Tag Archives: alternative

Homebuilding ETFs In Focus Following U.S. Home Resale Data

The recent home resale data from National Association of Realtors (“NAR”) indicated that the U.S. homebuilding sector still faces weaknesses. The data showed a 3.4% decline in existing home sales in the U.S. to an annual rate of 5.36 million units in October from 5.55 million units in September. The decline is blamed on the shortage of properties that pushed up prices and discouraged buyers of existing homes. Per NAR, the number of unsold homes for October ebbed 2.3% over the previous month to 2.14 million units. Unsold homes inventory was down 4.5% from the prior year. The tight inventory caused median home price to increase 5.8% from the year-ago level to $219,600, marking the 44th straight month of a year-over-year rise (read: Homebuilder Stocks and ETFs Gain on Solid Data ). Last week, U.S. Commerce Department also revealed disappointing housing starts data for October. Groundbreaking dipped 11% to a seasonally adjusted annual pace of 1.06 million units during the month, the lowest level in the past 7 months. The decline was attributed to slowdown in the construction of multi-family homes. Groundbreaking data for the largest housing market segment indicated a 2.4% fall in single-family home projects for October. Much of the decline has been contributed by a 6.9% downfall in groundbreaking activity in the South, the most active region for the homebuilding sector. Meanwhile, housing starts for the multi-family segment slumped 25.1% to the annual pace of 338,000 units. Notably, new single-family home sales in the U.S. tumbled 11.5% to a seasonally adjusted annual rate of 468,000 units in September from August. This has led to 5.8 months’ supply of new homes in September, the highest since July last year. The U.S. homebuilding sector already faces a major threat from the strong possibility of an interest rate hike by Fed in December. A higher interest rate environment heavily weighs on the affordability of homes. On the other hand, it raises the mortgage rates that could fend off existing homeowners from upgrading to luxury and expensive homes (read: Is it the Right Time for Homebuilder ETFs? ). However, some have predicted that the decline in housing activities during October could be short-lived, particularly when the labor market is improving and the broader market is recovering. Further, industry experts argue that Fed’s lift-off could send a positive signal about the economy and boost consumer confidence. ETFs in Focus The depressing homebuilding reports for October turns our attention to the ETFs tracking the performance of the sector. Although the two major homebuilding ETFs (discussed below) delivered good performance both in the one-month and year-to-date time frames, investors should remain cautious about them given the adverse developments and the threat of an impending rate hike by the Fed (read: Two Homebuilder ETFs & Stocks Set to Soar ). iShares U.S. Home Construction ETF (NYSEARCA: ITB ) This most popular homebuilding fund provides a pure play on the home construction sector by tracking the Dow Jones US Select Home Builders Index. It holds a basket of 41 stocks, with double-digit allocation going to both D.R. Horton (NYSE: DHI ) and Lennar Corp. (NYSE: LEN ). The product has amassed more than $2 billion in its asset base and trades in heavy volume of more than 3.7 million shares per day, on average. The ETF charges 43 bps in annual fees, and has added about 2.9% in the past one month and 10.4% in the year-to-date period (as of November 24, 2015). It has a Zacks ETF Rank #2 (Buy) with a High risk outlook. SPDR S&P Homebuilders ETF (NYSEARCA: XHB ) XHB follows the S&P Homebuilders Select Industry Index, representing the homebuilding sub-industry portion of the S&P Total Markets Index. The fund holds 36 securities in its basket, with none accounting for more than 3.87% of the assets. It has garnered about $1.9 billion in its asset base and exchanges a heavy volume of roughly 3.4 million shares per day, on average. XHB charges 35 bps in annual fees and returned 0.6% in the last one-month and 6.9% so far this year. It has a Zacks ETF Rank #2 with a High risk outlook. Original Post

Exelon Corp. Is A Buy

Summary EXC has a low beta which will help during potential market downturns. EXC underfunded pension liability offers a “negative earnings duration” which will benefit from rising rate environment. Forward dividend yield of 4.48% is supported by large dividend coverage ratio. Common shares are selling at a discount compared to historical valuations and peer group. Exelon Corp. (NYSE: EXC ) is a utility services holding company engaged in the energy generation and delivery business through its segments, Generation ComEd, PECO and BGE. According to the company’s website : Exelon’s family of companies represents every stage of the energy value chain. Exelon Generation is one of the largest competitive United States power generators, with approximately 32,000 megawatts of owned capacity comprising one of the nation’s cleanest, lowest-cost power generation fleets. Constellation provides energy products and services to more than 2 million