......}
As the market bounced around in anxious anticipation of last week's elections, the stocks of homebuilders steadily slipped away. Many of these stocks slid back under the 50 DMA: KBH, CTX, DHI, TOL, HOV, PHM, MHO, and MTH. BZH and LEN waited until after the elections to sink below this important short-term level of support. Of these stocks, PHM seems to be the worse off as it is now only 11% above its 52-week low. The enthusiasm seems to be subtly waning for playing the contrarian and anticipating an imminent turn-around in housing. And no wonder. For every eager analyst who pounds the table for cheap housing stocks, there is another housing CEO who declares that the bottom in the market remains elusive. Centex issued the first earnings warning that the market has taken seriously in many months and the stock has not been the same since. In fact, CTX is about another 5% below the low of that high-volume sell-off day. Interestingly, the optimistic analysts remained unfazed while the pessimistic analysts saw additional confirmation of the housing bear. Since then, more warnings have come and the market has not reacted with its contrarian buying habits this time. Another shift in sentiment may be upon us. Case in point: HOV and TOL, November 7, 2006.
Hovanian (HOV)
HOV announced the following warning on Nov 7th:
"'Our financial results for the fourth quarter continued to be negatively impacted by high cancellation rates and increased use of concessions and incentives, particularly on the resale of those homes which experienced contract cancellations,' commented Ara Hovnanian, President and Chief Executive Officer of Hovnanian Enterprises, Inc. 'As we begin fiscal 2007, we are optimistic that some of our more challenging markets will begin to experience decreasing cancellations and an improved sales pace. However, we have not seen signs of such improvement to date, despite reasonably healthy levels of buyer traffic at many of our communities.'" In other words, HOV is trying to remain optimistic, but they are warning folks that they have no real evidence on which to base these hopes. All the negatives that have brought the homebuilding industry down hard from its 2005 peak are still real problems. The market had been buying such bad news for the past 3 or 4 months. Not this time.
Toll Brothers (TOL)
On November 7, Robert I. Toll, chairman and chief executive officer, had this to say about the current conditions in the housing market (emphasis mine):
“FY 2006 has certainly been a very tough and challenging year. It is worth noting that, atypically, this housing market is weak in an environment of low interest rates and low unemployment. We believe weak buyer confidence is keeping many customers on the sidelines. “We continue to look for signs that a recovery is imminent but can’t yet say that one is in sight. We see some signs of pent-up demand when we have special sales events or new community openings. And in some markets, good weeks are interspersed amongst weaker ones. With continued growth in households and population and fewer lots than usual making their way through the approval process, we believe that, once the current inventory overhang is absorbed and consumer sentiment turns positive, the market should improve more rapidly than is generally anticipated.
Our nation’s demographics haven’t changed, and home ownership remains the American dream. With interest rates very attractive, the economy healthy and home builders motivated to move their product, it should be a great time to buy a new home. Our goal is to bring the quality of our brand to luxury buyers and to provide dream housing for them at all stages of their life cycles. With our broad geographic presence, diversified product lines and experienced team, we believe we will weather this challenging environment and emerge stronger."
In other words, TOL wants to declare the bottom is here, but they simply cannot pop the cork quite yet. Again, the evidence is just not there. But based on experience with past housing cycles, TOL assumes that a bottom should be around the corner somewhere and when the recovery comes, it is going to be gangbusters all over again. I will reiterate that these kinds of statements completely neglect the prospect for imminent economic weakness. If housing is languishing while the economy is firing on all cylinders, imagine what happens if the much anticipated slowdown becomes real.
