Homebuilders Should Buy Themselves Out: Analyst
The Street.com looks at the future of the public homebuilders. “Homebuilder stocks remain dismal performers of late. The question remains: How do you extract that value? The answer for builders, according to some industry watchers, is through large land sales, mega-mergers or share buybacks, which would make it clear to investors that it is cheaper to buy land on Wall Street than on Main Street.”
“Analyst Gregg Schoenleber has a unique take on the matter. ‘If the market is not willing to pay for the value we see in homebuilders, we think the builders themselves should do so, through buybacks. In essence, the companies would begin to ‘LBO’ themselves,’ Schoenleber wrote.”
“‘We estimate this would enhance annual EPS growth by 13 percentage points per annum from 2006-2010,’ he wrote. ‘At that point, when the industry has consolidated or the last share is for sale, the market may finally collectively proclaim, ‘Now we believe you!’”
“The difficulty is that builders report only the costs of land on their balance sheets and typically don’t break out exactly when that land was purchased. What compounds the problem is that public builders themselves have made up a large percentage of the buyers driving up the land prices in recent years, so it’s hard to tell if the whole group is overpaying.”‘
“‘The question to ask any CEO of a public homebuilder is why it would be more attractive to buy land right now than their own stock,’ says (fund manager) Michael Elrad. Investors looking for undervalued land on Wall Street should pay attention to which builders bought land many years ago at a lower cost rather than solely in the overheated market of the past few years, Elrad says. The older a company’s land holdings, the more investors can find comfort in paying premiums to book value.”
“Investors’ best bet may be to eye the builders with older land holdings and an aggressive buyback program. Because it’s the public builders who’ve bought most of the land in recent years, the buyback plan would demonstrate to the market just how undervalued their own land is.”
“For larger builders, however, harvesting such value isn’t as easy, because none appear to be looking to sell off large tracts of valuable land.”
Looking at Tolls balance sheet, one sees that close to two billion in inventory has been added since 2003 and well over one billion since last spring. And what good are share buybacks as the firm is issuing stock to insiders at under $5 per share and then they sell it?
Looking at their cash flow statement; where will they get the cash to do these buyback?
OT:
Rate hike survival guide
“Three families with three problem mortgages. Here’s how to fix them.
By Cybele Weisser, MONEY Magazine staff writer
May 17, 2006: 11:52 AM EDT
“NEW YORK (MONEY Magazine) - As the real estate boom inflated home values all over the country, millions of would-be owners did whatever it took to join the party: bid well over the asking price, hit up parents for a down payment and resorted to ever more creative financing tools, from short-term adjustable-rate mortgages to exotic interest-only option-payment loans.
“Now that the party seems to be winding down, many of those borrowers are going to be left with a messy cleanup.”
BTW, one of the articles this links to has a great headline:
Crazy mortgage, exhibit A
How the heck do these people sleep at night. The Long Island family is crazy. Move outta there fast. $3K-$5K monthly payments. Ouch. These LI people have sucker written all over them. If you are going to spend that kind of money, buy a real mansion in the Carolinas of Georgia for crying out loud.
Those people are crazy. Why take on that kind of mortgage when the 30 yr fx was near a 40 year low in 04? I like how he looks at the interest rate charts after his payments have gone up.
OT. Local morning radio quiz question: What do 50% of people do within 1 month of buying new house?”
Usual call in answers, paint, sex in kitchen, new tv, etc, until one caller said “Refinance”
Radio host laughed at caller and said “Do you really think 50% of people refince within 1 month of buying home?”
Caller said: “I’m in the mortgage business and I see it all the time.”
Note that Tolls cash position as of January 31, 2006 is $363 million and their accounts payable is $1.2 billion. Another Wall Street report:
‘H&R Block has been named Zacks Equity Research’s ‘Bear of the Day’ for May 15, citing challenges in the company’s mortgage and tax units. In its press release, Zacks said Block’s “management once again disappointed investors by announcing that earnings in fiscal year 2006 will be at the low end of previous guidance. Competition remains intense in the tax business, while fundamentals in the mortgage business continue to deteriorate.’
‘Block, the parent of subprime wholesaler Option One Mortgage Corp., Irvine, Calif., put out a statement on May 10, saying its full-year earnings per share is expected to be slightly below the $1.65 low end of its predicted range, in part due to weaker than expected results from mortgage services. Block added that its earnings guidance did not include the effect of previously announced charges to resolve refund anticipation loan litigation and for related fees, or charges for consolidation of a number of mortgage operations to reduce ongoing operating cost structures.’
