Will Public Home Builders ‘Implode’?
With all the home builder news out this past week, readers suggested related topics. “How about a ranking of public homebuilders in order of likelihood of implosion i.e. weakest to the strongest? Nominate your ‘favorite’ HB below for inclusion!”
One nomination, “From the bigger builders i vote for WCI. The first quarter 07 will be the make or break for them. They think they can sell the new condos. Good luck.”
Another said, “The homebuilders are screwed a lot worse than many think they are, especially smaller private developers and builders. Not only will they have massive inventory write-downs when they can’t sell the land for what they bought if for, but they also have massive interest expense built into the homes they are building.”
“I was just looking at KB’s latest 10-Q and saw that the amount of capitalized interest this quarter almost doubled from last quarter (up $50m+) and inventory climbed by over $2b. That ‘additional’ capitalized interest..represents an unusual high level of inventory on the books. Writing down their inventory by 30% would wipe out nearly all of the companies equity. And KBH is one of the stronger companies.”
“This same dilemma is also affecting smaller home builders across the country. Massive bankruptcies with developers all over the place. They simply can’t sustain the level of inventory they have. They have to move it quick.”
And another, “Why does the stock market have such a hard time figuring out the obvious? Why does the market not quickly price in common knowledge? When the conundrum ends, you can be sure the homebuilder share prices will have reverted to pre-Y2K levels.”
One on Ryland Homes. “I know that Ryland is discounting inventory homes heavily & renegotiating deals with current contract holders to keep them in line, after only offering incentives in the spring. So maybe they can ride it out if they play it smart and build smaller & cheaper homes to keep the first time home buyers in their niche.”
The LA Times. “Irvine-based Standard Pacific, which builds houses in California, Texas, Arizona and Colorado, will lower its earnings forecast for the third quarter and 2006, after new-home orders fell 58% in July and August from a year earlier.”
“‘We expected to be down year over year, but not to this degree,’ said Andrew Parnes, Standard Pacific’s CFO. ‘Clearly it’s turning out to be a more difficult situation than we thought at the beginning of the year.’”
From Reuters. “Leading U.S. home builders appear to have adopted one of two strategies to endure a rapidly deteriorating housing market, based on differing bets on just how long the slump will last and how bad it will get.”
“In one camp, which includes Hovnanian, Lennar and D.R. Horton, are companies that will prop up home sales by cutting prices.”
“In the other, including Toll Brothers, KB Home and Ryland, the companies plan to hold prices steady but sell fewer homes, to protect operating margins.”
“‘You don’t want your customers to get used to aggressive incentives,’ J.P. Morgan analyst Michael Rehaut said. ‘Obviously, the auto industry has continued to find itself in that position and it’s not a good position to be in.’”
“Hovnanian discounted prices in weaker markets, such as southeast Florida, which went from one of last year’s hottest markets to what Chief Executive Ara Hovnanian called either ‘the worst market in the country’ or one of the worst.”
“‘It is clear that the significant decline in our pace of net contracts per community has been partially offset by our growth in communities, which has kept our absolute number of sales from falling more substantially,’ CEO Hovnanian said. But net contracts per community stood at 7.7, down almost 40 percent from a year earlier and the lowest in 10 years.”
“On Friday, Lennar warned that its use of incentives was one of the reasons that earnings for the most recent quarter would fall short of its prior forecast. But it also said orders declined only 5 percent for the same reason. Horton and Lennar are two of the most tenured management teams, said UBS analyst Margaret Whelan. ‘You would think they’d be the best operators in a correction like this. It’s the worst strategy. They’re going to have the most margin erosion because of that.’”
“‘But if the market gets much worse in ‘07 and ‘08, Horton is going to look like the smartest guy in the room,’ Whelan said.”
“Toll offers ‘incentives.’ Although gross margins declined 410 basis points, they still topped 29 percent, analysts said. However, Toll issued a forecast that implied new orders will start to significantly improve over the next two quarter.”
“But Raymond James’ Rick Murray had his doubts, given that Toll’s orders fell 48 percent in the most recent quarter. ‘We believe a rebound in fundamentals is not in the foreseeable future,’ he said.”
