
A bank, a builder and two lumber plays -- these stocks will benefit from a recovery in the property sector.
We have four top picks for profiting from the key role the housing sector is poised to play as the economy recovers. While we would never claim that any of our recommendations are "sure" things, you can be assured that each company in this high-caliber quartet offers an excellent chance for success.
Despite some recently strong statistics, this important sector remains depressed, with room for growth over the next several years. And for investors looking to identify the biggest and most likely beneficiaries of a recovery in housing, we can mention a few with very high odds of success.
First, Wells Fargo (WFC) is by a wide margin the nation's largest originator of mortgages. Indeed, it wouldn't be wrong to call Wells a near franchise in the mortgage market.
Its largest shareholder is Warren Buffett, and he is on record saying that Wells Fargo should aim for a trillion dollars in mortgages. Although it's already very large -- even for banks -- the company still has enormous room for growth.
By virtually every measure Wells is ahead of the banking pack: its Tier One Capital measure is in double digits, and although there have been a couple of bumps regarding credit quality over the past several years, Wells has been improving dramatically.
Trading at less than nine times 2013 earnings, by any reasonable metric the stock is deeply undervalued. It would be hard to find a better risk-reward combination to play the housing recovery.
Next we'll mention NVR Inc. (NVR), our favorite home builder. It has no debt and has remained profitable throughout the entire housing debacle. Indeed, since housing peaked in 2006 and 2007, the company has purchased about 5% of its common stock, thanks to strong positive free cash flow.
The company rarely speculates on land purchases and has focused on specific geographical areas, such as the Mid-Atlantic States, which is the reason why its profitability has remained so high. The stock price has topped its all-time high -- it's the only home builder that can brag about that.
Some might say with a mid-20 multiple the share price is expensive. We don't agree. Free cash flow yield is well over 5% based on expected 2013 results, and by mid-decade its free cash could easily exceed $100 a share.
This company has continued to use excess cash to retire shares, which compounds earnings growth. NVR's profits in 2011 were about $23 a share and will be well over $50 in 2013.
Our other two picks are real-estate investment trusts (REITs) that profit from the demand for wood and thus are clear and sure beneficiaries of more home building.
Plum Creek Timber (PCL) has a massive resource base of over 6.5 million timberland acres in the U.S. The company manufactures lumber and plywood, so it is clearly leveraged to housing construction.
Cash flow peaked in 2006, roughly coincident with the peak in housing. Since then, this metric (which is most important for a REIT) has drifted lower, but not to the extent that the company has had to cut its dividend, which has remained at $1.68 a share. A jolt to the housing market will lift cash flow, and with a lag also lift the company’s payout. By 2015 the payout could easily approach $2 a share.
Our second REIT pick, Rayonier (RYN), is more dynamic and diversified than Plum Creek, but also somewhat leveraged to the housing market. Rayonier's timber acreage is less than half that of Plum Creek and divided between the U.S. and New Zealand.
The company serves a wide variety of industries in addition to housing. Most of those outside of housing are non-cyclical, such as cigarettes, food products, and pharmaceuticals.
The company began trading as an independent company in 1994. Virtually all important metrics -- cash flow, profits, and dividends -- will hit highs in 2012 and will likely continue to grow at a robust pace for at least the next three to five years.
Dividends, which have grown nearly four-fold over the past decade, will likely continue to march ahead at a double-digit rate.
The combination of dividend and profit growth, plus a modest (for a REIT) valuation in terms of earnings, should make Rayonier an exceptional total return vehicle.
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Why are stronger numbers considered bad news? Investors are worried about the impact on inflation and interest rates.
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