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We Raise Our Target on This Portfolio Name

Here's our promised update on ADT Inc. as May housing numbers land.
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We said we would look to revisit ADT Inc. (ADT) and our rating as May housing data was reported. That data came out this week with May housing starts that in total rose 4.3% month-over-month to a seasonally adjusted annual rate (SAAR) of 974,000 units. That’s far below the 1.6 million SAAR rate from January and February, but it suggests housing starts may have bottomed out in April, when they hit 934,000 on a SAAR basis.

Digging into the meat of the May housing starts report, however, we find single family housing starts were unchanged compared to April’s 674,000 units, again on a SAAR basis. This means the month-over-month rebound was almost exclusively in multi-family housing. Not bad, but not exactly ADT’s bread and butter business, either.

There are some positives to note. First, May building permits jumped to 1.22 million on a SAAR basis, meaningfully higher than 1.066 million in April. The issue with building permits is they are not necessarily tied to a firm order and are viewed more as an indication of interest. That said, the market tends to view rising building permits as a positive indicator of future activity. Second, The Mortgage Bankers Association Builder Application Survey data for May 2020 showed mortgage applications for new home purchases increased 10.9% vs. year ago levels and jumped 26% compared to April 2020. We see that as a far more bullish indicator of intent that should result in favorable New Home Sales data in the coming months and drive favorable metrics at the 71% of ADT’s business that caters to the residential market.

Over the last 30 days, we’ve seen consensus 2020 earnings per share for ADT rise to $1.05 from $0.98 with the 2020 consensus rising a few pennies to $1.10 per share. Should we see the low mortgage rates continue to drive favorable year-over-year comparisons, odds are we could see further lift in ADT’s 2020 EPS expectations. When we first added ADT shares to the active portfolio at the end of March, we suspected there would have been some downward revision in Wall Street’s earnings outlook for the company. There was one, albeit a modest one, and now thanks to the Fed as well as the pandemic, consumers are changing how they vacation -- opting instead for second homes they can drive to vs. traveling by plane and staying at a hotel. Given the resurgence in Covid-19 cases, we suspect this change will continue for some time. Most likely, once a vaccine for the coronavirus is developed en masse, folks are likely to resume old travel habits. But for now, it looks like that is at least a few quarters away.

Given those prospects, as well as the low mortgage rates that will stick around for some time, we are boosting our ADT price target to $10, roughly 9.1-times the current 2021 EPS consensus estimate. Fed Chair Jerome Powell, we should point out, appears to be in no rush to raise interest rates, as he sees a long recovery for the U.S. economy. While our target offers more than 17% upside, we are going to hold off boosting our rating following the surge the shares have had quarter to date. We would look to revisit our rating if the shares pulled back closer to $7.50 or on signs the housing market is stronger than currently expected.

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