‘Leading U.S. home builders appear to have adopted one of two strategies to endure a rapidly deteriorating housing market, based on differing bets on just how long the slump will last and how bad it will get. In one camp..are companies that will prop up home sales by cutting prices. In the other..the companies plan to hold prices steady but sell fewer homes, to protect operating margins.’
It should be pointed out that neither plan jives with what these firms said in corporate communications about the coming slump, which was to continue building and gobble up their weaker competitors. (Yes, they all knew a downturn was coming, even as the CEO’s went on television and talked about trees growing to the sky).
Then again, why should anyone expect them to be right about anything?
‘We expected to be down year over year, but not to this degree,’ said Andrew Parnes, Standard Pacific’s chief financial officer. ‘Clearly it’s turning out to be a more difficult situation than we thought at the beginning of the year.’
My vote is for the most condoed, overbuilt, speculative areas going down the hardest…….so WCI fits the bill the best. Under $10 by year end looks possible.
In one camp..are companies that will prop up home sales by cutting prices. In the other..the companies plan to hold prices steady but sell fewer homes, to protect operating margins.
The “other” camp obviously didn’t hear of the first one’s plan.
LOL, tj…how right you are. Stupid builders are going to “hold up prices” as if they are the only ones trying to sell homes.
Best to get out now. Build and sell as much as possible, because these prices won’t be seen for a long, long, long time, IMHO.
How Big U.S. Home Builders Plan to Ride Out a Downturn
“Horton and other big home builders insist they can keep increasing sales and profits rapidly even if the housing market slumps. They believe any downturn will be short-lived. And as the market consolidates into fewer hands, the big companies say they can squeeze suppliers for lower costs, grab the best land available and take market share from smaller rivals.”
http://www.realestatejournal.com/buysell/markettrends/20051201-hagerty.html
“In the other, including Toll Brothers, KB Home and Ryland, the companies plan to hold prices steady but sell fewer homes, to protect operating margins.”
KB is cutting prices like crazy in Sacramento. What went for 420K last year, is sitting at 360K this year.
- Writing down their inventory by 30% would wipe out nearly all of the companies equity.
Bye bye KB Home Builders …. however
- Irvine-based Standard Pacific, which builds houses in California
Will Be Fine … it’s different here.
Check this out from Cintex in Yuba City;…….
TEAL HOLLOW
Y U B A C I T Y
1,995 to 3,144 sq. ft.
From the mid $300,000s
(530) 751-9525
Thats $175. per foot !!! They must be loseing their butt on these….
Have you ever been to Yuba City? I described my trip out to those developments earlier this year. It’s crammed together subdivisions in the middle of old farmland with 100 degrees plus summers. Also, according to statistics, Yuba City averages 10% unemployment.
Does the term “irony” come to mind?
http://www.forbes.com/businesswire/feeds/businesswire/2006/09/01/businesswire20060901005143r1.html
OT, don’t know if anyone posted this already… the NYTimes has debuted its new RE magazine, called Key.
Good article, thanks for posting.
I mean the feature on Case Shiller index.
Kind of bad timing, like launching a publication for the investor in February 2000.
Most of the homes these turkeys have thrown up are ugly functionally obsolete white elephants of shoddy construction quality built by unskilled immigrants.
Scores of subdivions are in garbage locations.
Who knows?
Maybe the US homebuilders will follow the French wine industry which is currently tearing up and destroying centuries old vineyards, because of a billion bottle wine glut.
Good practice ops for all those volunteer fire departments.
Typical for “boom’…Clip the FB suckers…
hd;….shoddy construction quality built by unskilled immigrants.
Tell me about it;….Have you ever watched a good framer ?? Takes two strokes to sink a 16 penny…Can probably sink 15-20 or so in a minute…
I watched a unskilled immigrant swing a hammer on a house the other day…He was on his knees, the nails in his back pocket (No Nail Bags) and it took him at least six taps on the nail head to sink the nail….Just brutal…
A pair of Equadorian illegals doin’ re-siding work in Lynn MA fried themselves to death, when one hit an electrical wire with a ladder and knocked it against some metal scaffolding. The cops who were the 1st on the scene couldn’t reach one guy who was on fire and hangin’ off an eve. Local chief said it the most horrendous thing he’d seen in his 25 year on duty.
