Home builder rally tempting, temporary

By Helen Chernikoff - Analysis NEW YORK (Reuters) - Home builders' share prices are besting the broader market despite recent credit crisis volatility, but until foreclosures stop accumulating their rally may prove ephemeral. Builders' share prices are up 28 percent since mid-July, as measured by Dow Jones' home builders index .DJUSHB. By comparison, Standard & Poor's broader market index .SPX is down 2 percent. Pulte Homes Inc (PHM.N) Meritage Homes Corp (MTH.N) and Toll Brothers Inc (TOL.N) set new 52-week highs last week. But this may not mean housing is bouncing back. Most deem the rally unsustainable. Even a builder has doubts. Pulte Chief Executive Richard Dugas Jr. told CNBC television last week that builders' surging share prices were not an accurate indicator. "We have a ways to go before the fundamentals hit bottom," Dugas said. "There's a difference in what the equities are doing and the fundamentals in the business." Others are more blunt. UBS analyst David Goldberg said the stocks are "way ahead of themselves." Share prices will fall between 20 percent and 30 percent from the recent highs, Goldberg said. Anecdotal evidence that some of the markets hardest hit by the housing crisis, such as Northern California and Washington, D.C., are starting to stabilize might also have buoyed investor hopes. But even in newly stable markets, Goldberg noted, only the best-located communities are truly strong. JP Morgan sees builder shares pulling back in the next few weeks, according to a note by analyst Michael Rehaut. The recent rally was fueled more by a broader rotation strategy as investors exited sectors with outsized gains, such as energy and raw materials, than by value investors making a deliberate bet on builders, Rehaut wrote. GOVERNMENT INTERVENTION The federal government's move to save the economy by shifting bad home and construction loans and their derivatives off lenders' books has fueled much recent volatility, sending builder shares and the broader market up at the end of last week, and down on Monday and Tuesday. Raymond James analysts Paul Puryear and Buck Horne do believe the government's action will make the difference for builder shares. They wrote in a client note that because prices have already fallen, the missing plank to a floor under builder shares is credit availability. The bailout will solve that problem by enabling lenders to start lending again, they said. They see share price gains of 35 percent to 45 percent for the group. On the other hand, JP Morgan's Rehaut believes the intervention will not stop builders' shares from falling again. Unlike Puryear and Horne, he does not think the bailout will make mortgages more available to the bulk of homebuyers, those with low to moderate credit scores. PICK A BUILDER Prices will not stop falling until foreclosures stop rising, which will not happen until the second or maybe even the third quarter of 2009, Goldberg said. Nonetheless, investors tracking foreclosure rates should not wait until they peak to buy back into the builders, Goldberg warned. Historically, home builder shares anticipate a bottom by about five or six months, so investors must seize the coming pullback to build positions in those builders who will emerge strongest from the downturn, he said. The question: Who are they? The answer: Depends on whom you ask. For example, UBS' Goldberg, and Puryear and Horne at Raymond James, like Toll and Ryland Group Inc (RYL.N) for their attractive land position and balance sheet strength. Goldberg rates them a "buy" and Raymond James rates them a "strong buy." But JP Morgan's Rehaut is neutral on Toll, believing its strong balance sheet and cash flow are reflected in its valuation already. He's also neutral on Ryland. Goldberg has a "sell" rating on Pulte, believing its larger land position is risky, while Rehaut rates Pulte "overweight" on its active adult segment, which he sees as a source of long-term outperformance. Opinion is also divided on Centex Corp (CTX.N), with Rehaut rating it "underweight" on the assumption that lower prices and higher charges loom in its near-term future. Goldberg, on the other hand, urges investors to buy it, citing management's focus on manufacturing efficiencies. (Reporting by Helen Chernikoff, editing by Gerald E. McCormick) ʘ