residential, public sector and business customers, including more than two-thirds of the Fortune 100. And Exelon’s three utilities deliver electricity and natural gas to more than 7.8 million customers in central Maryland (BGE), northern Illinois (ComEd) and southeastern Pennsylvania (PECO).” Every day, we hear news about an impending stock market decline and an increase in interest rates. It was under this pretense that I went searching for companies that provide protection in both a rising interest rate environment and low beta stocks which could spare my portfolio in the event of a downturn. Low Beta The beta of a stock represents the systematic (market) risk of a company. When the beta is positive, the stock prices tend to move in the same direction as the market, and the magnitude of the Beta tells by how much. A stock beta greater than 1 implies that when the market goes up by 1%, we expect the stock to go up by more than 1% – the opposite is true if the market goes down by 1%. Utility companies are considered “Defensive” stocks because they typically have steady cash flows, attractive dividend yields and lower-than-average betas. Exelon is considered a “Diversified Utilities” company and has a lower-than-average beta of .24, compared to an average beta of .48 for all the “Diversified Utility” companies in the Russell 3000. All else being equal, we would expect to outperform its peer group in the event of a market downturn. Negative Earnings Duration What makes this sector especially enticing is that most of the firms have underfunded pensions, which represents a liability on the balance sheet. While that sounds ominous, it is quite common for older companies with pensions given the large amount of baby-boomers retiring today. In order to calculate the magnitude of the underfunded pension, you need to project out the future pension payments and discount them back at a specified rate of return, typically tied to the current interest rates. The difference in the pension liabilities is added or subtracted from earnings, depending on whether the liability is becoming smaller or larger. I like to call this “negative earnings duration” because the liability becomes smaller when you increase the discount rate (denominator). Duration measures the fall in price of a security given a 1% (parallel) rise in interest rates. In fixed income terms, we can say EXC has a negative earnings duration because earnings rise in a rising rate due the reduction in pension liability. Increasing interest rates reduce pension liabilities and increase earnings, all else equal. A quick glance at the magnitude of underfunded pensions in this sector makes EXC standout as an EPS beneficiary in a rising rate environment, given the size of its pension liability. On the Q3 conference call, Exelon management mentioned that every .25% rise in interest rates will lead to a .02 EPS increase. (click to enlarge) EXC selling at a discount compared to historical valuations and peer group Currently, EXC is selling below its 3 and 5 year price/earnings multiples, which could imply future mean reversion. Diversified utility companies typically have predictable cash flows and earnings due to the nature of the business and their hedging strategies. The charts below highlight the current PE multiple compared to its 3- and 5-year median as well as EXC quarterly earnings compared to analyst estimates. As expected, the actual earnings tend to oscillate around the estimates. (click to enlarge) (click to enlarge) Compared to its peer group, Exelon is selling at a discount by a nice margin based on PE multiples which implied that it is cheaper to own per share of earnings compared to its peer group: (click to enlarge) Dividend Coverage and Valuation Investors look to the utilities sector for dividends and EXC has not disappointed. The company has paid dividends consistently over the last 10 years and sports a healthy dividend coverage ratio. Dividend Cover is calculated by EPS/Common Dividends. For companies such as Exelon that are known to consistently pay dividends, taking a look at the dividend coverage ratio can be an effective way to see if dividend payments are being harder to make over time. Currently, dividend coverage is 1.816, which is healthy from historical perspective and makes the current dividend yield of 4.49% all the more attractive: (click to enlarge) When valuing EXC, we can look at the historical price earnings and price sales ratios for Exelon and its peer group over the last 20 years. From there, we can use the 2015 estimates for earnings and sales to derive a price for each and average the two together: Historical PE Multiple for EXC and Peer Group Average Median Blend 2015 EXC EPS estimate Price 1995-Present 22.9 16.2 19.55 2.5 48.875 Historical PS Multiple for EXC and Peer Group Average Median Blend 2015 EXC sales per share Price 1995-Present 1.5 1.23 1.365 28.11 38.37015 Source: Ycharts Blended price based on PS and PE 43.6258 Based on historical analysis, an intrinsic value of $43.62 represents a 58% upside from the current price ~$27.5 per share. Given EXC’s dividend coverage, low beta, (-) earnings duration and discount valuation, I believe it is a buy at these levels.

