Housing starts have been in the dump for most of 2010, especially after the experiation of the tax credits. This morning's report shows some life in this important sector. Perhaps the sector is now ready to stand on its own feet.
Mortgage rates however have been rising rapidly since the Congress and the Administration started to work on extending the Bush-era tax cuts. Investors have been shunning Treasuries, in favor of cash, commodities, or equities. This is not necessarily a reflection of rising inflation expectations, although that could be part of the reason (judging from the implicit inflation rate priced into TIPs). On balance, investors are probably betting that the expansionary monetary policy as expressed in QE2 should work well in the thort term with the accommodative fiscal policy should it passes the House. Rising long-term T rates, which causes the T yield curve to steepen, is a sign that the economic recovery may quicken 2011-2012.
The Fed's goal was to stimulate the economy via asset inflation. It has so far succeeded in chasing investors away from the "safe haven" of the Treasuries, into more risky assets that are more tied to the US and global economies.
That's only the beginning. For this twin stimulus to work, the private sector needs to move up in a big way to employ more works. Millions more. More jobs would help housing starts. And more housing starts would jump start more construction jobs.
For people looking to buy a house, mortgage rates in 5-6% are still relatively low. The dominating variable is job security. Besides, when the rates rise to a certain level, bond funds and foreign government would purchase more long-term US government bonds to help hold down the rates.
In this mix, banks that have repaired their balance sheets and have successfully re-positioned themselves to take advantage of the steep yield curve and the economic recovery should be ready to print profits in the boat loads. One of the prime beneficiaries will be Wells Fargo, whose market cap has again overtaken that of JP Morgan today with its share rising over $30. A recent Barron's article has put WFC's shares at $35-40 range based on its normalized earnings power, which it should start to show itself in 2011 when Wachovia branches are all converted.
Investors should hold on to these bank shares, and some of the home builder shares for an interesting "rabbit ride" in 2011.
Showing posts with label Home builder. Show all posts
Showing posts with label Home builder. Show all posts
Thursday, December 16, 2010
Monday, July 5, 2010
Best Time to Buy a House?
John Paulson said he is optimistic on the American economy. "I think we're at the tail end of the credit crisis," he said "We're in the middle of a sustained recovery in the US. The risk of a double dip is less than 10 percent.” Europe, however, “is the one soft spot in the world," he told an audience at the London School of Economics on Wednesday.
"It's the best time to buy a house in America. California has been a leading indicator for the housing market, and it turned positive seven months ago. I think we're about to turn a corner."
The housing market is probably in its worse shape: Both new and existing home sales have plummeted in June to new lows after the expiration of the federal home buyer tax credit. Mortgage rate has been steadily going down, which is an indication that housing demand is weak and getting weaker. All these are tightly linked to the weak labor market: Private job creation is anemic, and unemployment rate is expetecd to stay elevated for years.
The economy is so dark that economist/columnist Paul Krugman has warned that we maybe entering the "Third Depression."
But if you're a contrarian and you believe in the basic soundness of American businesses, then this is probably one of the best times to take a bullish bet, on housing and on U.S. economy in general.
See this article for the contrasting views of the hedge fund manager Joh Paulson and the academic/journalist Paul Krugman.
I've been looking for a house to buy in recent months as our lease was expiring. There are many good reasons to buy. Prices have been dropping over the last two years, and continue to drop. It's definitely a buyer's market. Renting now costs more in terms of after-tax cash flow. It's a good time to take advantage of the historically low mortgage rates and to start building home equity again...
But, there is no hurry! Unemployment is going to be a long hard problem to solve. Without massive job creation, there is very little real pent-up demand for additonal housing.
But, for the same reason, if job creation is getting in gear and we start to see hundreds of thousands of private jobs being created, a housing boom would not be far behind.
"It's the best time to buy a house in America. California has been a leading indicator for the housing market, and it turned positive seven months ago. I think we're about to turn a corner."
The housing market is probably in its worse shape: Both new and existing home sales have plummeted in June to new lows after the expiration of the federal home buyer tax credit. Mortgage rate has been steadily going down, which is an indication that housing demand is weak and getting weaker. All these are tightly linked to the weak labor market: Private job creation is anemic, and unemployment rate is expetecd to stay elevated for years.
The economy is so dark that economist/columnist Paul Krugman has warned that we maybe entering the "Third Depression."
But if you're a contrarian and you believe in the basic soundness of American businesses, then this is probably one of the best times to take a bullish bet, on housing and on U.S. economy in general.
See this article for the contrasting views of the hedge fund manager Joh Paulson and the academic/journalist Paul Krugman.
I've been looking for a house to buy in recent months as our lease was expiring. There are many good reasons to buy. Prices have been dropping over the last two years, and continue to drop. It's definitely a buyer's market. Renting now costs more in terms of after-tax cash flow. It's a good time to take advantage of the historically low mortgage rates and to start building home equity again...
But, there is no hurry! Unemployment is going to be a long hard problem to solve. Without massive job creation, there is very little real pent-up demand for additonal housing.
But, for the same reason, if job creation is getting in gear and we start to see hundreds of thousands of private jobs being created, a housing boom would not be far behind.
Friday, April 23, 2010
Watch Out for Standard Pacific’s Massive Dilution
This week’s releases on existing home sales and new home sales have ignited a sharp rally for home builders. The momentum seems un-stoppable, as more and more investors looking to participate in the government-assisted housing recovery.
According to Google Finance, year-to-date, the shares of Hovnanian (HOV) has gone up more than 80%, while Standard Pacific (SPF) has gone up more than 70%, and Lennar (LEN) more than 60%. The sharpest rally has been in the month of April, especially this week.
I have turned bearish on Hovnanian based on valuation concern. For Standard Pacific, I like its business model and its dominating exposure in California and in the South. But at $6-7/share, there is a massive potential share dilution hanging over its head.
When Standard was teetering on the edge of bankruptcy two years ago, a private equity firm MatlinPatterson from New York came in with a several hundred million dollars infusion. It saved the company. Moreover, the turn-around management team it installed has been successful in restructuring the company’s debt structure. At the same time, the team led by Ken Campbell was focused on controlling costs, selling off non-performing assets and other areas that are crucial for profitability. The company has also been early in acquiring lands in promising locations and communities. Impairment has stopped, and the company is now well-positioned.
All these did not come cheap. As of December 31, 2009, MatlinPatterson owns 450,829 shares of Series B Preferred Stock which are convertible into 147.8 million shares of common stock (as a point of reference, the current shares outstanding is 106 million). The conversion price is $3.05. As the stock heading higher, it’s only a matter of time before MatlinPatterson converts this massive amount of holding in preferred.
On top of that, the private equity firm also holds a warrant to purchase 272,670 shares of Senior Preferred Stock at a common stock equivalent exercise price of $4.1 per share, which is exercisable for Series B Preferred. And the shares of Series B Preferred will initially be convertible into 89.4 million shares of the common. The warrant may not be exercised in full before the stock reaches $10.5. But at this point, it is already quite far in the money.
A comparison in dollar value will help us understand just how much dilution the share holders will be subject to. For this purpose, let us fix the common stock price at $6.5/share. The current market cap is $689M.
If the preferred is converted into common right now, its value is $147.8*(6.5-3.05)M = $510M.
If the warrant is assumed to be fully exercisable and converted into common, its value is about $89.4*(6.5-4.1)M = $215M.
Add these all up, the if-converted total market cap would be $1.414B. Given the book equity of $435M, we’re looking at a potential market-to-book ratio of 3.25. That’s usually associated with high-growth stocks (Google’s is about 4.5, Cisco’s is about 3.8).
Just two months ago, when SPF was trading in $3-4 range, this was not a big concern yet. But now in the $6-7/share range, MatlinPatterson’s massive holding is becoming much more valuable than the current market cap. It’s only a matter of time before they flood the market to exit their astute investment.
For investors at large, it’s not a great idea to bid up the shares too much ahead of earnings. At this point, the company only has the potential to deliver, but has not consistently delivered the earnings that would justify the high multiple.
Other home builder stocks, especially the still-highly-levered Hovnanian (run by the same management that drove it to the ground), also appears to be running too much ahead of their earnings.
(I want to thank Seeking Alpha member Searsdog for bringing up this important issue. I’ve earlier put out a warning on my blog after Standard Pacific’s Q1 earnings release.)
According to Google Finance, year-to-date, the shares of Hovnanian (HOV) has gone up more than 80%, while Standard Pacific (SPF) has gone up more than 70%, and Lennar (LEN) more than 60%. The sharpest rally has been in the month of April, especially this week.
I have turned bearish on Hovnanian based on valuation concern. For Standard Pacific, I like its business model and its dominating exposure in California and in the South. But at $6-7/share, there is a massive potential share dilution hanging over its head.
When Standard was teetering on the edge of bankruptcy two years ago, a private equity firm MatlinPatterson from New York came in with a several hundred million dollars infusion. It saved the company. Moreover, the turn-around management team it installed has been successful in restructuring the company’s debt structure. At the same time, the team led by Ken Campbell was focused on controlling costs, selling off non-performing assets and other areas that are crucial for profitability. The company has also been early in acquiring lands in promising locations and communities. Impairment has stopped, and the company is now well-positioned.
All these did not come cheap. As of December 31, 2009, MatlinPatterson owns 450,829 shares of Series B Preferred Stock which are convertible into 147.8 million shares of common stock (as a point of reference, the current shares outstanding is 106 million). The conversion price is $3.05. As the stock heading higher, it’s only a matter of time before MatlinPatterson converts this massive amount of holding in preferred.
