This Small Bet on Housing Could Build Into Something Big
Here's why and how after being a long-time bear on the sector, I am establishing an initial position in, yes, a homebuilder.
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My regular readers here on TheStreet Pro know that I have been bearish on the housing sector for more than a year now. Housing affordability remains near historical lows and mortgage rates still hover near 7%. Home prices have managed to still climb slightly, largely as a result of the "lock in effect" where existing homeowners are unwilling to put their properties on the market due to the low mortgage rate loan they have against them.
Existing home sales both in 2023 and 2024 came in at the lowest levels since 1995. The lack of existing homes on the market benefited new homebuilders for some time as they built to meet demand. However, those forces are ebbing, and new home inventory has surged in recent quarters. This has resulted in homebuilders needing to offer additional incentives such as free upgrades and mortgage-rate buydowns to move houses in their communities. This is having an increasing impact on profit margins.
Beazer Homes BZH is not immune to these forces and in its most recent quarterly report, the homebuilder saw gross profit margins fall some 470 basis points from the same period a year ago to 15.2%. Meanwhile, the stock declined around 25% immediately after posting those earning results in late January but is in the process of staging an impressive recovery in recent trading sessions. I took an initial stake in Beazer Homes this past week as the equity started to rebound.
There are several reasons I dipped my toe back into the water in the housing sector with this new stake in Beazer. The stock is still down a quarter from its recent highs in late November. Management has done a commendable job reducing the leverage of its balance sheet in recent years, giving me confidence that the company is well-positioned should headwinds increase for the overall housing sector. In addition, there were some good data points within Beazer's most recent quarterly report. While profits margins fell, sales still increased by about 20% on a year-over-year basis as Beazer continues to increase its community count. Average selling prices also held up well and the cancellation rate fell noticeably from the same quarter a year ago. What's more, the company did a good job pushing some operating costs lower.
BZH stock trades at less than six times trailing earnings. And while profits look like they will fall about 20% to 25% in this fiscal year (ending September), revenues should rise in the low teens and management is committed to using some of that cash flow to reduce balance sheet leverage further and buying back stock.
Finally, unlike some homebuilders such as Lennar LEN and Toll Brothers TOL, whose stocks trade at significant premiums to book value even after their recent declines, BZH trades at a solid discount to book value. The equity also has solid liquidity in the options against it.
Option Strategy
This is how one can initiate a holding in BZH with a covered call order. As a reminder, covered call orders involve buying an equity and simultaneously selling just out of the money call strikes against the new position.
Using the August $24 call strikes, fashion a covered call order with a net debit in the $21.00 to $21.30 a share range (net stock price - option premium).
This strategy provides downside protection of just over 15% with upside potential of 13% even if this equity trades slightly down over the option duration.
At the time of publication, Jensen was long BZH.
