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For Now, D.R. Horton Avoids Fallout from Declining Energy Prices

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D.R. Horton’s 3Q16 EPS 

D.R. Horton (DHI) reported net income of $294.8 million, or $0.66 per share, for 3Q16. On a YoY (year-over-year) basis, the net income rose 13% from $221.4 million or $0.60 per share. This was right in line with Wall Street expectations.

D.R. Horton is based in Texas. Analysts fear that the fall in energy prices will hit the Texas housing market. D.R. Horton is seeing some softening in the market in Texas, especially Houston. So far, the worries about Texas haven’t come to pass, as strength in other markets like Dallas and San Antonio are offsetting any weakness in Houston.

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Profit margins rise as gross margins increase and SG&A falls

The gross margins were up 40 basis points on a sequential basis and on a YoY basis to 20.3%. Meanwhile, SG&A (selling, general, and administrative) expenses decreased from 9% to 8.9%. D.R. Horton has been making strides in improving SG&A expenses. Pre-tax profit margin was up 40 basis points to 11.7%.

Size and scale matter

Big builders like PulteGroup (PHM), Lennar (LEN), and Toll Brothers (TOL) have an advantage over smaller builders. They’re able to access capital markets and raise funds very cheaply. Smaller builders are finding themselves almost shut out of the capital markets. This gives bigger builders a tremendous advantage.

Large institutional investors are almost throwing money at the bigger builders. The smaller guys can’t take advantage of opportunities due to tight credit conditions. Smaller builders typically borrow from their local community banks. Many of them are still hurting from the real estate bust. They don’t have much of an appetite for construction loans.

Mergers and acquisitions might take hold

This climate is certainly a recipe for M&A (mergers and acquisitions). Smaller builders will be driven into the arms of the bigger builders. Between rock-bottom borrowing rates and the inherent advantages of size, we should see more M&A activity. D.R. Horton addressed M&A on the conference call. It continues to look at potential transactions. However, cultural fit is important to the company.

We’ve already seen some deals in the sector. We saw a wave of mergers in the late 1990s in this sector while it recovered from the small bust of the late 1980s and early 1990s. The recent deal between Standard Pacific and Ryland Group, forming CalAtlantic Group (CAA), could be a harbinger of things to come. Investors who want exposure to the homebuilding sector can look at the SPDR S&P Homebuilders ETF (XHB).

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