On top of that, the private equity firm also holds a warrant to purchase 272,670 shares of Senior Preferred Stock at a common stock equivalent exercise price of $4.1 per share, which is exercisable for Series B Preferred. And the shares of Series B Preferred will initially be convertible into 89.4 million shares of the common. The warrant may not be exercised in full before the stock reaches $10.5. But at this point, it is already quite far in the money.
A comparison in dollar value will help us understand just how much dilution the share holders will be subject to. For this purpose, let us fix the common stock price at $6.5/share. The current market cap is $689M.
If the preferred is converted into common right now, its value is $147.8*(6.5-3.05)M = $510M.
If the warrant is assumed to be fully exercisable and converted into common, its value is about $89.4*(6.5-4.1)M = $215M.
Add these all up, the if-converted total market cap would be $1.414B. Given the book equity of $435M, we’re looking at a potential market-to-book ratio of 3.25. That’s usually associated with high-growth stocks (Google’s is about 4.5, Cisco’s is about 3.8).
Just two months ago, when SPF was trading in $3-4 range, this was not a big concern yet. But now in the $6-7/share range, MatlinPatterson’s massive holding is becoming much more valuable than the current market cap. It’s only a matter of time before they flood the market to exit their astute investment.
For investors at large, it’s not a great idea to bid up the shares too much ahead of earnings. At this point, the company only has the potential to deliver, but has not consistently delivered the earnings that would justify the high multiple.
Other home builder stocks, especially the still-highly-levered Hovnanian (run by the same management that drove it to the ground), also appears to be running too much ahead of their earnings.
(I want to thank Seeking Alpha member Searsdog for bringing up this important issue. I’ve earlier put out a warning on my blog after Standard Pacific’s Q1 earnings release.)
Monday, April 19, 2010
Standard Pacific: Don't sweat the small stuff
Earnings was released early in the morning. Missed revenue projection by a mile. Surprisingly, the stock held up OK.
Despite the miss, there are things to like about the company's position: both net new orders and backlog are up substantially year-over-year and Q-to-Q. Land acquisition is up significantly, and according the CEO, approved land deals in April was above $100M, which is about the amount approved in all of Q1 (itself a significant increase). These will translate into substantial land holding this year.
The company focuses on higher price points than entry level homes, so it's not competing directly with foreclosures. That is, it is focusing on move-up home buyers.
It is still focusing on controlling the cost structure and profitability, not so much on increasing sales and revenue. Company not looking to increase sales a whole lot year-over-year, due to high unemployment rate. Higher sale should arrive when the employment picture improves. That's when things get interesting.
During the call, CEO estimated that the company can comfortably do $2B in revenue when the housing market recovers. It did $1.1B in 09. With a disciplined margin control, if and when that happens we can expect annual net income to hit $100M. Roughly, the market cap can reach $1B. So from here to there, we're looking at a double.
CEO also mentioned that there are prospective buyers who do have jobs and qualified, but still need to feel more confident about keeping their jobs before making new home purchases. They need to see that the economy is adding jobs consistently to jump off the fence. That's my view as well.
This is the kind of micro-cap I like to play: it has a clear plan and is focused on a long term vision that it knows it'll come out ahead. At this point, Standard's stroy is all about positioning. When buyers return, which they will, the company will do very well.
Caution for investors: Watch out for the massive dilution that will for sure arrive when the private equity firm MatlinPatterson converts their Series B Preferred shares and their warrants. Until then, enjoy the bumpy ride.
Despite the miss, there are things to like about the company's position: both net new orders and backlog are up substantially year-over-year and Q-to-Q. Land acquisition is up significantly, and according the CEO, approved land deals in April was above $100M, which is about the amount approved in all of Q1 (itself a significant increase). These will translate into substantial land holding this year.
The company focuses on higher price points than entry level homes, so it's not competing directly with foreclosures. That is, it is focusing on move-up home buyers.
It is still focusing on controlling the cost structure and profitability, not so much on increasing sales and revenue. Company not looking to increase sales a whole lot year-over-year, due to high unemployment rate. Higher sale should arrive when the employment picture improves. That's when things get interesting.
During the call, CEO estimated that the company can comfortably do $2B in revenue when the housing market recovers. It did $1.1B in 09. With a disciplined margin control, if and when that happens we can expect annual net income to hit $100M. Roughly, the market cap can reach $1B. So from here to there, we're looking at a double.
CEO also mentioned that there are prospective buyers who do have jobs and qualified, but still need to feel more confident about keeping their jobs before making new home purchases. They need to see that the economy is adding jobs consistently to jump off the fence. That's my view as well.
This is the kind of micro-cap I like to play: it has a clear plan and is focused on a long term vision that it knows it'll come out ahead. At this point, Standard's stroy is all about positioning. When buyers return, which they will, the company will do very well.
Caution for investors: Watch out for the massive dilution that will for sure arrive when the private equity firm MatlinPatterson converts their Series B Preferred shares and their warrants. Until then, enjoy the bumpy ride.
Sunday, April 18, 2010
Focusing on earnings
The first week of the earnings season turned to be rather eventful.
Intel and JP Morgan reported fantastic results that pushed the market higher. Google's somewhat disappointed.
March housing starts was a positive surprise, even though it's still way below average.
Friday was a bomb. SEC's charge against Goldman, combined with weak reading on consumer sentiment sent the market sharply down, erasing the gain for the week. Goldman story will linger on for months, as it's a poster child for Wall Street's greed and power. Everybody will be jumping up and down on this unfolding saga, and people are expecting more and more followup scandals and discoveries... the political risk of owning bank shares is getting even higher.
For bank stocks, two things to focus on. (1) We can avoid these Wall Street concepts. I've sold off JPM and BAC for that reason. I've stayed with my long-term holding WFC, for it has a very small I-banking business inherited from Wachovia Securities, and the rest is doing very well. I still think it could become the largest bank stock in market cap. (2) Pick up some of the bank stocks such as GS if they are excessively over-sold, so that the political risk is well-compensated. One of the Barron's articles argues that GS already looks under-valued after Friday's selloff. I agree somewhat, but the article may have underestimated the political fervor. Similarly, JP Morgan also looks expensive. Jaime Dimon's approach to dealing with Washington may not help. These Wall Street firms don't seem to get it: Washington will not leave them alone to do business as usual, doesn't matter what they say or do.
Last week, Sandra Ward had an article on Barron's about how retail investors are finally following the lead of institutional investors in getting into equity funds. It's well worth a read. I think there is more to come, which can turn out to be a powerful factor for the stock market.
James Paulsen's thesis on the recovery appears to be intact. This week, he re-confirmed the view by observing that "Despite persistent, widespread economic anxiety, the contemporary recovery appears remarkably normal." That is, there is no "new normal."
According to Tax-Refund Monitor,
Investors with a long term view informed by economic data will be in an advantageous position to play this market. Stay in the market, raise some cash when your winners become too large, and pick up good stocks when they're wacked by short-term forces. This is a sound strategy that I've played with with good results.
On Monday my favorite builder SPF will report Q1 earnings at market open. I'm somewhat optimistic. Citigroup, Goldman Sachs and Wells Fargo will report too. During the week there will be existing home sales and new home sales reports. It'll be very interesting.
Intel and JP Morgan reported fantastic results that pushed the market higher. Google's somewhat disappointed.
March housing starts was a positive surprise, even though it's still way below average.
Friday was a bomb. SEC's charge against Goldman, combined with weak reading on consumer sentiment sent the market sharply down, erasing the gain for the week. Goldman story will linger on for months, as it's a poster child for Wall Street's greed and power. Everybody will be jumping up and down on this unfolding saga, and people are expecting more and more followup scandals and discoveries... the political risk of owning bank shares is getting even higher.
For bank stocks, two things to focus on. (1) We can avoid these Wall Street concepts. I've sold off JPM and BAC for that reason. I've stayed with my long-term holding WFC, for it has a very small I-banking business inherited from Wachovia Securities, and the rest is doing very well. I still think it could become the largest bank stock in market cap. (2) Pick up some of the bank stocks such as GS if they are excessively over-sold, so that the political risk is well-compensated. One of the Barron's articles argues that GS already looks under-valued after Friday's selloff. I agree somewhat, but the article may have underestimated the political fervor. Similarly, JP Morgan also looks expensive. Jaime Dimon's approach to dealing with Washington may not help. These Wall Street firms don't seem to get it: Washington will not leave them alone to do business as usual, doesn't matter what they say or do.
Last week, Sandra Ward had an article on Barron's about how retail investors are finally following the lead of institutional investors in getting into equity funds. It's well worth a read. I think there is more to come, which can turn out to be a powerful factor for the stock market.
James Paulsen's thesis on the recovery appears to be intact. This week, he re-confirmed the view by observing that "Despite persistent, widespread economic anxiety, the contemporary recovery appears remarkably normal." That is, there is no "new normal."
According to Tax-Refund Monitor,
... taxes withheld in March showed a very large increase over February. There were no changes in law or withholding schedules ... it often indicateds activity has accelerated, but is not yet being captured in the labor-market data. ...Last Friday's WSJ, however, did have an article on "Tech Leads Jobs Recovery" that shows that Silicon Valley is ramping up hiring on tech talents.
Investors with a long term view informed by economic data will be in an advantageous position to play this market. Stay in the market, raise some cash when your winners become too large, and pick up good stocks when they're wacked by short-term forces. This is a sound strategy that I've played with with good results.
On Monday my favorite builder SPF will report Q1 earnings at market open. I'm somewhat optimistic. Citigroup, Goldman Sachs and Wells Fargo will report too. During the week there will be existing home sales and new home sales reports. It'll be very interesting.
Tuesday, April 13, 2010
Will Standard Pacific Pacify?
Investors have bid up Standard Pacific Homes (SPF) ahead of its Q1 earnings release next Monday (4/19). Since the company has a very large exposure in California, this is likely due to the March sales data just reported by MDA DataQuick. SoCal's sales volume has gone up 5% over the same period last year, and the median price has been up by 14%.