Fritas on the side.
Are you sure this didn’t happen in Fairhaven, MA? My father-in-law was telling my wife he can’t go to his favorite bar up the street anymore because it burned down in a situation similar to the one you described. Couple of guys doing a siding job, hit a power line and poof… at least one dead and the building went up in flames.
Looks like Hopebuilders are trying to sell land as fast as they can before the land prices plummet. It goes without saying that % decline in land prices will be far greater than in the prices of Hopes.
Jas Jain
“Hopebuilders” — funny.
To the extent that the HBs bought or optioned a lot of their land on the cheap, they are still making money by selling at much lower prices . . . I remember in 1997, waterfront condos in Hoboken NJ (with pool, etc.) full page ads in NYT, starting at $150,000. Building costs have not increased that dramatically . . . the runup in prices has meant pure profit for the builders.
The problem they have is, they can’t build any more given the supply situation, so their revenue outlook is fvcked. And conveniently, they have been agressively dividending out the profits, and buying back shares, so long-term holders and insiders who sold aggressively in 2005/6 have already secured their gains from creditors if the HB goes belly up.
The moral of the story is 1) Don’t by HB stock, and 2) don’t buy a house/condo in the next 2 years, minimum.
It’s going to be ugly.
Here’s the latest real estate crash video report:
http://louminatti.blogspot.com/2006/09/real-estate-crash-news-report.html
good stuff Lou!
Excellent Lou !!!!
Well Done Lou! You, sir, are one talented fellow.
Nice work, Lou.
wunderbar!
Thanks Lou , I enjoyed that!
I vote for WCI as the most likely to go bankrupt. Its stock is tricky and volatile in the short term, partly because it’s the only one of the “majors” with high short interest. But the prospects for selling condos in Florida seem so grim.
Standard Pacific SPF seems like a good choice for a very weak home builder as well (with headquarters in CA). Its warning on Friday (yesterday), while not real specific looks bad. They say that they are going to update full year guidance next week–could be interesting. I think that the recent buyers of housing stocks are going to be in for a disappointment when they find out that the down turn in home sales and prices is just on its first leg.
I have or had puts on most of the builders, including about 50 Dec 25 SPF puts. My housing bubble put portfolio is up about 150% since April. My home builder puts have been loosing money in August and Sept, but lenders have made up the difference (puts on LEND, FMT, CFC, TMA, WM, NDE and FHM and a few more.
Timing what is happening is difficult. My main stategy is to buy puts 3-8 months out. So far that works well. While a lot of investors are trying to call a bottom among home builders, I think that their earnings will continue in free fall for another year.
I think that JOE still looks like a good short/put. On Friday it first fall and then recovered strongly on the news that it is exiting home building. However, just who are they going to sell their land to in Florida? It seems that Florida was over builder and that there is and will be net emigration due to high costs of housing, property taxes and home owner’s insurance.
In a further sign of the complete corruption of the public homebuilders WCI announced an expansion of their stock buyback plan. Instead of buying back 2 million shares they now plan to buy back 5 million shares. Their stock rose to $15.75 per share. In the previous quarter they bought back several million shares at an average cost over $20 per share.
The stock is a declining asset for WCI but they continue to pump cash into it. This is cash they might desperately need during this downturn. I expect shareholder lawsuits on a massive scale in the coming years for all of the homebuilders. The activities of the likes of Bruce Karatz (KB Homes), Robert Toll (Toll Brothers) and now WCI show the depths of corruption in this industry.
I forgot to mention that the increased buyback was announced yesterday, September 8th. This coincided with a wave of terrible earnings announcements running through the industry. Real estate is all about cash flow. WCI is throwing their cash out the window. Nice move!
the key to survival for any home builder is how variable their expenses are. For example if a builder was building single homes on lots purchased only through an option process not that much risk…no buyer you don’t exercise the option.
