Best to take wait-and-see approach to homebuilder stocks, says Jim Cramer

Key Concepts

• Homebuilder stocks and their reaction to Fed rate cuts
• Lennar's Q3 performance and outlook
• KB Home's Q3 performance and outlook
• Impact of mortgage rates on housing demand
• Gross margins and incentives in the homebuilding industry
• Speculative builders (spec builders) and their impact on the market
• The "wait and see" approach of potential homebuyers
• The relationship between Fed rate cuts and long-term interest rates

Lennar's Q3 Performance and Outlook

• Initial Optimism vs. Reality: Over the summer, home builders rallied, anticipating rate cuts from the Fed. However, Lennar's Q3 results revealed a "continued softening of market conditions and affordability."
• Financial Results: Lennar posted weaker-than-expected revenue, with lower-than-expected deliveries. Average selling prices were in line with expectations.
• Gross Margin Decline: The housing gross margin was 17.5%, 30 basis points lower than anticipated and 500 basis points lower than the previous year.
• Earnings Outlook: Lennar expects earnings for the current quarter to be below expectations.
• Incentives and Pricing: To achieve sales, Lennar used additional incentives, which negatively impacted gross margins. They aim to be less promotional going forward.
• CEO Stuart Miller's Commentary: While acknowledging "early signs of greater customer interest and stronger traffic," Miller stated that "stronger sales have not yet followed" the downward trend in mortgage rates.
• Cost Cutting: Lennar has cut construction costs due to the extended period of high interest rates, aiming for a leaner cost structure to benefit from a market rebound.
• Rate Expectations: Lennar believes demand will increase significantly when mortgage rates approach or fall below 6%.
• Interest Rate Sensitivity: Lennar needs lower long-term interest rates to improve performance.

KB Home's Q3 Performance and Outlook

• Better Than Expected Results: KB Home posted better-than-expected sales, average selling prices, and deliveries (though still down year-over-year). Gross margin also exceeded expectations, leading to a bottom-line beat.
• Sales Forecast Cut: Despite the positive results, KB Home cut its full-year sales forecast by a sizable amount.
• Long-Term Optimism: Management remains optimistic about the long-term outlook for housing, citing demographics and a shortage of homes.
• Positive Signs: KB Home saw positive signs starting in June, including price stability and demand.
• Mortgage Rate Impact: The company highlighted that the roughly 60-basis-point decline in mortgage rates translates to $30,000 of purchasing power for their customers, who are primarily first-time homebuyers or those looking to upgrade.
• Strategic Approach: Unlike Lennar, KB Home is not focused on chasing incremental volume and is avoiding competing with speculative builders who are heavily discounting to close out the year.
• Order Uptick: While orders have been good, KB Home hasn't seen the "big uptick" they expected from the change in mortgage rates.
• "Wait and See" Mode: Potential homebuyers may be waiting for rates to decline further before making a purchase.
• Stock Buybacks: KB Home prefers to buy back stock rather than build homes if gross margins are expected to decline.

Mortgage Rates and Market Dynamics

• Current Rates: The current rate for a 30-year fixed mortgage is roughly 6.4%, down from over 7% but still above the sub-6.2% level seen before the Fed rate cut.
• Long-Term Rate Concerns: There is concern that long-term rates are rising again after the Fed rate cut, potentially repeating the previous year's scenario where Fed cuts didn't lower mortgage rates.

Conclusion

Based on the commentary from Lennar and KB Home, the initial optimism surrounding Fed rate cuts and their impact on the housing market may have been premature. While both companies are optimistic about the prospect of lower mortgage rates, the recent rise in long-term rates presents a challenge. A "wait and see" approach is recommended for homebuilder stocks, given the uncertainty in the bond market and the potential for a repeat of the previous year's negative outcome. The key takeaway is that lower mortgage rates are crucial for the success of homebuilders, but the relationship between Fed rate cuts and long-term rates is not always straightforward.