According to the same source, similar trend but smaller magnitude has been observed for January and February Southland home sales.
For Q1, analysts are expecting a $0.06/share loss, which is about -$6 M in net income, on revenue of $184 M.
The revenue estimate is very likely an underestimate.
In the March quarter of 2009, Standard recorded $209 M in revenue. Given the increases in both sales and prices year-over-year in one of the major markets where Standard operates, and the fact that the company has been ramping up in California, we think it's likely that the revenue will increase, rather than decrease substantially.
Newer communities, which may account for more than 10% of the company's total sales, should contribute higher margins. Compensation cost is expected to come down a bit. It is likely that the company will report a small profit excluding tax benefit this quarter.
While increased sales is certainly a big welcome, investors should look for increases in community counts and backlogs as the company heads for the Spring selling season. We will also be looking at the company's use of capital in new land acquisition, and the geographic distribution of its communities. How it positions itself to benefit from a rocky recovery is at least as important as how the last quarter turns out.
This is a very volatile stock. The share price can go up or down 20% easily around earnings release. Should the stock price continue to rise in the next few days, the stage may be set for a big selloff after earnings. If that doesn't happen, we may see a more pacific trading next week.
According to the same source, similar trend but smaller magnitude has been observed for January and February Southland home sales.
For Q1, analysts are expecting a $0.06/share loss, which is about -$6 M in net income, on revenue of $184 M.
The revenue estimate is very likely an underestimate.
In the March quarter of 2009, Standard recorded $209 M in revenue. Given the increases in both sales and prices year-over-year in one of the major markets where Standard operates, and the fact that the company has been ramping up in California, we think it's likely that the revenue will increase, rather than decrease substantially.
Newer communities, which may account for more than 10% of the company's total sales, should contribute higher margins. Compensation cost is expected to come down a bit. It is likely that the company will report a small profit excluding tax benefit this quarter.
While increased sales is certainly a big welcome, investors should look for increases in community counts and backlogs as the company heads for the Spring selling season. We will also be looking at the company's use of capital in new land acquisition, and the geographic distribution of its communities. How it positions itself to benefit from a rocky recovery is at least as important as how the last quarter turns out.
This is a very volatile stock. The share price can go up or down 20% easily around earnings release. Should the stock price continue to rise in the next few days, the stage may be set for a big selloff after earnings. If that doesn't happen, we may see a more pacific trading next week.
Tuesday, April 6, 2010
Not sure I should be excited when the Mad Money guy agrees with me
I usually don't watch Cramer's Mad Money. This guy flip-flops too much, and there is too much yelling.
So I was curious to see he has turned bullish on California housing market, even recommending one of my top holdings to play this recovery: Standard Pacific (SPF). He still doesn't quite understand how Standard got here. I don't mean to brag, but there are good reasons to like this company. See my analysis here, here and here.
See CNBC Yahoo report and the video.
(note added on 4/8/10) Cramer was able to pump up SPF by 4-5% or so. Amazing. When he is so bullish, it's about time to take some profits.
So I was curious to see he has turned bullish on California housing market, even recommending one of my top holdings to play this recovery: Standard Pacific (SPF). He still doesn't quite understand how Standard got here. I don't mean to brag, but there are good reasons to like this company. See my analysis here, here and here.
See CNBC Yahoo report and the video.
(note added on 4/8/10) Cramer was able to pump up SPF by 4-5% or so. Amazing. When he is so bullish, it's about time to take some profits.
Sunday, April 4, 2010
Are New Home Sales About to Go UP?
(This article has been published on Seeking Alpha: http://seekingalpha.com/article/196985-are-new-home-sales-about-to-go-up )
Much discussion on new home sales has been focused on how bad the recent sales have been (for example, see this post). March number will probably not be any better.
The rear-mirror view is consistent with high unemployment, sluggish job recovery, abundant supply of foreclosed homes, consumer retrenchment and low household formation coming out of a severe recession.
Looking forward, however, there are signs that point to an upturn, however slow it may turn out to be.
GDP has been growing for the past three consecutive quarters. Much of that growth is underpinned by manufacturing expansion, surge in export and strength in technology. The expansion is spreading to other key industries such as retail, construction, travel, financial services etc. That will add much needed jobs.
Job loss appears to have stopped. And we can now look forward to job growth in the coming months. Job creation is probably the single most important factor that will spur housing rebound.
In a series of recent posts, John Lounsbury has examined analysts forecast for home builder revenues in the next three quarters (see here and there). While his main point is that these estimated revenues appear to be too optimistic, I think he might have identified a turning point for new home sales.
In the table and the graph below, let’s look at the annual revenue picture as a whole for some representative builders, to smooth out seasonality. The data is obtained from Yahoo Finance, or from companies annual reports.
On average, builder revenue has been dropping 30% - 40% for at least three years since 2006. The size of some builders as measured by sales has shrunk over 75% since the peak. The correction has been severe, and rightly so. They should not be building so many houses.
Looking forward, analysts are estimating only a 1.2% increase for these six builders (DHI, LEN, KBH, SPF, HOV, TOL) for 2010 over 2009. And for 2011, the growth is about 18%.
Looking at the graph below, if these estimates are right, 2010 will represent a turning point for new home sales, and 2011 will only see a modest increase.
Going into the recession, analysts tend to over-estimate sales, whereas coming out of the recession, they tend to under-estimate revenues and profits. So I think it is very likely we are at the turning point. The next couple of quarters should see increased home sales year-over-year.
We all know about the problem with foreclosures and the feared “shadow” inventory. Those are the potential supply that may hit the market over the next few years. That may help depress new home sales.
One can argue that there is a countervailing factor, i.e. the “shadow” demand that may materialize as the economy improves. This potential demand is difficult, if not impossible to estimate. But we know there is a substantial population growth in the U.S. and people have been putting off home purchase due to jobs and credit. One interesting area to look at is the household formation.
Household formation in the U.S. historically has been running at about 1.3 million per year. It has slowed dramatically during the recession, to about 400,000 or so in 2009. Young men and women who cannot find jobs tend to go back to live with parents, or share apartments. If employment situation improves, there is a glaring gap of nearly one million new households to be formed. That could definitely help drive up new home sales due to affordability and low mortgage rates.
Another important and overlapping demand factor is from those who have jobs but have been sitting on the fence. If they gain more confidence in the economy and the job market, they’re a ready source of buyers who will benefit from owning homes at a low price point.
In many sub-markets, new homes are not competing directly with foreclosures. It is likely that we'll see warm markets developing while many foreclosure hot spots are still facing huge pressure in the next few years. It is not realistic to think that the excess inventory must be cleared out first before new homes can be built.
Much discussion on new home sales has been focused on how bad the recent sales have been (for example, see this post). March number will probably not be any better.
The rear-mirror view is consistent with high unemployment, sluggish job recovery, abundant supply of foreclosed homes, consumer retrenchment and low household formation coming out of a severe recession.
Looking forward, however, there are signs that point to an upturn, however slow it may turn out to be.
GDP has been growing for the past three consecutive quarters. Much of that growth is underpinned by manufacturing expansion, surge in export and strength in technology. The expansion is spreading to other key industries such as retail, construction, travel, financial services etc. That will add much needed jobs.
Job loss appears to have stopped. And we can now look forward to job growth in the coming months. Job creation is probably the single most important factor that will spur housing rebound.
In a series of recent posts, John Lounsbury has examined analysts forecast for home builder revenues in the next three quarters (see here and there). While his main point is that these estimated revenues appear to be too optimistic, I think he might have identified a turning point for new home sales.
In the table and the graph below, let’s look at the annual revenue picture as a whole for some representative builders, to smooth out seasonality. The data is obtained from Yahoo Finance, or from companies annual reports.
Looking forward, analysts are estimating only a 1.2% increase for these six builders (DHI, LEN, KBH, SPF, HOV, TOL) for 2010 over 2009. And for 2011, the growth is about 18%.
Going into the recession, analysts tend to over-estimate sales, whereas coming out of the recession, they tend to under-estimate revenues and profits. So I think it is very likely we are at the turning point. The next couple of quarters should see increased home sales year-over-year.
We all know about the problem with foreclosures and the feared “shadow” inventory. Those are the potential supply that may hit the market over the next few years. That may help depress new home sales.
One can argue that there is a countervailing factor, i.e. the “shadow” demand that may materialize as the economy improves. This potential demand is difficult, if not impossible to estimate. But we know there is a substantial population growth in the U.S. and people have been putting off home purchase due to jobs and credit. One interesting area to look at is the household formation.
Another important and overlapping demand factor is from those who have jobs but have been sitting on the fence. If they gain more confidence in the economy and the job market, they’re a ready source of buyers who will benefit from owning homes at a low price point.
In many sub-markets, new homes are not competing directly with foreclosures. It is likely that we'll see warm markets developing while many foreclosure hot spots are still facing huge pressure in the next few years. It is not realistic to think that the excess inventory must be cleared out first before new homes can be built.
Sunday, March 28, 2010
Current housing market according to Lennar
One of my holdings in home builders, Lennar (LEN), has reported its 1Q earnings a few days ago. The CEO's summary of the housing market is worth paying close attention to (my emphases).
... While the new home market and housing in general still faced serious headwinds from current economic and legislative conditions, the market and overall economy appear to be continuing to stabilize and are generally in recovery. As we have expected, at least as it relates to housing, the recovery is not presenting itself as a V shape, return to better times, but instead is proving to be a rocky, stabilizing bottom with visibility obscured by more questions than clear answers.
