Morgan Stanley starts homebuilders with cautious view, Toll Brothers only Buy

Morgan Stanley initiated coverage of U.S. homebuilders in a recent report, adopting a cautious outlook for the sector. The firms are deemed better positioned now than before, yet they are experiencing pressure on affordability and margins, according to the bank. Toll Brothers was rated as Overweight, with a price target of $159 - Morgan Stanley's single positive rating in the note.

The other homebuilders allocated by the analysts were Lennar, NVR, and KB Home at Underweight, while D.R. Horton and PulteGroup received an Equal Weight.

Adam Kramer, the analyst responsible for the research, pointed out that builders have gained market share, reduced debt, and adopted land-light strategies. These improvements have positively impacted cash flow and buybacks. However, the analyst cautioned that high inventory levels, falling median new home prices, and the year's most challenging affordability conditions are putting a damper on demand.

Morgan Stanley projects a roughly flat number of closings and average prices in 2027, with a margin deterioration of approximately 50 basis points. The earnings estimates for the six homebuilders in 2027 and 2028 are about 9% lower than the consensus, even though the Street forecasts have already been cut significantly. Kramer believes this presents a re-rating opportunity for Toll Brothers without expecting a sharp earnings recovery.

He noted that affluent buyers are less sensitive to mortgage rates, and Toll Brothers is currently trading at around 10 times forward earnings, the lowest among the group and a 26% discount to peers.

Regarding Lennar, Kramer believes that the company's transition to land-light strategies needs to deliver better earnings. He sees downside potential even when applying a quality premium, and KB Home's discount to book value does not compensate for its weak growth outlook. Additionally, Kramer highlighted the risk that the stocks may recover before the earnings do.