The other extreme may be a builder building high rise condos. The higher the rise the greater the risk because you have to build the entire building. So even if you get 20% deposits from “buyers”, it may make more sense for the buyer not to close, expecially if the place is worth more than 20% less.
Then the builder has a problem…how many high rise towers does WCI build?
the key to survival for any home builder is how variable their expenses are. For example if a builder was building single homes on lots purchased only through an option process not that much risk…no buyer you don’t exercise the option.
The other extreme may be a builder building high rise condos. The higher the rise the greater the risk because you have to build the entire building. So even if you get 20% deposits from “buyers”, it may make more sense for the buyer not to close, expecially if the place is worth more than 20% less.
Then the builder has a problem…how many high rise towers does WCI build?
Might be remembering incorrectly, but didn’t St. Joe have that land in trees before they decided to build on it? Notwithstanding that lumber id down, who knows what influence they have on congressmen — wonder if they’ll get back to their roots (pun intended)?
Bill,
We have very similar strategies, though my puts are a little longer out, especially the ones on mortgage lenders, many are Jan 09, partly because I think it be a slow fall, just like it’s been for the homebuilders, and partly because the cost of going that far out was cheap. And a plus is that if I hold them more than a year it’s a LT gain. Another good one is FED, a specialist in oprion ARMs. More than half their profit is now the paper gain to “assets” when a borrower pays the minimum (neg amortization). There still seem to be good plays for March puts.
I hadn’t heard of TMA, but it looks like that train might have left the station.
Happy hunting…
Actually, one more stratedy. I think there could be a big problem for the big Wall St banks. The investment banks all are mortgages deep now through securitization, some even retailing them. All the big banks are trafficing the MBS and derivatives from them.
Foreign firms and individuals are buying a lot of these bonds and I think the risk is massively under priced and at some point this market could just about evaporate.
So I actually have some leap puts on XLF, i.e., the entire financial sector.
By A.G. Edwards (in Barron’s) on Lennar:
“By our count, and what we find rather unnerving given the current industry demand/supply imbalance, is the roughly 7,700 under construction and unsold homes Lennar has scheduled for completion by the end of its fiscal year (November).”
Remember hoe these guys all swore they didn’t break ground without a contract?
Here’s some caution on shorting through puts (my method) also from Barron’s:
“There has been speculation that WCI Communities (WCI), one of the hardest-hit homebuilders, could be sold. Florida-based WCI, whose shares are down 41% this year to 15.76, trades for just 65% of its book value. While still profitable, WCI has been hurt by its exposure to expensive, Florida high-rise condominiums. WCI has one of the highest leverage ratios in the industry, and short interest stands at a high at 40% of shares outstanding. A WCI spokesman dismisses the takeover talk: “The company has no plans to seek a change in control of any kind at this time.”"
I’m thinking of buying WCI puts on Monday. I’m not sure I can believe a buyout is likely. Someone would have to be willing to take a lot of debt for an asset (Florida development lant) that’s falling in value. If someone is going to buy, I think they’ll wait for it to fall a lot more.
I will guess WCI is the most likely to implode, Toll the least likely. Toll is in pretty rough shape, but I don’t think they are as heavily dependent on the really speculative markets. I have the feeling they’ve just been more forthright about telling it like it is.
I’m holding Jan-08 puts at 10. I think they’ll be bankrupt in 07, so Jan 08 might be farther out than you need to be, but Jan 08 puts seem to be a good value compared to March 07 puts. There are two chances of WCI being bought out, slim and none, and slim just left the building.
I think that HB stocks (CTX, LEN, etc.) are controlled by Wall Street speculators - hedge funds, and similar. For example, CTX went up about 2% on Friday (I think).
The stocks are completely disconnected from fundamentals. However, the fundamentals will eventually win, but I don’t know when.
What will be breaking point?
remember, in the short term the market is random. could have been short covering.
nothing has kept the homebuilders up. their stocks are down 50%
It’s typical for stocks in a trend to go down (or up) for a while, and then move sideways and then to move down (or up) again. You can see this on almost any chart. The HB stocks mostly hit lows in late July and since then have been mostly side ways to a little up. Looking at a 12 month chart, the last 6 weeks are hardly anything. Anyone who expects stocks to go straight up or down is naive. They are tricky. This is one reason to move in and out gradually, rather than buying a whole position or selling one all at once.