The overhang of foreclosures and the prospects of additional delinquencies ahead continued to moderate recovery, as shadow inventory continues to be absorbed and then even replenished. Unemployment and a generally sluggish economic bounce back combined to full demand at traditionally low levels. And the prospects of a pullback driven by elimination of legislative and fiscal incentives limit visibility and create pending uncertainties about the immediate future of the strength of the market.
And finally, the debate over whether inflation or deflation lies ahead and the impact of sovereign credit risks add uncertainty to the view ahead of interest rate. Nevertheless, as we reviewed our operations from the field geography-by-geography, there are some common themes that appear to be validating the current trend.
First, prices are not free-falling and in fact in many markets are continuing to stabilize and even recover. In most of our divisions, there continues to be a meaningful reduction in the incentives used and the sales process and that fact is reflecting itself in higher gross margins. For the company overall, incentives were 12.5%, down from 13.2% last quarter and 17.1% last year. And margins improved on a pre-impairment basis to 20.3% from 17.8% last quarter and 14.3% last year. While these trends are vulnerable to the upcoming elimination of the $8,000 tax credit and the elimination of fiscal stimulus to the lending market in the short term, it feels that the momentum provided by consumer confidence and home affordability will likely equalize their impact over a short period of time.
These government programs work very well as a kick-start to a free-falling housing market, but it now seems that the free market is positioned to take over in orderly fashion. Second, inventories of new homes remains significantly reduced. While there has been a great deal of talk about potential spec building of new homes to beat the end of the tax credit, we are finding that, that as limited. In most markets, new homes are still being built to order and for the segment of the market that wants a new home, there are limited immediate opportunities to choose from, and that is helping to reduce incentives.
Next, while foreclosures continue to be a significant driver of absorption and pricing, the effect is continuing to decline as the bulk of foreclosure activities is situated in areas that do not compete with new home construction, such as the inner city or the extreme outskirts of markets in which we operate. The better situated foreclosure homes are being absorbed in an orderly fashion and the market is clearly in the inventory overhang in many locations. The $8,000 tax credit has facilitated that clearing process and has helped enable a return to normalcy. In our operating meetings, we found that a number of our markets were no longer effective at all by foreclosure homes as they had already been absorbed. I have noted many times that housing is a localized business and inventories in micro markets, not broad geographic markets are most important in considering demand trends.
Finally, we have heard that unemployment rates in many of our markets is at least stabilizing and in some instances beginning to recover. Accordingly, a general sense of confidence has returned to the consumer and there is a tangible sense that with prices and interest rates low, now is the right time to purchase a home for future security.
This is perhaps the most important element driving the future of the housing markets as the threat of losing one’s job has deterred many from the housing market for some time now. With the ground now firming beneath us, and with solid foundation of our balance sheet, we are able to find new acquisitions of home sites to build new communities where homes can be delivered at responsible profit levels at today’s price level and given zero market appreciation and Rick will give further color on our operations will talk about our acquisitions.
As you can see from our press release this morning, at Lennar, we have continued to position our company to return to fundamental profitability in 2010. We have made meaningful progress in preparing our company for a stabilized and ultimately recovering housing markets. That preparation is primarily reflected in our balance sheet and is now – that is now well positioned for the future. Through the end of last year, we aggressively impaired or disposed of assets that would not add to our profitability in the future. This process enabled us to both clean up our balance sheet, while maximizing the tax benefits derived from the net operating loss carry-back extension that Congress enacted last year.
This in turn has enabled us to move forward with additional liquidity to make strategic purchases and to begin to add back jobs that were lost as the markets deteriorated. In the first quarter, we made meaningful investments that we believe are positioning our company for success. After a rather long four-and-a-half years of mending process, we are pleased to finally be using our cash again to invest for future profitability rather than support impaired property.
Our balance sheet remains fortified with a homebuilding and Rialto debt-to-total cap ratio net of cash of 45.9% and homebuilding cash of approximately 1.15 billion, which includes the 230 [ph] in cash taken in two days after the end of the quarter. The number of joint ventures has fallen to 58 currently and that’s down from 62 last quarter. Many of the remaining ventures are good ventures that have already been reworked and have solid access to the position for the future. We expect to continue to reduce this number as we go forward into 2010. Additionally, we have continued to reduce our maximum recourse debt for the company to $279 million.
Finally, on the opportunity side, we have made our first strategic investments in the Rialto segment of our business. As I noted in prior quarters, we have been preparing to be a significant participant in the distress opportunities that naturally present themselves in down cycles. We have been incubating and operating team of experienced professionals for the past few years. The team is now formed and we have begun the process of actively investing in unique distressed investments. Mid-quarter, we announced the acquisition of over $3 billion of face value of loan in partnership with the FDIC, and we described our progress no our PPIP program with AllianceBernstein.
While I will let Jeff Krasnoff update you on those programs, I will note that we have made meaningful investments that we believe will add significant shareholder value. This is a tough business, but we do it exceptionally well. Yesterday evening, we had our weakly asset managers meeting, and as I reviewed assets with our managers from around the country, I was enthusiastic to see just how comfortably we operate and manage this very unique segment. We are clearly beginning to see more opportunities present themselves in this area and with our unique expertise, we expect to be an active participant in this part of the market recovery, as we feel these investments can add outsized return to our recovering homebuilding operations.
At the end of the day, we are very pleased with the progress that we have made to date and the very exciting position that our company is currently in. Our balance sheet is strong and positioned with adequate liquidity to support investment for our future. Our core homebuilding operations are positioned for success and beginning to grow again, adding communities and leveraging our right-sized overhead. And our Rialto Investments segment is now fully operational and investing capital to create strong returns as we build profitability.
While we have recognized that the current economic environment is fragile at best, we feel today that we are extremely well positioned to navigate the rocky bottom and ultimate recovery that lies ahead.
Wednesday, March 24, 2010
Rocky Bottom
Home builder Lennar reported good quarterly earnings today. CEO characterized the current housing market as moving along a "rocky bottom."
Major headwind is high unemployment and foreclosures.
Expiration of tax credit does not seem to be a major factor going forward. Buyers are more focused on affordability and the opportunity to own a decent home at a decent location to take advantage of low mortgage rates.
Incentive is down. Average sale price is up. A major factor is in California where certain markets have turned warm. Gross margin is up. Expect profitability in 2010.
A subtantial amount of cash is being put to work. More opportunities in distressed properties are expected. Lennar is in a unique position to work with FDIC and banks and other investors to opportunistically invest and/or co-invest in distress loans.
We get the sense that the housing market is going to be very uneven. Certain home builders who has the flexibility and the ability will be able to take advantage of local conditions better than others.
We like the type that are both aggressive and cautious.
Major headwind is high unemployment and foreclosures.
Expiration of tax credit does not seem to be a major factor going forward. Buyers are more focused on affordability and the opportunity to own a decent home at a decent location to take advantage of low mortgage rates.
Incentive is down. Average sale price is up. A major factor is in California where certain markets have turned warm. Gross margin is up. Expect profitability in 2010.
A subtantial amount of cash is being put to work. More opportunities in distressed properties are expected. Lennar is in a unique position to work with FDIC and banks and other investors to opportunistically invest and/or co-invest in distress loans.
We get the sense that the housing market is going to be very uneven. Certain home builders who has the flexibility and the ability will be able to take advantage of local conditions better than others.
We like the type that are both aggressive and cautious.
Thursday, March 4, 2010
Land grab: Housing cycle heading up before hitting bottom
Very good article on Business Week about cash-rich builders buying land again. It's worth quoting the entire article.
New Business March 3, 2010, 8:34PM EST
Housing: Hope on the Horizon
Cash-rich builders are buying land again, betting on a turn in the market for new homes
By Peter Coy and John Gittelsohn
You would think the nation's biggest homebuilders would be writhing in pain right about now. Sales of new single-family homes sank in January to the lowest seasonally adjusted rate in nearly five decades of record keeping and are now off 78% from the housing market's frothy peak in 2005.
Yet in a housing industry as vast and varied as America's, the data often fail to keep up with reality. It turns out that big publicly traded builders, thanks to cost-cutting, asset sales, bond issues, and tax breaks, aren't in grim shape. Their shares have nearly doubled over the past year and they're back in the game of competing for land, reflecting confidence that after years of falling prices, rising foreclosures, and busted dreams, better days are ahead.
The number of lots owned or controlled by a dozen of the biggest builders rose slightly in the second half of 2009 after years of decline as renewed buying offset heavy tax-related selling of unwanted parcels, according to a Bloomberg analysis of company reports. In crash-prone markets such as Southern California and Florida, prices of some construction-ready lots are up 50% or more from their 2009 lows. "There is definitely a shortage of land, and you cannot turn the switch on overnight," says Douglas C. Yearley Jr., executive-vice president of luxury builder Toll Brothers (TOL). "That will cause builders to aggressively buy the land they can."
Land buying began to pick up last year after finished lots hit the market at below the cost of improvements, and housing prices stabilized. Builders could finally turn out homes with some assurance of making a profit, says Scott D. Clark, the CEO of Americap Development Partners, a residential land developer in San Ramon, Calif. Greater affordability and tax incentives should help in the short term. What's more, the big builders believe population growth will eventually require a burst of construction. Warren Buffett agrees. In his Feb. 27 letter to shareholders of Berkshire Hathaway (BRK/A), which owns manufactured-housing maker Clayton Homes, he predicted that "within a year or so residential housing problems should largely be behind us."
Bargain Buying
The builders are staying disciplined for now, selectively scooping up bargains while buying just what they need to meet expected demand for the next few years. "There isn't one public homebuilder that's stupid. They're all well-seasoned. They've shrunk down to the size they need to be, and now they're reacting accordingly" to opportunities for growth, says James T. "Nate" Nathan, the president of Scottsdale (Ariz.)-based land broker Nathan & Associates.