“Note that Tolls cash position as of January 31, 2006 is $363 million and their accounts payable is $1.2 billion.”
Hmm… that should work out well in a time of falling sales/margins and rising interest rates. This is going to get very ugly very quickly.
Time for Toll to lock into fixed rate loans, just like the F-Bs with broken ARMs…
My calculator says: That quick ratio stinx!
The title and gist of this post makes me want to puke. What the analyst is really saying is, “the homebuilders should buy me out of the dumb-ass ‘investment’ I made for my own account while recommending further investment in these companies to the general public for the past 12 months.” Right.
One of the wisest men on the investment scene today is Richard Russell who for the past 53 years has been writing Dow Theory Letter.
Here is what he said today:
“As subscribers know, I’ve been zeroing in on the home building/real estate picture, mainly because this has been the engine of growth in the US over the past four or five years. Low interest rates have allowed the builders to run “wild” year after year. Furthermore, consumers have taken trillions of dollars out of the price appreciation in their homes, taken the money out through refinancing their mortgages. This money hasn’t been spent on capital improvements or new industries, no, the money’s been spent on cars, restaurants, vacations, room additions, kid’s camps, you name it.
The charts are telling me a story. If I’m to believe the charts, the story is that the housing boom is kaput — it’s over. Below are the daily charts of three of the biggest builders in the US — the Ryland Group, Toll Brothers and Lennar Corp. You don’t have to be a chart genius to be able to interpret what these three charts are saying. In a word, it’s “top-out” (or is that two words?).
At any rate, what these charts are telling us, I believe, will show up in the economy and in consumer spending before this year is out. And I think it’s going to be deflation of the housing boom in both prices and the number of new houses that will be built.”
If you haven’t shorted the home builders yet, do it tomorrow.
Maybe they couldn’t pay the debt from an LBO from cashflow unless they suspend land purchases. Even if they can pay interest on debt…they could pay so much for the company that there’s no value for them.
Land purhcased in the past year is probably worth less than 50 cents on the dollar. Land is more sensitive to housing prices than finished houses. If you can put a 300K house on a lot and sell it for 500K, then the lot is worth 200K. If the house is now worth 350K, then the lot is worth only 50K. Simplistic but explanatory, I think.
Thought I remember Toll paying 1M / acre in LV. Vegas, I think, will go into one of its regular “bust” periods as all the HELOC money from CA dries up. Lot of vacation / HELOC money being spent in LV recent years.
“Thought I remember Toll paying 1M / acre in LV.”
Thought I remember Ben posting the news that LV land values had recently plummeted by 47% or so due to BLM land sales…
Within the last couple of weeks they paid over $2 million per acre in LV.
OT- talk about disconnect, look at this predicted appreciation:
http://money.cnn.com/2006/05/12/real_estate/reguide_moneymag_whatsnext_0606/index.htm
getting rich in real estate (LOL)
http://money.cnn.com/2006/05/15/real_estate/reguide_moneymag_getrich_0606/index.htm
What is up with CNN.money? One week they are predicting a slowdown and now modest growth???
This way, they can claim they were right either way. Is this what “hedging” is in journalism?
Heck, they predict I’ll only make $30,000 in appreciation this year. Sniff. Here on the ground I’ve actually lost $200,000-$300,000 since the peak. They have no clue. Put them in the same bucket with GaryWatts and his 17 percent in the bag.
Anyone predicting 7% gains in San Francisco and Santa Cruz has zero credibility. How CNN didn’t simply dismiss that “expert” is baffling. 7% of 800k is $56k!!! I think these descriptions of “real estate addicts” is spot-on — the housing bubble has spawned a new subcategory of gambling addition.
“Analyst Gregg Schoenleber has a unique take on the matter. ‘If the market is not willing to pay for the value we see in homebuilders, we think the builders themselves should do so, through buybacks. In essence, the companies would begin to ‘LBO’ themselves,’ Schoenleber wrote.”
This analyst must have training in alchemy. He seems to believe in the possibility of transmuting base metals into gold.
Is anybody following what’s happening today on Wall St in reaction to CPI? It looks to me there will be no Fed pause anytime soon.
How can BB pause now without becoming a latter-day Hester Prynne with the scarlet letters “HELICOPTER BEN” forever branded on his clothing?
“Looking at Tolls balance sheet, one sees that close to two billion in inventory has been added since 2003 and well over one billion since last spring. And what good are share buybacks as the firm is issuing stock to insiders at under $5 per share and then they sell it?”
