Rising Mortgage Rates And DR Horton Ties Will Cripple Demand

Key Takeaways

• Heavy reliance on a single major customer and unfavorable housing market trends threaten revenue growth and profitability stability.
  
• Demographic shifts, climate risks, and changing buyer preferences in key regions pose long-term challenges to demand and asset values.
  
• Strong lot sales pipeline, robust balance sheet, and strategic partnerships position Forestar for stable long-term growth, margin expansion, and resilience across housing cycles.

Catalysts

Operates as a residential lot development company in the United States.

• Persistent affordability constraints and higher mortgage rates are making homeownership less accessible, which has already led Forestar to lower its lot delivery forecast for the year, signaling downward pressure on future revenue as demand for new homes stalls.
  
• Slowing household formation and broader demographic trends like declining birth rates threaten long-term demand for new single-family homes-Forestar's core market-which will cap both volume growth and pricing power over the coming decade, ultimately risking a sustained erosion in revenues and gross margins.
  
• Forestar's extreme customer concentration, with over 80 percent of sales to D.R. Horton, leaves the company highly exposed to any downturn or change in purchasing strategy at D.R. Horton; should D.R. Horton slow its community growth as suggested on recent calls, Forestar's revenues and earnings will likely contract materially.
  
• Significant ongoing investments in land acquisition and development, much of it in high-growth but climate-vulnerable markets like Texas and Florida, increases the risk of future impairments if land values decline due to natural disasters, shifting migration patterns, or a cooling housing market, with an eventual negative impact on return on invested capital and net earnings.
  
• The core suburban and exurban markets that Forestar focuses on may be increasingly challenged by the growing appeal of urban amenities, remote work-driven geographic shifts, and potential regulatory restrictions, which could slow lot absorption and raise entitlement costs, putting long-term pressure on both revenue growth and net margins.

Forestar Group Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Forestar Group compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Forestar Group's revenue will grow by 8.1% annually over the next 3 years.
• The bearish analysts assume that profit margins will shrink from 10.5% today to 8.1% in 3 years time.
• The bearish analysts expect earnings to reach $158.1 million (and earnings per share of $3.06) by about July 2028, down from $162.6 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 9.3x on those 2028 earnings, up from 7.9x today. This future PE is lower than the current PE for the US Real Estate industry at 32.5x.
• Analysts expect the number of shares outstanding to grow by 0.35% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 9.51%, as per the Simply Wall St company report.

Forestar Group Future Earnings Per Share Growth

Risks

• Forestar's record-high contracted backlog of 25,700 lots representing $2.3 billion in future revenue, along with a 26% year-over-year increase in owned lots under contract to sell, provides strong visibility into long-term revenues and supports sustained earnings.
  
• Ongoing U.S. housing supply shortages, especially for entry-level and suburban homes, are keeping lot prices firm and have enabled Forestar to maintain or increase average selling prices, which is likely to benefit both revenues and profit margins over the long term.
  
• The company's disciplined balance sheet management, with $792 million in liquidity and a net debt-to-capital ratio of 28.9%, reduces financial risk and supports capital deployment for growth, minimizing the likelihood of earnings volatility due to market downturns.
  
• Forestar's strategic relationship with D.R. Horton, with a mutual goal to double the proportion of Horton homes built on Forestar lots, provides a high-volume, stable customer pipeline and underpins revenue and earnings growth as the partnership deepens.
  
• Geographic expansion into high-growth regions such as the Pacific Northwest and continued market share consolidation in fragmented industry segments position the company to outperform through regional housing cycles and drive upward momentum in long-term revenues and profitability.

Valuation

• The assumed bearish price target for Forestar Group is $22.0, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of Forestar Group's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $33.0, and the most bearish reporting a price target of just $22.0.
  
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $1.9 billion, earnings will come to $158.1 million, and it would be trading on a PE ratio of 9.3x, assuming you use a discount rate of 9.5%.
  
• Given the current share price of $25.12, the bearish analyst price target of $22.0 is 14.2% lower.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.