It's tough to say how much land prices have risen because each market is different. Last year, DMB Associates, a developer in Scottsdale, and its partners bought back about 400 lots in DMB's Verrado master-planned community in Buckeye, Ariz., that builders had acquired and then defaulted on. They spent about $15,000 per lot, then quickly resold 300 of the lots to other builders for an average $40,000 per lot. Nationally, though, increases have been considerably smaller than that.
The uptick in prices matters because land is the main factor in real estate's roller-coaster cycle. When housing prices boomed in the middle of the last decade, it wasn't the structures that were suddenly deemed more valuable but the land. Economist Morris A. Davis of the University of Wisconsin-Madison School of Business estimates that the price of U.S. land used for houses and apartments nearly tripled from the beginning of 2000 to the end of 2005. Prices more than tripled over the period in Washington, Miami, Tampa, San Diego, Los Angeles, and Phoenix, and better than quadrupled in two inland California markets, Sacramento and San Bernardino, Davis estimates. He figures that national land prices fell nearly two-thirds through early 2009 before bouncing back more than 20% in the rest of '09. (To calculate the implied value of land, he takes the fluctuating market value of residential properties and subtracts the relatively stable replacement cost of the structures on them.)
The sharp decline in land prices was especially hard on the small builders that account for about 70% of the market. The National Association of Home Builders says its membership has fallen by about 20%, or 45,000. Many that remain have slashed staff. Jerry Howard, CEO of the NAHB, says banks are refusing to extend credit to small builders and stiffening the terms on existing credit.
In contrast, most of the big builders whose shares are publicly traded are battle-hardened and ready to grow again. Writedowns and write-offs by 13 of the largest public builders exceeded $32 billion through December, according to Fitch Ratings. In contrast to small builders, which rely almost entirely on banks for financing, several big builders were able to raise funds by issuing bonds.
Tax-Refund Windfall
An additional boost came last year when Congress passed a law allowing companies to get refunds on past years' tax payments by applying their recent losses to earnings dating back five years. Many sold land at big losses to boost their refunds. The result was a windfall of $2.3 billion for the builders as a group, including $800 million for No. 1 Pulte Homes (PHM).
The result of those balance-sheet heroics? Builders have more than $12 billion in cash they can use to replenish their land inventory. Pulte and D.R. Horton (DHI) each had $1.9 billion in cash and near-term equivalents at the end of December, Toll Brothers had $1.6 billion at the end of January, Lennar (LEN) had $1.3 billion, and KB Home (KBH) had $1.2 billion at the end of November.
Some of that cash is going for parcels that weaker builders lost through default or short sales. On Feb. 25, Starwood Land Ventures of Bradenton, Fla., announced it received "interest from nearly every major homebuilder in Florida" for about 5,400 residential lots it bought in the bankruptcy auction of Hollywood (Fla.)-based TOUSA, one of the few big builders that bit the dust. Lennar was first in line, agreeing with Starwood to acquire or get purchase options on more than 2,700 of the TOUSA lots across Florida. The price wasn't disclosed, but Lennar said it expects to earn gross margins of 20% or better on the deal. In Loveland, Colo., land broker Craig Harrison of Harrison Resource Corp. says he's "in shock and awe" at the amount of interest he's getting from builders and investors for 5,000 acres of land across northern Colorado that recently went on the market for $177 million.
Builders are buying land in part because the parcels they have aren't in the places where they need them. Property on the outer fringes of metro areas is still out of favor, says Daniel Oppenheim, a Credit Suisse (CS) homebuilding analyst. Prices have risen the most for closer-in lots that already have sewer lines, water, electricity, and sidewalks, because builders can throw up houses on them quickly and sign deals by Apr. 30 to qualify for federal homebuyer tax credits. Builders that aren't focused on a quick sales pop are choosing to buy cheaper "paper lots" that lack infrastructure, says Jody Kahn, vice-president of regional markets for Irvine (Calif.)-based John Burns Real Estate Consulting.
Interest in unfinished land usually comes later in the housing cycle, says Thomas E. Lucas, senior vice-president of operations for DMB in Scottsdale. "We didn't think we'd sell raw land for three to four years," Lucas says. That's a striking vote of confidence considering the threats to housing from high unemployment, rising mortgage rates, and foreclosures.
Everything seems to happen faster these days—including the housing cycle, which is heading up before it has hit bottom.
Coy is Bloomberg BusinessWeek's Economics editor. Gittlesohn is a reporter for Bloomberg News.
New Business March 3, 2010, 8:34PM EST
Housing: Hope on the Horizon
Cash-rich builders are buying land again, betting on a turn in the market for new homes
By Peter Coy and John Gittelsohn
You would think the nation's biggest homebuilders would be writhing in pain right about now. Sales of new single-family homes sank in January to the lowest seasonally adjusted rate in nearly five decades of record keeping and are now off 78% from the housing market's frothy peak in 2005.
Yet in a housing industry as vast and varied as America's, the data often fail to keep up with reality. It turns out that big publicly traded builders, thanks to cost-cutting, asset sales, bond issues, and tax breaks, aren't in grim shape. Their shares have nearly doubled over the past year and they're back in the game of competing for land, reflecting confidence that after years of falling prices, rising foreclosures, and busted dreams, better days are ahead.
The number of lots owned or controlled by a dozen of the biggest builders rose slightly in the second half of 2009 after years of decline as renewed buying offset heavy tax-related selling of unwanted parcels, according to a Bloomberg analysis of company reports. In crash-prone markets such as Southern California and Florida, prices of some construction-ready lots are up 50% or more from their 2009 lows. "There is definitely a shortage of land, and you cannot turn the switch on overnight," says Douglas C. Yearley Jr., executive-vice president of luxury builder Toll Brothers (TOL). "That will cause builders to aggressively buy the land they can."
Land buying began to pick up last year after finished lots hit the market at below the cost of improvements, and housing prices stabilized. Builders could finally turn out homes with some assurance of making a profit, says Scott D. Clark, the CEO of Americap Development Partners, a residential land developer in San Ramon, Calif. Greater affordability and tax incentives should help in the short term. What's more, the big builders believe population growth will eventually require a burst of construction. Warren Buffett agrees. In his Feb. 27 letter to shareholders of Berkshire Hathaway (BRK/A), which owns manufactured-housing maker Clayton Homes, he predicted that "within a year or so residential housing problems should largely be behind us."
Bargain Buying
The builders are staying disciplined for now, selectively scooping up bargains while buying just what they need to meet expected demand for the next few years. "There isn't one public homebuilder that's stupid. They're all well-seasoned. They've shrunk down to the size they need to be, and now they're reacting accordingly" to opportunities for growth, says James T. "Nate" Nathan, the president of Scottsdale (Ariz.)-based land broker Nathan & Associates.
It's tough to say how much land prices have risen because each market is different. Last year, DMB Associates, a developer in Scottsdale, and its partners bought back about 400 lots in DMB's Verrado master-planned community in Buckeye, Ariz., that builders had acquired and then defaulted on. They spent about $15,000 per lot, then quickly resold 300 of the lots to other builders for an average $40,000 per lot. Nationally, though, increases have been considerably smaller than that.
The uptick in prices matters because land is the main factor in real estate's roller-coaster cycle. When housing prices boomed in the middle of the last decade, it wasn't the structures that were suddenly deemed more valuable but the land. Economist Morris A. Davis of the University of Wisconsin-Madison School of Business estimates that the price of U.S. land used for houses and apartments nearly tripled from the beginning of 2000 to the end of 2005. Prices more than tripled over the period in Washington, Miami, Tampa, San Diego, Los Angeles, and Phoenix, and better than quadrupled in two inland California markets, Sacramento and San Bernardino, Davis estimates. He figures that national land prices fell nearly two-thirds through early 2009 before bouncing back more than 20% in the rest of '09. (To calculate the implied value of land, he takes the fluctuating market value of residential properties and subtracts the relatively stable replacement cost of the structures on them.)
The sharp decline in land prices was especially hard on the small builders that account for about 70% of the market. The National Association of Home Builders says its membership has fallen by about 20%, or 45,000. Many that remain have slashed staff. Jerry Howard, CEO of the NAHB, says banks are refusing to extend credit to small builders and stiffening the terms on existing credit.
In contrast, most of the big builders whose shares are publicly traded are battle-hardened and ready to grow again. Writedowns and write-offs by 13 of the largest public builders exceeded $32 billion through December, according to Fitch Ratings. In contrast to small builders, which rely almost entirely on banks for financing, several big builders were able to raise funds by issuing bonds.
Tax-Refund Windfall
An additional boost came last year when Congress passed a law allowing companies to get refunds on past years' tax payments by applying their recent losses to earnings dating back five years. Many sold land at big losses to boost their refunds. The result was a windfall of $2.3 billion for the builders as a group, including $800 million for No. 1 Pulte Homes (PHM).
The result of those balance-sheet heroics? Builders have more than $12 billion in cash they can use to replenish their land inventory. Pulte and D.R. Horton (DHI) each had $1.9 billion in cash and near-term equivalents at the end of December, Toll Brothers had $1.6 billion at the end of January, Lennar (LEN) had $1.3 billion, and KB Home (KBH) had $1.2 billion at the end of November.
Some of that cash is going for parcels that weaker builders lost through default or short sales. On Feb. 25, Starwood Land Ventures of Bradenton, Fla., announced it received "interest from nearly every major homebuilder in Florida" for about 5,400 residential lots it bought in the bankruptcy auction of Hollywood (Fla.)-based TOUSA, one of the few big builders that bit the dust. Lennar was first in line, agreeing with Starwood to acquire or get purchase options on more than 2,700 of the TOUSA lots across Florida. The price wasn't disclosed, but Lennar said it expects to earn gross margins of 20% or better on the deal. In Loveland, Colo., land broker Craig Harrison of Harrison Resource Corp. says he's "in shock and awe" at the amount of interest he's getting from builders and investors for 5,000 acres of land across northern Colorado that recently went on the market for $177 million.
