2 Small Caps: Should You Bet the “House”?

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By Ronald Tech

The housing supply problem in the US is well-documented. And mortgage originations and refinancings have shown an acute sensitivity to the Fed funds rate. We believe the combination of this supply issue and possible falling rates could provide favorable catalysts for homebuilders, although the exact cadence of possible rate lowering by the Fed is unclear. Additionally, relative market location strength also plays a critical role in stock selection.

Here we highlight two homebuilders with Zacks Outperform ratings, but with different business complexions. Hovnanian Enterprises (HOV) is a well-diversified builder with a focus on first-time and move-up buyers. Hovnanian’s deliberate focus on 27 of its most profitable markets allows it to mitigate risks associated with geographic concentration while maximizing returns from high-demand areas.

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On a geographical basis, 48.6% of FY23 sales were derived from the West, 35.5% from the Northeast, and 16% from the Southeast. Hovnanian Enterprises’ (HOV) aggressive land acquisition strategy has led to a 34% year-over-year increase in total lots controlled, reaching 39,516 as of July 2024.

The company raised its full-year adjusted income before taxes guidance midpoint by 11%, projecting it to reach $313 million. Total revenues are expected between $2.9 billion and $3.05 billion. Adjusted EBITDA is projected between $420 million and $445 million, with earnings per share estimated between $29 and $31.

The stock is currently trading at 0.39X trailing 12-month EV/Sales TTM, which compares to 1.41X for the Zacks sub-industry, 3.58X for the Zacks sector and 5.47X for the S&P 500 index.

Over the past five years, the stock has traded as high as 0.65X and as low as -0.08X, with a 5-year median of 0.08X.

As of July 31, 2024, the company had nearly $899 million in senior notes and credit facilities, along with more than $115 million in non-recourse mortgages secured by inventory.

AMREP Corporation (AXR), unlike Hovnanian Enterprises (HOV), is focused exclusively upon one real estate market: New Mexico. AMREP (AXR) holds a competitive advantage due to its significant land holdings and operations in New Mexico. The company’s focus on residential land development in the rapidly growing Albuquerque metropolitan area positions it well to benefit from ongoing demographic shifts. As regions like New Mexico experience housing demand driven by affordability compared to other states, AMREP’s expansive land inventory (valued at $52.7 million as of July 2024) is a strategic asset.

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Revenues were up 85.5% year over year, reaching $19.1 million, with land sale revenues contributing $9.3 million, up 40.4% from $6.7 million in the prior-year period. The increase in land sales was largely due to the higher sales of developed residential land. Home sale revenues saw an even steeper increase, rising to $8.9 million, up 164.3% from $3.4 million, as the number of homes sold rose from 6 to 21 during the quarter.

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The operating income in first-quarter fiscal 2025 totaled $4.9 million, up 146.8% year over year. Net income in the fiscal first quarter increased 201.9% to $4.1 million in first-quarter fiscal 2025 from $1.3 million in first-quarter fiscal 2024.

AMREP maintains a solid financial position, with total cash and equivalents of $40.9 million as of July 31, 2024. The company has negligible debt. The operating income in first-quarter fiscal 2025 totaled $4.9 million, up 146.8% year over year.

Despite the significant growth, cost management remains a challenge. The cost of home sales grew in line with revenues, resulting in lower gross margins in the homebuilding segment, which fell to 19% from 29% a year ago due to rising input costs and an increase in smaller-sized homes sold.

The stock is currently trading at 1.9X trailing 12-month EV/Sales TTM, which compares to 3.6X for the Zacks sub-industry, 1.2X for the Zacks sector and 5.5X for the S&P 500 Index.

Over the past five years, the stock has traded as high as 2.6X and as low as 0.7X, with a five-year median of 1.4X.

The stock is currently trading at 2.6X trailing 12-month P/S TTM, which compares to 3X for the Zacks sub-industry, 5.1X for the Zacks sector and 5.7X for the S&P 500 Index.

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Hovnanian Enterprises Inc (HOV) : Free Stock Analysis Report

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