D.R. Horton

D.R. Horton posted decent fiscal third-quarter results but gave a mixed outlook. The 30-year fixed-rate mortgage reached 6.05% in February, but inflation concerns have reignited downside risks for the housing industry, as mortgage rates have risen to about 6.5% since then.

Why it matters: Third-quarter revenue and homes sold came in at the higher end of the guidance despite concerns about consumer sentiment and elevated rates. Despite a reasonably strong quarter, management reduced its full-year guidance, highlighting the weakness in the housing market. Homes closed increased 3.6% year over year to 23,983, but average price declined 2.1%, resulting in homebuilding revenue growth of 1.4%. Strong volume resulted in pretax income of $1.2 billion and 13.3% margin, higher than management's 12.2%-12.7% guidance. Despite the quarter's outperformance, management reduced its full-year guidance for homes closed to 83,800-84,300 from 86,000-87,500. The guidance reduction is 2,700 at the midpoint for the fourth quarter and points to continued stress in the market.

The bottom line: We are maintaining our $150 fair value estimate for no-moat-rated D.R. Horton as our longer-term outlook is unchanged. While we are cautious about the near term, we continue to believe that the homebuilding market is currently in a cyclical downturn. We expect the firm's midcycle pretax margin to be around 14.0%-14.5% once the housing market recovers. Homebuilders are materially affected by factors such as geopolitical turmoil, consumer sentiment, unemployment, and mortgage rates. However, D.R. Horton's affordable price points and best-in-class operations will allow the company to adjust faster than its peers if conditions deteriorate further.

Big picture: The affordability crunch affecting the sector is real, but demand can recover rapidly if mortgage rates decline.

While volume is expected to remain under pressure, we are impressed by the firm's margin performance in a challenging environment. The firm reported gross margin of 20.7% in the homebuilding segment, which is encouraging in the current context. On a midcycle basis, we project homebuilding gross margin of 22% for the company and think there is possible upside to this assumption, given recent performance.

Affordability steadily worsened between 2019 and 2024 as the median sale price for existing homes in the US increased about 50%, far surpassing the concurrent increase in median household income. To make matters worse, the average 30-year fixed-rate mortgage more than doubled from the 2.65% low in 2021. The impact of higher rates on affordability can be seen in significantly higher monthly mortgage payments. D.R. Horton primarily caters to the affordable housing segment, and its customers are highly sensitive to higher monthly housing payments. Sales incentives like rate buydowns have helped maintain volume, but affordability remains a core concern. Prospective customers are shifting to the rental market, as renting is much more affordable right now than buying a home. This is having a direct impact on demand and the need to maintain high incentives to move volume.

We are maintaining our $150 per share fair value estimate after incorporating the latest results. Our fair value estimate equates to 12.5 times our adjusted EPS estimate for 2027 and about 1.7 times our estimate of tangible book value per share for 2027. Our weighted average cost of capital for the firm is 10.0% based on a cost of equity of 10.3%, a 24.5% long-term tax rate, and a 95% equity weighting.

Our revenue growth projections are based on our US housing demand forecast, along with D.R. Horton’s market share and average selling price assumptions. We forecast D.R. Horton to increase consolidated revenue at about a 4.2% compound annual growth rate, or CAGR, through 2035. We expect single-family housing starts to rebound to over 1.1 million units by 2029 as the housing market recovers and starts to remain above 1.05 million units on a midcycle basis. We expect D.R. Horton to continue to gain market share and project its share of home sales to reach 15% by 2035 from about 13% in 2025, due to its strong position in the entry-level market and ability to acquire prime land through its scale. This results in a 3.2% CAGR for homes closed over the next decade. We assume roughly 1.2% ASP growth through 2035 (compared with 2025) due to a continued mix shift to lower-priced homes and moderating new home prices in 2025-26. We model D.R. Horton's 2027 delivered home ASP to be about 5% lower than the 2022 peak, with low-single-digit price appreciation thereafter.

D.R. Horton and other homebuilders enjoyed robust pricing power between 2020 and the first half of 2022, which resulted in elevated gross profit margins. Indeed, D.R. Horton's home sales gross margin reached nearly 29% in 2022 compared with 20.7%, on average, between 2016 and 2020. However, more recently, D.R. Horton, along with the homebuilding industry, has increased sales incentives and selectively lowered base home prices to improve affordability and support a steady sales pace. D.R. Horton's gross margin moderated to 23.5% in 2023-24 and slipped to 21.6% in 2025. We project gross margin to remain around 20%-21% in 2027 as incentives and pricing actions will be needed to attract buyers in a sluggish housing market. However, we see D.R. Horton's home sales gross margin improving to 23% by 2030 as mortgage rates normalize and economic conditions improve. Over the longer term, we expect D.R. Horton's gross margin to migrate closer to 22% on a midcycle basis due to greater competition from the resale market (as existing-home sales normalize), with little relief in labor and land costs.

Selling, general, and administrative expenses as a percentage of home sales revenue increased 40 basis points in fiscal 2024 to 7.5% and another 80 basis points in 2025 to 8.3%. We think this ratio will remain at or above 8% in 2027 due to the weak housing market and the inherent operating leverage within the business. But over the long run, we expect revenue growth, share gains, and efficiency improvements to unlock operating leverage, reducing SG&A expenses as a percentage of home sales. We model this ratio to average approximately 7.8% over the next 10 years. In comparison, this ratio averaged 9.1% during the five years before the pandemic.