Builders are buying land in part because the parcels they have aren't in the places where they need them. Property on the outer fringes of metro areas is still out of favor, says Daniel Oppenheim, a Credit Suisse (CS) homebuilding analyst. Prices have risen the most for closer-in lots that already have sewer lines, water, electricity, and sidewalks, because builders can throw up houses on them quickly and sign deals by Apr. 30 to qualify for federal homebuyer tax credits. Builders that aren't focused on a quick sales pop are choosing to buy cheaper "paper lots" that lack infrastructure, says Jody Kahn, vice-president of regional markets for Irvine (Calif.)-based John Burns Real Estate Consulting.
Interest in unfinished land usually comes later in the housing cycle, says Thomas E. Lucas, senior vice-president of operations for DMB in Scottsdale. "We didn't think we'd sell raw land for three to four years," Lucas says. That's a striking vote of confidence considering the threats to housing from high unemployment, rising mortgage rates, and foreclosures.
Everything seems to happen faster these days—including the housing cycle, which is heading up before it has hit bottom.
Coy is Bloomberg BusinessWeek's Economics editor. Gittlesohn is a reporter for Bloomberg News.
Thursday, February 25, 2010
Is the Market Ignoring the Dismal New Home Sales?
What's the matter with this market? Just one day after we learned that the January new home sales has hit a half-century record low, the stocks for homebuilders have mostly recovered?
In fact, some have shown a gain today. HOV is up 1%. KBH is up a fraction. Most outrageous of all: SPF is up by 5%. How can that be?
Is the market just ignoring the gloomy employment picture and the dismal sales data indicative of a housing market ready to fall off a cliff again?
Some have argued that millions of "shadow inventory" are on their way to foreclosure, which is bound to put a downward pressure on home prices over the next quarters or years. There won't be any housing recovery and homebuilders and banks are logical candidates for short sale. If that's the case, perhaps many more "John Paulsons" are about to be made!
Trouble is, we all have learned that the real John Paulson has been buying banks (BAC, C). That's a bet that the housing problem and the commercial real estate problem will at least be contained.
Perhaps the market is right to ignore the new home sales statistic, as long as it has confidence in the Fed to keep the interest rate low. After all, the statistic comes with a huge standard error that you can almost run a horse through it: + or - 15% for that 11.2% decline. That means, you may as well believe there was an increase from December if you'd like. Investors can't really make much out of the striking headline, can they?
We should probably pay more attention to the earnings releases and conference calls from the builders. Many of them, including Toll Brothers (TOL) today, have reported improved operating data for recent months. Most have also cautioned about the very challenging environment ahead, with the expected high unemployment rate and high foreclosures.
SPF's market reaction today is particularly interesting. The only news is that their Carolina division has announced an acquisition of a condo community called Glenmore. The size and the term were not disclosed. We only know that the floor plans have been downsized. This is likely a good move: picking up some stalled developments and remaking it at lower price points. But that would not justify a 5% move for the stock.
Perhaps this last sentence is what's catching investors' attention: "Glenmore is the first of several new Standard Pacific Homes communities to be announced in the Charlotte and Raleigh markets in the very near future."
North Carolina remains a relatively healthy sub-market, dominated by Pulte Homes (PHM). SPF has some presence, but not as much as in California. The expansion looks like a major ramp-up effort consistent with the company's turnaround strategy. While Pulte is still busy integrating with the old Centex, Standard is able to pick up or start a series of communities that fit its criteria.
Hmm, so much for the headline statistic. Mr. Alpha lies elsewhere.
Disclosure: Long SPF, LEN
In fact, some have shown a gain today. HOV is up 1%. KBH is up a fraction. Most outrageous of all: SPF is up by 5%. How can that be?
Is the market just ignoring the gloomy employment picture and the dismal sales data indicative of a housing market ready to fall off a cliff again?
Some have argued that millions of "shadow inventory" are on their way to foreclosure, which is bound to put a downward pressure on home prices over the next quarters or years. There won't be any housing recovery and homebuilders and banks are logical candidates for short sale. If that's the case, perhaps many more "John Paulsons" are about to be made!
Trouble is, we all have learned that the real John Paulson has been buying banks (BAC, C). That's a bet that the housing problem and the commercial real estate problem will at least be contained.
Perhaps the market is right to ignore the new home sales statistic, as long as it has confidence in the Fed to keep the interest rate low. After all, the statistic comes with a huge standard error that you can almost run a horse through it: + or - 15% for that 11.2% decline. That means, you may as well believe there was an increase from December if you'd like. Investors can't really make much out of the striking headline, can they?
We should probably pay more attention to the earnings releases and conference calls from the builders. Many of them, including Toll Brothers (TOL) today, have reported improved operating data for recent months. Most have also cautioned about the very challenging environment ahead, with the expected high unemployment rate and high foreclosures.
SPF's market reaction today is particularly interesting. The only news is that their Carolina division has announced an acquisition of a condo community called Glenmore. The size and the term were not disclosed. We only know that the floor plans have been downsized. This is likely a good move: picking up some stalled developments and remaking it at lower price points. But that would not justify a 5% move for the stock.
Perhaps this last sentence is what's catching investors' attention: "Glenmore is the first of several new Standard Pacific Homes communities to be announced in the Charlotte and Raleigh markets in the very near future."
North Carolina remains a relatively healthy sub-market, dominated by Pulte Homes (PHM). SPF has some presence, but not as much as in California. The expansion looks like a major ramp-up effort consistent with the company's turnaround strategy. While Pulte is still busy integrating with the old Centex, Standard is able to pick up or start a series of communities that fit its criteria.
Hmm, so much for the headline statistic. Mr. Alpha lies elsewhere.
Disclosure: Long SPF, LEN
Wednesday, February 24, 2010
Invest in housing recovery
January's new home sales was only 309,000 units, down 11.2% from Dec. That's a new record low in recent decades. Home buyers are not buying. It may have something to do with bad weather in the Northeast region, but most likely it's because of the grim outlook in employment. Jobs are scarce. The millions of unemployed don't have a chance. The still employed may fear losing their jobs. It's not the time to go shop for new homes.
Yet, the bad news argues for the case of investing in the housing recovery. And buying stocks in publicly traded home builders may be the best way to go. I have argued elsewhere why these builders deserve a close look, mostly because they have survived the downturn and look ready to take advantage of the low costs and the eventual return of a healthier market.
If 2009 was the year to invest in credit market turnaround, 2010 is the year to invest in companies that are in the best positions to take advantage of housing and economic recovery.
The Fed will continue to keep the rates low and steady. Inflation is not going to be a threat this year. Banks may be reluctantly starting to lend more. Government will cease to be the leading force in job creation. The positive feedback loop will turn when certain leading sectors start to add jobs. Manufacturing and technology are likely candidates. Financial sector may add more jobs. Only more jobs will help new home sales. That may happen in the second half of 2010.
Home builders that are best positioned may not be the ones who are working very hard to take advantage of the soon-to-expire federal tax credit. They are the ones that have great capital and human positions, which will allow them to move to promising sub-markets and/or take advantage of land opportunities.
We do not necessarily look for great recent sales. The last few months are not the best time to pound on sales and marketing. We want to invest in builders that have been methodically building its capital and portfolio. We've picked up some LEN shares because of its capital position and its ability to work with distressed assets on a large scale.
Yet, the bad news argues for the case of investing in the housing recovery. And buying stocks in publicly traded home builders may be the best way to go. I have argued elsewhere why these builders deserve a close look, mostly because they have survived the downturn and look ready to take advantage of the low costs and the eventual return of a healthier market.
If 2009 was the year to invest in credit market turnaround, 2010 is the year to invest in companies that are in the best positions to take advantage of housing and economic recovery.
The Fed will continue to keep the rates low and steady. Inflation is not going to be a threat this year. Banks may be reluctantly starting to lend more. Government will cease to be the leading force in job creation. The positive feedback loop will turn when certain leading sectors start to add jobs. Manufacturing and technology are likely candidates. Financial sector may add more jobs. Only more jobs will help new home sales. That may happen in the second half of 2010.
Home builders that are best positioned may not be the ones who are working very hard to take advantage of the soon-to-expire federal tax credit. They are the ones that have great capital and human positions, which will allow them to move to promising sub-markets and/or take advantage of land opportunities.
We do not necessarily look for great recent sales. The last few months are not the best time to pound on sales and marketing. We want to invest in builders that have been methodically building its capital and portfolio. We've picked up some LEN shares because of its capital position and its ability to work with distressed assets on a large scale.
Tuesday, February 16, 2010
Wise to Invest Alongside Governments?
(This article has been published and distributed by Seeking Alpha.)
Recent events from China’s tightening, Euro-zone sovereign risk, to US policy towards banks have illustrated just how important it has become for investors to consider this question: is it wise to invest alongside the governments, or not?
This question is relevant not just for bond investors and credit investors, but also for equity investors.
PIMCO was known to invest alongside the US government when the government was trying to contain the financial crisis, and ripped huge benefits by doing so. However, it is clear from Bill Gross’ Investment Outlooks in recent months that the bond shop has changed its tune:
PIMCO’s New Normal has an inherent bias against equities. It argues that in this post-crisis world of de-leveraging, re-regulation, and de-globalization, there will be little growth, and hence little upside for equities. This is the year to preserve capital.
Sweeping arguments of this sort appear more self-serving than helpful to individual investors, however. If you’re an equity investor, we think the government factor will continue to play a large role. Investing in equities in 2010, by and large, is investing in economic recovery alongside the government efforts to spur growth and create jobs. No doubt, government actions also represent a great source of risk.