Residential REITs Offer Steady Dividends With Long-Term Growth Potential

Summary REZ is a well-diversified ETF with both moderate long term growth potential and a 3.3% dividend yield, making it a great income play. REZ has ~49% of its holdings in residential REITs, which are expected to experience steady demand over the next few years as renting becomes more and more attractive. REZ also has ~29% of its holdings in healthcare REITs, which are primarily composed of different types of senior housing. As baby boomers retire, demand here is expected to skyrocket. Finally, REZ has ~22% of its holdings in self-storage REITs, a booming industry of late. They tend to follow economic trends, so I’m bullish on self-storage REITs as well. The potential risk posed to REITs from an interest rate hike is not to be ignored, as it increases the cost of financing new projects. The iShares Residential Real Estate Capped ETF (NYSEARCA: REZ ) is a popular ETF for those who wish to invest in US residential real estate without actually being a landlord. It does this by using the FTSE NAREIT All-Residential Capped Index as its benchmark index, which is comprised of many different REITs. Taking into account demographic changes, a trend towards renting instead of buying and a recovering economy, I’m bullish REZ in the long term. I view it as a great income play with moderate long-term growth potential as well. REZ Overview Offering an attractive dividend yield of 3.3% and a tolerable expense ratio of 0.48%, this ETF has been popular with investors since its inception in May 2007. It currently has about $316MM in assets. REZ can generally be looked at as holding 3 different types of REITs. The first are obviously residential REITs, which develop multifamily housing such as apartment complexes. The second are healthcare REITs, which can generally be categorized as senior housing. The third are self-storage REITs. (click to enlarge) (Source: Data for chart by iShares.com ) To find the holdings for the chart above, I went through each individual holding and categorized it as self-storage, healthcare or residential. Some that I categorized as residential may have been categorized by iShares as specialty. Due to this, my percentages are about 2% off of iShares own classification, which is between residential, healthcare or “specialty” (which I felt was too broad). As you can see, while traditional residential REITs make up 49% of this ETF, there are still significant investments in self-storage and healthcare REITs. Due to this, one has to consider many more factors than just the residential housing market when considering investing in REZ. I’ll be reviewing the outlook for all 3 of the different types of REITs in this article. Residential REITs Outlook Housing prices are just below record highs, but this time it’s not thought to be a bubble , as strong economic growth has fueled increasingly higher housing prices. This is very bullish for residential REITs, as more and more people are resorting to renting. Mortgage requirements are tighter, making it more difficult for lenders to make loans than it was pre-2008. This coupled with slow wage growth makes buying a home less feasible for many people. Additionally, new US housing starts are very low, with these high prices simply mirroring the scarcity of supply. As you can see below, builders still haven’t recovered from the recession. (Source: tradingeconomics.com ) When adjusted for inflation, housing prices are just below record highs, according to the census . The rate at which housing prices have increased has also remained at a respectable level into these highs as well. (click to enlarge) (Source: Data by S&P Dow Jones Indices) Keith Gumbinger, VP of HSH.com, dismissed the idea that a bubble is forming, stating that “Today’s rising prices are fueled by actual market forces, backed up by real money.” This couldn’t be more true in my opinion, and many economists do not believe a bubble is forming either. All of these factors, which make buying a home less and less realistic are very bullish for residential REITs, as people will naturally resort to renting. As you can see in the chart below, the trend has clearly been in favor of renting the last 5 years. The US rental vacancy rate is currently reaching lows not seen since 1985. (Source: US Rental Vacancy Rate data by YCharts) It’s thought that housing prices will continue to increase, albeit at a slower rate than they have in the past few years. I don’t see the vacancy rate significantly rising again either. So with housing prices expected to continually grow, the only risk I can see to this REIT category is the potentially negative effect an interest rate hike could have. This investment is not without its risks though, as higher interest rates increase the cost of financing the balance sheet. This makes projects more expensive for REITs, which depend heavily on debt to finance new projects. Some would disagree that an interest rate hike is net bearish for REITs, saying that increased economic growth and occupancy rates are closely linked to the performance of REITs. They say that once everything is factored in, REITs will come out at a net gain due to increased occupancy rates and inflation. So while the net affect of an interest rate