During my last year or so of options trading, I’ve learned to take a half profit on a big move in my direction, especially if the profit is over 200%. Similarly, it’s better to buy a put or sell short after a bounce up. Fundamentals are strong over a period of a few months, but don’t mean much day to day.
Last week, after listening to an analyst say that HOV was the strongest HB stock I sold my Sept HOV puts (for a 150% profit). On Friday, the next day, HOV was the weakest HB stock, down over 3%. At least I still have some Jan 30 Hov puts.
Stocks are always going to be tricky on the short term. That doesn’t mean that there is a conspiracy.
Keep an eye on DHI and PHM. There are over 20,000 sept DHI 22.5 calls (Stock at 22) and a similar number of PHM 30 sept calls (stock about 29). I want to see whether something fishy is going to happen with so much money riding on what happens next week. Both stocks went up on Friday, especially DHI, which was very strong. The call buyers need a little over $1 above the strike prices to break even. If the stocks stay below the strikes, perhaps they will drop alot after option expiration, as all of the calls unwind, assuming that whoever sold that many calls had to hedge their positions. I don’t have any PHM but do have DHI Nov 25 puts. So I am keeping an eye on DHI.
Interesting. What is also interesting that there is 7K puts for Feb’07 (stock at 20). I think the prediction is that HB will go sideways till New Year and then it will plummet.
Bill, I share your sentiments…. I find it curious that much too often a companies stock will close within cents of the option strike price its most popular option.
My listing of HB’s from weakest to strongest is weighted by long term assets as a percentage of equity (potential land valuation problems) and short term debt as a percentage of equity (potential financing problems):
1. WCI
2. CTX
3. KBH
4. PHM
5. LEN
6. TOL
7. BZH
8. SPF
9. DHI
10. RYL
WCI is completely fried with business concentrated in Florida condos and is my number one pick for the ghoul pool. Centex has probably the largest exposure to financial services risk through through their subsidiary CTX Mortgage Company that did $15.8 billion in originations in 2006. I haven’t drilled down to find out how many mortgages were retained on the CTX balance sheet however I bet they have a few billion. Expect a few to come back and bite them in the butt. Centex also seems to have the lowest margins and massive inventory.
Ryland and D.R. Horton have a nice combination of minimum long term assets (land) and low short term debt (less likely have liquidity problems) vs. their equity and vs. the competition.
I agree. WCI is fried. I was surprised when I learned that there about 40% of float in short interest. I’m completely new in stock market, but I suppose that means: WCI is going down.
what about SPF? isn’t it heavily leveraged to cali?
All of the major HB’s concentrate their operations in the same geographical areas (California, Nevada, Arizona, Florida) so its difficult to differentiate by geographical risk with the exception of WCI which is not only Florida but Florida Condos. This is probably why HBs all move in unison on the stock market.
here is my take on wci
http://immobilienblasen.blogspot.com/2006/09/wci-ausser-kontrolle-out-of-control.html
And another, “Why does the stock market have such a hard time figuring out the obvious? Why does the market not quickly price in common knowledge? When the conundrum ends, you can be sure the homebuilder share prices will have reverted to pre-Y2K levels.”
In a bear market, there are television show gurus that show relatively inexperienced traders how to make money when a stock goes down. Of course they don’t know what to do when there’s a short squeeze other than to panic. The option sellers know that which is the main reason for all of the volatility on options expirations week. So playing this in the short-term can be difficult but everyone knows what the long-term chart looks like.
Ok, I’m looking at short selling some of the big homebuilders. Especially KBH. Possibly WCI.
The only opportunities I see in the stock market right now are going long on MSFT and going short on homebuilders, even though I’ve missed most of that party.
remember when the homebuilders weren’t afraid of a downturn because they would just gobble up market share? some of them even welcomed it.
2 homes sold in my hood at 2005 prices 22151
04 by 07 ?