The US will in the foreseeable future have to focus on getting credit to flow, stabilizing the all-too-important housing sector, creating jobs either by directly expanding the public sector or by encouraging private hiring. This focus places a great importance on banking industry, housing industry and the industrial sector.
Banks are healing. Investors who invested alongside the government efforts in 2009 were rewarded. Despite the risk of new regulation and finger-pointing, credit creation remains to be the key for economic recovery. The remaining banks, especially the well-run ones such as Wells Fargo (WFC) and JP Morgan (JPM), continue to represent good opportunities to invest alongside the government.
The battered home building industry enjoys unusual government supports, yet it has caused much less controversy over bailout. The generosity from the government is beyond belief. Take the loss carry-back tax break, for example. Many commentators say it’s a one-time effect. But the fact is home builders are able to collect this benefit over many years. And the government, from the Fed, to the Administration, to the Congress, to agencies like FDIC, all appears determined to put a floor on property prices.
One recent example: The FDIC has chosen Lennar (LEN) as a co-investor in a $3.1 billion portfolio of distressed loans from failed banks seized by the agency. These loans are linked to both commercial and residential properties. The two parties will pay a combined $1.2 billion, or about 40 cents on a dollar. Lennar will contribute $243 million for a 40% equity stake in the venture, while the FDIC will pay $365 million for the rest. The remaining $627 million is seven-year interest-free debt provided by the FDIC. So if these loans, backed by land, developed lots, and other real properties, appreciate in value, Lennar stands to benefit alongside the government and the tax payer. On top of that, Lennar will collect a management fee from FDIC for overseeing the portfolio and loan work-out.
Success is not guaranteed, but with such generous financing terms and a determined government as co-investor, the odd is more than good.
By taking a 60% equity stake, FDIC appears to be sending a strong signal to the real estate market that there will be no fire-sale, and that a bottom has in all likelihood been reached, or supported.
Other builders, if nothing else, should benefit from the price support.
If Uncle Sam is becoming more of a shareholder, shouldn’t individual investors?
Disclosure: Long WFC, JPM, SPF
Recent events from China’s tightening, Euro-zone sovereign risk, to US policy towards banks have illustrated just how important it has become for investors to consider this question: is it wise to invest alongside the governments, or not?
This question is relevant not just for bond investors and credit investors, but also for equity investors.
PIMCO was known to invest alongside the US government when the government was trying to contain the financial crisis, and ripped huge benefits by doing so. However, it is clear from Bill Gross’ Investment Outlooks in recent months that the bond shop has changed its tune:
If 2008 was the year of financial crisis and 2009 the year of healing via monetary and fiscal stimulus packages, then 2010 appears likely to be the year of “exit strategies,” during which investors should consider economic fundamentals and asset markets that will soon be priced in a world less dominated by the government sector. If, in 2009, PIMCO recommended shaking hands with the government, we now ponder “which” government, and caution that the days of carefree check writing leading to debt issuance without limit or interest rate consequences may be numbered for all countries.
PIMCO’s New Normal has an inherent bias against equities. It argues that in this post-crisis world of de-leveraging, re-regulation, and de-globalization, there will be little growth, and hence little upside for equities. This is the year to preserve capital.
Sweeping arguments of this sort appear more self-serving than helpful to individual investors, however. If you’re an equity investor, we think the government factor will continue to play a large role. Investing in equities in 2010, by and large, is investing in economic recovery alongside the government efforts to spur growth and create jobs. No doubt, government actions also represent a great source of risk.
The US will in the foreseeable future have to focus on getting credit to flow, stabilizing the all-too-important housing sector, creating jobs either by directly expanding the public sector or by encouraging private hiring. This focus places a great importance on banking industry, housing industry and the industrial sector.
Banks are healing. Investors who invested alongside the government efforts in 2009 were rewarded. Despite the risk of new regulation and finger-pointing, credit creation remains to be the key for economic recovery. The remaining banks, especially the well-run ones such as Wells Fargo (WFC) and JP Morgan (JPM), continue to represent good opportunities to invest alongside the government.
The battered home building industry enjoys unusual government supports, yet it has caused much less controversy over bailout. The generosity from the government is beyond belief. Take the loss carry-back tax break, for example. Many commentators say it’s a one-time effect. But the fact is home builders are able to collect this benefit over many years. And the government, from the Fed, to the Administration, to the Congress, to agencies like FDIC, all appears determined to put a floor on property prices.
One recent example: The FDIC has chosen Lennar (LEN) as a co-investor in a $3.1 billion portfolio of distressed loans from failed banks seized by the agency. These loans are linked to both commercial and residential properties. The two parties will pay a combined $1.2 billion, or about 40 cents on a dollar. Lennar will contribute $243 million for a 40% equity stake in the venture, while the FDIC will pay $365 million for the rest. The remaining $627 million is seven-year interest-free debt provided by the FDIC. So if these loans, backed by land, developed lots, and other real properties, appreciate in value, Lennar stands to benefit alongside the government and the tax payer. On top of that, Lennar will collect a management fee from FDIC for overseeing the portfolio and loan work-out.
Success is not guaranteed, but with such generous financing terms and a determined government as co-investor, the odd is more than good.
By taking a 60% equity stake, FDIC appears to be sending a strong signal to the real estate market that there will be no fire-sale, and that a bottom has in all likelihood been reached, or supported.
Other builders, if nothing else, should benefit from the price support.
If Uncle Sam is becoming more of a shareholder, shouldn’t individual investors?
Disclosure: Long WFC, JPM, SPF
Sunday, February 7, 2010
Looking for value in home builders
Last week saw earnings releases from many of the nation’s largest home builders including DHI, MDC, SPF, MHO and BZH. It was a busy week. All reported the first profit, largely due to loss carry-back tax credit, since the downturn. Without the tax credit, most builders would still have been producing a loss. But by and large the amount of loss and the amount of asset write-down appeared to have come to an end.
New home sales are at the lowest point in two decades. Against the backdrop of foreclosures and short sales, new home inventory is also at a depressed level. An army of private builders have gone out of business, due to lack of refinancing. The remaining group of public builders now has ample cash reserve, lean workforce, much reduced balance sheet, much lower level of leverage, and lower level of competition than before. If you think economic recovery is likely to materialize, unemployment rate is likely to improve from this point on, and banks are about to increase their lending activities, and that home builder is one of the first pro-cyclical industries to benefit from the upturn, then it is perhaps the best time to look into this group and see where the value and potential is.
This article takes the first step to examine the value aspect of the group by comparing some common metrics among 8 builders. Since they’re still not making positive incomes without the tax credit, we will ignore P/E ratio. Instead we’ll look at price-to-book ratio, price-to-sale ratio and price-to-cash ratio. The table below lists the closing price, market cap, book equity and the three ratios based on data gathered from the latest earnings releases. The data is not guaranteed to be accurate, but they should give us a good ground for comparison analysis.
I also included a leverage ratio measure, total asset to total equity ratio (A/E), to give us a sense for their balance sheet strength.
Hovnanian still hasn’t reported yet, the data is based on the last release. It is one of the weakest companies with about $350M negative equity. It is amazing that it has managed to survive the credit crunch. Market gives it one of the lowest valuations, based on P/Sale and P/Cash ratio. The only other company that looks that bad is Beazer Homes, which still sports an excessive level of leverage.
Because of their debt problem, these two stocks will continue to be very volatile and may not represent risks worth taking.
MHO just reported a good quarter. It was profitable even excluding the tax credit. Its balance sheet is very healthy. It has raised a good chunk of cash and left the year 2009 with $132M of cash. There is no liquidity problem. This stock has a very low P/B and P/Sale ratios. It represents a good value.
SPF is one of the risks I like. With the shares trading in mid-3, all three valuation ratios are among the lowest. Yet, after asset sale and equity infusion, its leverage ratio is now quite normal (for a point of reference, a 20% down home purchase would give you an A/E ratio of 5 for that house). Standard Pacific’s gross margin is consistently among the highest in the industry. The company appears not very interested in competing with the mountain of foreclosed homes out there. Last quarter it mothballed 52 communities, taking a wait-and-see attitude. That was probably the main reason why it did not increase orders by much year-over-year in its 4Q. They might have overdone it, but it was a reasonable tradeoff. The company also appears not geared towards first-time home buyers who are keen on taking advantage of the federal tax credit. Most other companies analyzed here were heavily geared towards that group of home buyers. The silver-lining in this is that when the tax credit expires, SPF can perform relatively well.
Investors who had hoped for a blow-out quarter from Standard were disappointed and quickly drove down the shares from above $4 to mid-3. At this price level, it represents a great value. I also like the fact that the market cap is only 60% of the company's cash, most of it is unrestricted.
KB Home, another Southern California based builder, appears quite expensive at 1.6 P/B. Its leverage level is manageable, but higher than that of Standard Pacific.
MDC reported an unimpressive quarter. It has a healthy balance sheet, but on the expensive side.
Both DHI and LEN have reported pre-tax profits last quarter. Both are well-positioned to take advantage of the home-buyer tax credit. They have strong balance sheets, and are priced reasonably. These are good choices for investors interested in larger companies.
For a hedged strategy, investors may consider going long MHO, SPF and DHI, against shorts in HOV, BZH and KBH. Of course, for a more sophisticated hedged play, more quantitative and qualitative factors should be included.
New home sales are at the lowest point in two decades. Against the backdrop of foreclosures and short sales, new home inventory is also at a depressed level. An army of private builders have gone out of business, due to lack of refinancing. The remaining group of public builders now has ample cash reserve, lean workforce, much reduced balance sheet, much lower level of leverage, and lower level of competition than before. If you think economic recovery is likely to materialize, unemployment rate is likely to improve from this point on, and banks are about to increase their lending activities, and that home builder is one of the first pro-cyclical industries to benefit from the upturn, then it is perhaps the best time to look into this group and see where the value and potential is.