Homebuilder valuations based on a discounted cash flow model are very sensitive to inventory (land, work in progress, and capitalized construction costs) assumptions. For 2026 and 2027, we have modeled the inventory/homes sales revenue ratio as 80% and 76% respectively, driven by a continuation of current housing and rental demand trends. Longer term, we assume that D.R. Horton’s inventory as a percentage of home sales revenue will decrease to 72% given its focus on land-light strategy.

We use a three-stage DCF model for valuation, with the first stage being explicit forecast years. The second and third stage assumptions within our DCF model imply a terminal EV/ EBIDTA multiple of 7.8 times.

We assign a no-moat rating to D.R. Horton, as we believe the firm has limited benefits from its scale and has no significant cost advantages. US homebuilders operate in a highly cyclical, competitive, and capital-intensive industry that makes it challenging to earn consistent economic profits over the business cycle. The market has been consolidating but remains highly fragmented and intensely competitive. Homebuyers looking for new homes in a specific market have many options, and pricing is often the primary lever in their decisions. The industry is characterized by a lack of sustained product differentiation, which translates into minimal pricing power for homebuilders. Due to this dynamic, brand loyalty among homebuyers is virtually nonexistent, making homebuying decisions highly price sensitive. Scale-based cost advantage is the most relevant moat source in the homebuilding industry. Large homebuilders have an advantage over small-scale (local mom-and-pop) builders in their ability to acquire regional builders and capture market share quickly. However, we believe the market, especially in densely populated metropolitan areas, is largely saturated, which will make it harder for builders to grow their market share as quickly in the future.

Industry Dynamics: America's homebuilding industry remains highly fragmented despite considerable consolidation in the past four decades. This fragmentation is driven by the highly local nature of residential construction, where homebuilders must respond to local demand and supply while also navigating complex zoning ordinances, land-use regulations, and building codes. The industry’s low barriers to entry allow thousands of small homebuilders to compete in the US.

Lack of Pricing Power: Due to the highly competitive environment, we believe homebuilders lack significant pricing power. By comparing the average sale price of new homes nationally with homes sold by Lennar and D.R. Horton, we see that large homebuilders adjust their prices in line with the market. Moreover, we believe affordability is a key driver of home prices, as seen in the decrease in D.R. Horton’s average selling price during periods of high mortgage rates. In addition to simple price cuts, homebuilders often turn to incentives (like lower mortgage rates) to maintain a consistent volume, which compresses margins even further during downcycles. We believe D.R. Horton’s lack of pricing power stems from its largely undifferentiated product. We see location, quality, and pricing as critical drivers for consumers. Competitors can also enter new markets and replicate successful product and land acquisition strategies with relative ease, potentially diminishing returns for incumbents. We see few barriers preventing builders from replicating successful product and land acquisition strategies, especially for public companies with the scale, experience, and capital availability to do so.

Cyclicality: The homebuilding industry is highly cyclical, with economic downturns driving significant slowdowns in housing starts. During downturns, smaller homebuilders that do not have strong relationships with banks can feel significant pressure when demand for housing decreases. In response, many of these small firms may trigger price wars to drive up volume, despite suffering poorer margins. Due to the lack of pricing power across the industry, these price wars can exacerbate downcycles even for the largest of homebuilders. On the other hand, during good times, low barriers to entry can fuel the inflow of new entrants when returns are high, thereby lowering returns across the industry.

Land-Light Strategy: Homebuilders have been moving toward controlling land through option contracts that grant them the right, but generally not the obligation, to purchase land at a specified price on a future date. While these contracts boost ROICs, option contracts charge a premium over the underlying asset; therefore, the cost of acquisition, on average, is expected to be higher than buying raw land itself. Land optioning reduces outsized cyclical downside risks, improves capital efficiency, and improves free cash flow conversion, but this strategy can result in margin compression, assuming everything else is equal.

Scale: We believe that the decentralized structure of the industry, across both small and large firms, makes it challenging to gain any cost advantage. D.R. Horton, despite its national scale, hires subcontractors to manage local building operations. The market for subcontractors is highly competitive due to low barriers to entry, and subcontractors are often selected by homebuilders through a bidding process. Additionally, scale does not materially influence the cost of land acquired by homebuilders. We believe larger homebuilders do gain from volume discounts on materials such as timber, concrete, and home appliances, but we also think that most publicly listed builders benefit from similar discounts, preventing large players such as D.R. Horton from gaining any advantage. Overall, these arguments, regarding both labor and material costs, explain why size shows little correlation with margins within the homebuilding industry.

We do not have confidence in the firm's ability to generate excess returns over the next 10 years, given the current industry dynamics. The industry has consolidated significantly over the past few decades, and the competitive positioning of the largest players has improved relative to peers, but the core characteristics of the industry remain unconducive to moats. D.R. Horton’s scale will benefit the company over the next decade, and we expect the firm to continue gaining market share, but we would like to see significantly more consolidation and stronger evidence of volume-based scale advantages before we reconsider our moat rating.

The US housing market is undersupplied. This supply/demand imbalance will take years to address and should support homebuilder pricing power.

There is significant long-term demand for entry-level housing as the millennial generation forms households. D.R. Horton's Express brand is positioned to capitalize on this underserved market.

D.R. Horton's strategic relationship with publicly traded land developer Forestar and its property rental businesses should help fuel growth. The firm’s excellent balance sheet should enable it to weather severe downturns in the housing market.

High home prices, elevated interest rates, and economic uncertainty could cause a meaningful and protracted slowdown in housing demand. Muted demand, along with elevated new homes inventory, can lead to significant margin pressure.

Underemployment and onerous student debt obligations could limit the demand potential from younger generations.

Constrained land supply and elevated labor and material costs, especially if restrictive immigration policies are enacted, could limit D.R. Horton's production and/or profitability on delivered homes.