Builder inventory-to-backlog ratios flag spec risk pre-Q3 earnings

As we enter the third-quarter reporting season, a key issue to watch is what each homebuilder’s inventory levels signal about its outlook and strategy. Broadly speaking, builders taking a conservative approach will report less spec inventory as a result of efforts to reduce it, while builders who remained optimistic about the environment have started more spec homes and maintained a higher inventory of homes under construction. While one might assume all large, publicly traded builders took a more cautious approach this year, their financial statements tell a different story. Not all of them did. We think Q3 results may be telling, as we believe the spike in mortgage rates and lower September absorption may leave builders with more spec inventory than they intended, potentially foreshadowing margin pressure in the fourth quarter. We’ve classified builders into three categories based on their inventory balance of homes under construction relative to the value of their backlogs (as of the end of their most recently reported quarter): Conservative (ratio of inventory of homes under construction to backlog value of less than 1.2x): builders who appear to assume that tough market condit...