Homebuilder earnings are under pressure, but valuations should expand, says Seaport's Kenneth Zener

Investment Recommendation - Seaport Research Partners upgrades Taylor Morrison and Toll Brothers to "buy" from "neutral," suggesting that the builders' stocks have already priced in much of the negative news and now offer potential upside [1] - The home building analyst believes that the current market sentiment is no longer at the "really bad part" [2] - The stocks have underperformed the market by roughly 40% from their prior peaks, which historically has only led to further downside in the worst housing cycles, a tail risk not currently seen as in play [7][8] Market Dynamics & Strategy - The strategy involves getting into the builders' stocks when the sentiment is bad and exiting when the sentiment is really good [2] - The firm had been short on the group from August until March, when they began rotating half of their stocks to "buy" [2] - Larger, more entry-level builders were initially favored due to concerns around the discretionary buyer and market volatility [6] Florida Housing Market - Florida and Texas previously drove outsized margins for builders [4] - Excess supply is more pronounced in Florida, particularly with HOAs and condo issues, making it the most difficult margin market for home builders [5] - Public builders have been pulling down their inventory by roughly 7% in the first quarter year-over-year, while census data shows an increase of upwards of 10%, indicating a divergence [9] - The Florida market will continue to face margin pressure due to ongoing supply [8] Financial Performance & Outlook - Taylor Morrison derives roughly 35-4% of their profits from Florida, which was a previous concern [6] - Fundamentals are seen as stabilizing, with order declines lessening [7] - While earnings are still expected to be under pressure into next year due to lower volume, the valuation should be expanding, consistent with cyclical industries [10][11]