2 Homebuilding Stocks to Avoid as Interest Rates Rise

The 30-year fixed-rate mortgage's average contract interest rate has climbed to 3.72% from 3.64%, prompting fears among homebuyers that they will no longer be able to afford the properties they want. According to the Mortgage Bankers Association's seasonally adjusted index, mortgage refinancing applications, which are particularly sensitive to daily rate swings, have declined 13% for the week and are 53% lower year over year.

In addition, considering the Fed's decision to hike interest rates in March to tame inflation, persistent supply chain crisis, and a tightening labor market, the home building industry's growth prospects could be negatively affected.

Therefore, we think investors are better off avoiding homebuilding stocks Toll Brothers Inc. (TOL) and KB Home (KBH). These stocks have suffered significant price declines over the past few months and could continue to retreat further based on their bleak growth outlook.

Toll Brothers Inc. (TOL)

TOL and its subsidiaries design, build, market, sell, and arrange to finance a variety of detached and attached houses in luxury residential communities around the United States. Traditional Home Building and City Living are the company's two operational segments. In addition, it has a strategic partnership with Equity Residential to develop new rental apartment communities in the U.S. markets. TOL is headquartered in Horsham, Pa.

TOL's selling, general, and administrative expenses increased 4.8% year-over-year to $258.19 million in the fourth quarter, ended Oct. 31, 2021. Its 22.4% trailing-12-months gross profit margin is 37.6% lower than the 35.9% industry average. Also, its CAPEX/Sales multiple and asset turnover ratio are 69.6% and 25.7% lower than their respective 2.5% and 1.1% industry averages.

The stock has declined 7.1% in price over the past three months and 20.3% over the past month.

KB Home (KBH)

KB Home is a Los Angeles-based home building company. It primarily caters to first-time, first-move-up, second-move-up, and active adult homebuyers by building and selling connected and detached single-family residential houses, townhomes, and condos. The company operates in four segments: West Coast, Southwest, Central, and Southeast. In addition, it provides financial services, such as insurance and title services.

For the fourth quarter, ended Nov. 31, 2021, KBH's cost and expenses increased 35.4% year-over-year to $1.45 billion. Its interest income declined 97.2% from its year-ago value to $11,000. The company's cash and cash equivalents decreased 57.3% from the prior year to $290.76 million.

KBH's 22.5% trailing-12-months gross profit margin is 37.4% lower than the 35.9% industry average. Also, its CAPEX/Sales multiple and asset turnover ratio are 75% and 2.3% lower than their 2.5% and 1.1% respective industry averages. Furthermore, its trailing-12-month cash from operations stood at a negative $198.76 million compared to the $183.70 million industry average.

The stock has declined 17.4% in price over the past nine months and 7.4% over the past month.

TOL shares were trading at $55.62 per share on Thursday morning, down $0.55 (-0.98%). Year-to-date, TOL has declined -22.98%, versus a -7.22% rise in the benchmark S&P 500 index during the same period.

Pragya is an equity research analyst and financial journalist with a passion for investing. In college she majored in finance and is currently pursuing the CFA program and is a Level II candidate.

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