This article takes the first step to examine the value aspect of the group by comparing some common metrics among 8 builders. Since they’re still not making positive incomes without the tax credit, we will ignore P/E ratio. Instead we’ll look at price-to-book ratio, price-to-sale ratio and price-to-cash ratio. The table below lists the closing price, market cap, book equity and the three ratios based on data gathered from the latest earnings releases. The data is not guaranteed to be accurate, but they should give us a good ground for comparison analysis.
I also included a leverage ratio measure, total asset to total equity ratio (A/E), to give us a sense for their balance sheet strength.
Hovnanian still hasn’t reported yet, the data is based on the last release. It is one of the weakest companies with about $350M negative equity. It is amazing that it has managed to survive the credit crunch. Market gives it one of the lowest valuations, based on P/Sale and P/Cash ratio. The only other company that looks that bad is Beazer Homes, which still sports an excessive level of leverage.
Because of their debt problem, these two stocks will continue to be very volatile and may not represent risks worth taking.
MHO just reported a good quarter. It was profitable even excluding the tax credit. Its balance sheet is very healthy. It has raised a good chunk of cash and left the year 2009 with $132M of cash. There is no liquidity problem. This stock has a very low P/B and P/Sale ratios. It represents a good value.
SPF is one of the risks I like. With the shares trading in mid-3, all three valuation ratios are among the lowest. Yet, after asset sale and equity infusion, its leverage ratio is now quite normal (for a point of reference, a 20% down home purchase would give you an A/E ratio of 5 for that house). Standard Pacific’s gross margin is consistently among the highest in the industry. The company appears not very interested in competing with the mountain of foreclosed homes out there. Last quarter it mothballed 52 communities, taking a wait-and-see attitude. That was probably the main reason why it did not increase orders by much year-over-year in its 4Q. They might have overdone it, but it was a reasonable tradeoff. The company also appears not geared towards first-time home buyers who are keen on taking advantage of the federal tax credit. Most other companies analyzed here were heavily geared towards that group of home buyers. The silver-lining in this is that when the tax credit expires, SPF can perform relatively well.
Investors who had hoped for a blow-out quarter from Standard were disappointed and quickly drove down the shares from above $4 to mid-3. At this price level, it represents a great value. I also like the fact that the market cap is only 60% of the company's cash, most of it is unrestricted.
KB Home, another Southern California based builder, appears quite expensive at 1.6 P/B. Its leverage level is manageable, but higher than that of Standard Pacific.
MDC reported an unimpressive quarter. It has a healthy balance sheet, but on the expensive side.
Both DHI and LEN have reported pre-tax profits last quarter. Both are well-positioned to take advantage of the home-buyer tax credit. They have strong balance sheets, and are priced reasonably. These are good choices for investors interested in larger companies.
For a hedged strategy, investors may consider going long MHO, SPF and DHI, against shorts in HOV, BZH and KBH. Of course, for a more sophisticated hedged play, more quantitative and qualitative factors should be included.
Wednesday, February 3, 2010
Acting Cautiously: Standard Pacific’s Net Sales Up By Only 1% Yoy
Standard Pacific (SPF) reported $0.31 per share net income on revenue of $339.8M for 4Q of 2009. The net income of $82.7 million included an income tax benefit of $94.1 million. Without the tax benefit, the company would have reported a small operating loss. This result is less appealing than the pre-tax profit reported from M/I Homes (MHO) this morning. It is also much less so than the result from D.R. Horton (DHI) reported yesterday.
Its gross margin improved to 20.3% from 18.6% in the third quarter, excluding the relatively small impairments. This is one of the company’s strong areas, and it is getting stronger. The company’s cash position has continued to increase due to land sales and tax refund.
Community counts are down sequentially from 139 average selling communities in the third quarter to 128. Net new orders totaled 554, down from 922 in the third quarter. Compared to 2008, the net new orders are up by only 1%. But on the “same store” basis, they’re actually up by 40%. The dynamics is very different from the “brisk” sales activities reported by D.R. Horton. Horton’s net sales orders were up 45% year over year.
This is an important point for analysis. Since the margin is healthy and steady. Profitability rests on increasing sales. Horton appeared to be completely out there to take advantage of the federal tax credit for the first time home buyers, and was able to generate sales profitably. There is an important question as to how long it can last with the pending expiration of that credit.
Standard Pacific appeared to be getting at it much more cautiously. It has increased land acquisition with small steps. It is still consolidating its balance sheet. No question, Horton’s balance sheet is much stronger, and can afford to be more aggressive.
The question for investors though is, given the state of the economy and the eventual withdrawal of the federal tax credit, which approach seems more beneficial for the long term? And for what price? DHI shares are priced richly at nearly 2 times book, while SPF is trading at about its book.
We hope to gain more insights from the conference call on Thursday.
Its gross margin improved to 20.3% from 18.6% in the third quarter, excluding the relatively small impairments. This is one of the company’s strong areas, and it is getting stronger. The company’s cash position has continued to increase due to land sales and tax refund.
Community counts are down sequentially from 139 average selling communities in the third quarter to 128. Net new orders totaled 554, down from 922 in the third quarter. Compared to 2008, the net new orders are up by only 1%. But on the “same store” basis, they’re actually up by 40%. The dynamics is very different from the “brisk” sales activities reported by D.R. Horton. Horton’s net sales orders were up 45% year over year.
This is an important point for analysis. Since the margin is healthy and steady. Profitability rests on increasing sales. Horton appeared to be completely out there to take advantage of the federal tax credit for the first time home buyers, and was able to generate sales profitably. There is an important question as to how long it can last with the pending expiration of that credit.
Standard Pacific appeared to be getting at it much more cautiously. It has increased land acquisition with small steps. It is still consolidating its balance sheet. No question, Horton’s balance sheet is much stronger, and can afford to be more aggressive.
The question for investors though is, given the state of the economy and the eventual withdrawal of the federal tax credit, which approach seems more beneficial for the long term? And for what price? DHI shares are priced richly at nearly 2 times book, while SPF is trading at about its book.
We hope to gain more insights from the conference call on Thursday.
Monday, February 1, 2010
The case for taking a chance with SPF
California home sales have been going up for a year now. Median prices have been creeping up too. Most of the sales are coming from foreclosures and other distress sales. They've also been helped by government policies and low mortgage rates.
Inventory has shrunk to a 5 year low, according to a recent Wall Street Journal article:
Home builders as a group provide a way to participate early on the economic recovery. Over the last few years, most of these companies have all been losing money. Their stocks have plunged for good reasons. Some have gone out of business. Many of these names were our shorts two years ago. We think it's time now to take a close look at the survivors as long candidates. Against all the headwinds one can list, we think a positive case can be made based on these factors:
We think SPF may be more undervalued than most. The company has over $500M in cash. Its cash flow has been positive. It has a large concentration in California which is improving. Margin has been steady. Yet, the market cap is about $400M. Leverage is still a bit high, with total asset at $2B and total debt over $1.4B. But most of the debts won't come due before 2013. The equity infusion from MatlinPatterson in 2008 saved the company from a deadly cash crunch. The new management installed by the private equity firm appears to be jelling. While the cash infusion played a critical role in stabilizing the company, much of it is sitting there. The real test of the turnaround will be how well the company can identify and acquire profitable lots and sell more finished homes above costs in this challenging environment.
Judging from the California home sale reports in recent months, we think there is a reasonable chance that SPF can surprise on the upside this Wednesday. But more importantly, we want to see how well the company has positioned itself for the expiration of government tax credit and the very slow recovery ahead.
Inventory has shrunk to a 5 year low, according to a recent Wall Street Journal article:
The supply of unsold single-family homes dropped to 3.8 months from 5.6 months a year ago and 16.6 months in January 2008, when inventories were at a peak, according to estimates released Friday by the California Association of Realtors. The inventory levels are now at their lowest level since 2005, resulting in frenzied sales with multiple offers in some cities.Is it time to give the California housing market a chance? Is it time to buy shares of home builders?
Home builders as a group provide a way to participate early on the economic recovery. Over the last few years, most of these companies have all been losing money. Their stocks have plunged for good reasons. Some have gone out of business. Many of these names were our shorts two years ago. We think it's time now to take a close look at the survivors as long candidates. Against all the headwinds one can list, we think a positive case can be made based on these factors:
- They have been shrinking inventories
- They have been repairing balance sheets, in some cases buying back debts using cash
- They've been building cash, cutting down costs, shrinking workforce
- They've been writing down assets, to the point that there is little to be written down further
- Most can now refinance their debts either with banks, debt market, or with private lenders
- The housing resale market has been bottoming in parts of the country, e.g. California
- Land and construction costs are now much more reasonable
- In some cases, distress land sales create economical opportunities
- At least some people still like new homes, and more will as jobs improve
We think SPF may be more undervalued than most. The company has over $500M in cash. Its cash flow has been positive. It has a large concentration in California which is improving. Margin has been steady. Yet, the market cap is about $400M. Leverage is still a bit high, with total asset at $2B and total debt over $1.4B. But most of the debts won't come due before 2013. The equity infusion from MatlinPatterson in 2008 saved the company from a deadly cash crunch. The new management installed by the private equity firm appears to be jelling. While the cash infusion played a critical role in stabilizing the company, much of it is sitting there. The real test of the turnaround will be how well the company can identify and acquire profitable lots and sell more finished homes above costs in this challenging environment.
Judging from the California home sale reports in recent months, we think there is a reasonable chance that SPF can surprise on the upside this Wednesday. But more importantly, we want to see how well the company has positioned itself for the expiration of government tax credit and the very slow recovery ahead.
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