It also seems that the optimistic analysts are finally getting gun-shy along with the bad news buyers. Marketwatch reported on the reaction from three analysts. They are all the same analysts that have remained negative on the sector, but it was notable nonetheless:
"Order declines worsened significantly, despite the easier comparison [to the year-ago quarter], increased community growth, and a likely greater willingness to adjust prices as management has seen that the slowdown has stamina," wrote Banc of America Securities analyst Daniel Oppenheim in a research note Tuesday. "We expect the cancellation rate to remain elevated while home prices decline and the time [needed] to sell a home lengthens," he added. Meanwhile, analyst Rick Murray at Raymond James & Associates said the current housing slowdown is likely to be more protracted and along the lines of past cyclical downturns in the sector. "Despite much recent discussion regarding a potential recovery in the mid-Atlantic region (Washington, D.C. in particular), we note that Toll's order trends in this quarter show continued acceleration to the downside for this region, dropping 50% and 54% in units and dollars, respectively," Murray wrote in a report to clients Tuesday. Another analyst following home builders, Ivy Zelman at Credit Suisse, said the market is wrestling with the problem of higher inventories of new and existing homes. "On the new side, builders are forcing more supply on the market in an effort to deal with bloated balance sheets," Zelman said in a note. "On the existing side, homeowners are skeptical to sell at market clearing prices, begetting cancellations for the builders late in the game."
UBS Building and Building Products Conference
Finally, on to the main event. I took the opportunity to listen to the UBS Building and Building Products Conference held in New York City, Nov 8-9, 2006. There is nothing like an analyst day to get the real deal from the executives. Even as a homebuyer, rather than an investor, I think it is very useful to hear how the folks think on the other side of the table. I chose to focus on the "Homebuilder CEO Panel" as a good summary of the sentiment from management. It indeed proved very educational. The following represents my notes from what I found most interesting from the discussion:
Speakers:
Beazer Homes USA, Inc. - Ian J. McCarthy - President & CEO
D.R. Horton, Inc. - Donald J. Tomnitz - President & CEO
Hovnanian Enterprises, Inc. - Ara K. Hovnanian - President & CEO
Toll Brothers, Inc. - Robert I. Toll - Chairman & CEO
(Note that I do not always identify the speak given that I could not be sure of the identity behind the voices.)
- Hope but don't fully believe market will recover by 2008.
- Taking action now to get through a tough year - job cuts, reducing land holdings.
- Don't mind missing first few quarters of an uptick
- Asking sub-contractors to bring prices down
- Reconsidering site planning and product to enhance profitability
- Not buying any stock back, can use cash to plunder guys doing even worse
- Incentives go down as inventory goes down - don't mind sitting on land, but hate sitting on houses. Guessing that the decline n incentives may itself start the ramp back up.
- Pool of pent-up demand being created
- Private builders are forced to keep building to show to banks returns on debt - can't go on much longer
- Builder/developer and loan officer is in trouble where they paid too much for land, built too expensive home on the land, etc...homebuilders are waiting for market shifts toward bankruptcy court to get this on the cheap. Too early to take this now. Market not ready to sell.
- Moderator said that for first time in 5 years she has not heard CEOs complaining about the low P/Es of their stocks
- Asked why not take out private builders before they get distressed and take inventory off now
- Keeping powder ready and dry for when the sellers finally give in and start showing up in bankruptcy court
- During last down cycle, all of them wish they had bought more dirt when the bankers disgorged themselves
- Land values have come down, but sellers in general have not recognized this with price drops. Those who can be patient, will be
- Tried really hard to weed speculative investors out. Had controls in place, but they still got in. Speculators even lied on disclosure forms - signing and saying they are not investors. Even when they are kept out, speculators would go to a competitor's development and still put pressure on market. They [the homebuilders] wake up one day and find out that they are all selling to the same guy who is driving prices up.
- Don't think any of the majors will fail this downturn. Unlike last time. If they had followed advice of doomsday media all the previous years, they would not have been able to build in the billions of dollars of additional book value.
- Not much motivation for medium-size or large publics to sell out their companies at these current prices
- Don't expect economy in 2008 to be as good as it is now. Still optimistic for industry to look better than they look now.
- Highly regulated markets are where all the action has been recently. Supply is tightly controlled.