Rising Mortgage Rates ‘Temper Our Enthusiasm' For Home Builders, Analyst Warns

JPMorgan has switched from bullish to bearish sentiment on KB Home and has cut D.R. Horton to neutral, but Meritage Homes are now seen as a buy.

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There were declines in the shares of D.R. Horton Inc. and KB Home on Monday as JPMorgan analyst Michael Rehaut backed away from his bullish ratings for the home builders, citing concerns that the recent increase in mortgage rates will hamper the housing market.

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The analyst went so far as to shift his view from bullish to bearish on KB Home KBH, -1.80%, noting that the stock's recent outperformance led to a significant premium relative to its smaller-capitalization peers, which is a risky move.

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“Although we remain positive about home builders for 2023 following a relatively solid earnings season (relative to expectations),” Rehaut wrote in a note to clients that fundamentals may go sideways or even soften slightly over the coming quarter or so as the housing market absorbs the recent increase in mortgage rates of around [7 percentage points].

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D.R. Horton's stock DHI, -1.23% had fallen as much as 1.5% intraday before bouncing to be down 0.4% in morning trading after it had been downgraded from overweight to neutral because of the company's $31.7 billion market cap. From a target price of $107, Rehaut has lowered his target to $102.50 from $107.

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Rather than reflecting the company's above-average fundamental profile, Rehaut believes its premium valuation reflects the company's premium valuation.

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Over the past three months, the stock has risen by 10.1%, and over the past 12 months, it has advanced by 8.2%, while the iShares U.S. Home Construction exchange-traded fund ITB, -1.09% has rallied 15.3% over the past three months and has gained 3.2% over the last year.

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Compared to the S&P 500 SPX, 0.27%, it has gained 3.3% in the past three months but lost 5.8% over the past year.

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After Rehaut's double downgrade to underweight from buy, California-based KB Home KBH, -1.80%, shed 1% but had fallen 2.3% earlier. From $36 to $32.50, he reduced his price target on the stock.

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KB Home is valued higher than its smaller-cap peers, so the stock looks "expensive," especially given that Rehaut expects the company's return on equity and gross margins to be below average.

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In the last three months, the share price of the company has risen 16.9%, but it has fallen 9% over the last year.

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Separately, Meritage Homes Corp.'s stock moved 1.7% higher in morning trade after Rehaut raised his rating to overweight from neutral on the $4.1 billion market cap builder.

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In his view, the current market valuation of the stock does not accurately reflect his outlook for the company's fundamentals to be above average.

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Over the past three months, the stock has soared by 30.7%, and over the past year, the stock has risen by 13.3%.

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