hike isn’t clear, I’d recommend those interested in REZ conduct their own due diligence to decide for themselves. Healthcare REITs Outlook Healthcare REITs make up 29% of REZ’s holdings and are very well positioned to take advantage of the massive impending demographic changes in the United States. The “Baby Boomer” generation is aging, with about 10,000 turning 65 every day . As this segment of the population begins to age, healthcare REITs owning senior housing facilities will see a huge and steady surge in demand. (Source: FiveThirtyEight.com ) Investments in healthcare REITs are a long-term strategy though, so I wouldn’t recommend this ETF to medium-term investors, as nearly a third of REZ’s holdings are in healthcare REITs. As a 2005 study by Stefano DellaVigna and Joshua Pollet found one needs to wait 5-10 years before fully reaping the benefits that demographic changes bring to businesses. I think this finding applies best to healthcare REITs in the current environment. With many of them having been beaten down over the last couple years, there is serious growth potential to go along with the handsome dividends these REITs offer to those who are patient. So for those willing to wait, I view this segment of REZ bullishly in the long term. Self Storage REITs Outlook Self storage REITs, which make up about 22% of REZ’s holdings, have exploded over the last few years in both share price and popularity. With average occupancy rates around 90% and a business that tends to reflect economic trends, there are plenty of reasons to be bullish here. These REITs are extremely profitable as well. REZ’s largest self-storage holding (12% of assets), PSA, had a net profit margin of 52% last year. Most self-storage REITs have performed very well over the past few years as well, showing the sector has growth potential in addition to respectable dividends. I expect demand to grow with the economy as well, so I have a favorable long-term outlook for these REITs. (click to enlarge) (Source: San Clemente Self Storage ) I expect demand for these self-storage units to go hand in hand with demand for rental housing as well. An article by the CCIM institute noted that about 30% of the average property’s customer base lives in apartments and about 13% live in townhomes/condos. These higher housing prices are driving more people to renting or downsizing, increasing demand as they’ll need more room to store all of their “stuff.” It’s worth noting though that self-storage REITs see increased competition compared to many other types of REITs, as the vast majority of self-storage facilities are owned by local entrepreneurs. Back in 2000, REITs made up less than 10% of new development. While that was a long time ago, I expect that local entrepreneurs still maintain ownership of a sizable portion of self storage facilities. Some of the more profitable facilities are being acquired by REITs, but the large amount of locally owned facilities puts increased competitive pressure on REIT-owned facilities. In general though, I view self-storage REITs very bullishly in the medium term to long term. REZ: A Great Income Play With Long-Term Growth Potential After a thorough review, one can see that this ETF is well-diversified into many more sectors than purely residential REITs, as the name suggests. In my opinion, REZ would be a great addition to the portfolio of a long-term income investor who is interested in taking on a little bit more risk in exchange for moderate growth potential. The 3.3% dividend offers a great opportunity for steady income just as owning physical real estate would, but with much greater liquidity. In addition to the dividend, it offers a moderate growth opportunity to more aggressive income investors who believe housing prices are going to rise and want to take advantage of the drastic demographic changes taking place. I believe each of the 3 primary types of REITs that REZ holds will grow with the economy over the next decade. This investment is not without its risks though, so when considering an investment in REZ, one should weigh the immediate negative affect an interest rate hike could have with the dividends and long-term growth potential. I wouldn’t recommend investors use REZ as their primary income source, as the trend towards renting may change over time, which could have an adverse affect on share prices and dividend payments. Overall though, I think the factors mentioned above would make REZ a great portfolio addition for long-term growth investors who want their portfolio to generate additional income, as well as purely income investors who want to pursue moderate growth while not giving up their income stream. Conclusion REZ is a well-diversified ETF that is much more than simply a residential REIT. There are many factors one needs to account for and many different markets that one should research. From a fundamental perspective, though, I view each of the 3 primary REIT types that REZ holds bullishly in the long term. I think that long-term investors who believe that growth and income investing don’t have to be mutually exclusive could benefit greatly from this ETF. I think that long-term investors who are patient will see their diligence handsomely rewarded through steady dividend payments and moderate growth.