What a great scam — use corporate share buybacks to keep the stock propped up above $27, while big boys buy the stock for $5/share and pocket a $22/share capital gain. Is this part of the new business model that Robert Cote keeps insisting will help these builder stocks do better during the current housing crash than in previous crashes?
Not for long.
I have been hammering on the buy back scam for a year on here. What a total joke - well not to Bob Troll!
Who are the bagholders? What fool holds on to a stock that has already dropped in value by 50% and still looks rather plungy?
Index funds and other passive funds hold stocks across-the-board, regardless of performance. In fact, “rebalancing” may result in acquiring more underperforming stocks, and selling overperforming stocks.
Rebalancing works great under conditions of general inflation. Next time the broad market reverts to fundamental value after 18 years of Greenspan puts, the weakness of the strategy will come to light.
Max, the obvious problem with passive investors being the bagholders of the homebuilder stocks is the fact that homebuilder stocks were the overperforming stocks for 2000 to mid 2005. So by your definition the indexes were selling off during this time and reducing their positions to preserve their desired weighting in the sector and reducing their exposure to the 50% plunge that occured.
Northern VA,
I didn’t imply that they were the bagholders for HBs, but they may BECOME ones.
Thank you for hammering. I’ve made several thousand on TOLL puts.
Is this part of the new business model that Robert Cote keeps insisting will help these builder stocks do better during the current housing crash than in previous crashes?
No! Read more carefully. The stocks will be punished and punished badly. My only defense of the HBs is that the -companies- will weather the bubble beetter this time, not the stocks. I thought Iwas explicit in this difference.
On a related matter if TOL were a homeowner and had a $200k mortgage and $50k in the bank and a $250k salary would you worry about them? Cash on hand, revenue and debt I just quoted are roughly comparable to what Ben posted above.
What if the salary (revenue) dropped 50%??
Exactly. And their “mortgage” is not fixed nor long term. The money in the bank could evaporate in one bad court ruling or more likely even be used for years long litigation expenses. Still, this just doesn’t look like a company anywhere close to the edge. They could be debt free with a land and options fire sale and still have enough to be profitable at lower sales rates and prices and margins. TOL still does something. They make houses, people need houses. You can touch the land, the lumber. The worry part is the mortgage origination, placement and holding division. Unless they’ve firewalled well any problem there could set the whole building on fire. Still, you own on the ex-dividend day and you get $5 per year on your $28. Lose all the dividends? So what you own $3bn in assets and those dividends for only $6.1bn market cap. Damn good for a normal stock even though TOL is fasr from normal. Point being decent company about to go through a tough time. Lousy stock about to go through hell.
I still can’t see any way that TOL can escape bankruptcy. Both the value of their home inventory and their land is likely to drop substantially over the next year or so. They are still building in a totally glutted market. On another thread, Ben posted an item stating that currently there are 128, 000 spec homes available, an all-time record high. And they are still building. My guess is that they will be in bankruptcy by end of year 2007.
They avoid bankruptcy by slashing dividends, contracting personell, selling assets and continuing to build whatever they can for a buck. I can’t believe my “it isn’t that bad” comments about their fundamentals and partial preparation has me defending a gamed stock. If TOL BKs then almost all of the ^HGX goes down. That is worse than even a depression.
I wonder if TOL can cut dividends sufficiently to make up for the cash flow shortfall coming. I doubt it. And of course they will cut personnel as they slide down the bankruptcy chute, but they are too exposed for such steps to make them a worthy creditor. That is a lot of debt that has to be repaid and their revenues are going to drop substantially later this year.
Looks like bankruptcy to me.
Here is what I foresee for TOL:
The dividend will be discontinued before year end 2006.
The debt will be restructured due to their inability to make the scheduled payments before mid year 2007.
They will cut back on personnel several times beginning in the fall of 2006.
They will attempt to sell assets starting this fall but will find few takers and will be unable to raise much cash.
They will file bankruptcy no later than December, 2007.
Let’s file this away someplace and check it out at end of next year. In the meantime, there is still profits to be made by shorting the homebuilders.
That is worse than even a depression.
I would say it’s not that much because of ^HGX, but ^SPSY.
And the debt was linked to an ever increasing Prime rate??
Actuall the Cash is 363 and the debt is 3,617 - thats a 10-1 ratio.
So its more like $50k in cash $500k in debt
In that case, I would worry, especially if interest rates were on an upward tear (they are), the “mortgage” (corporate debt) was short term (as I strongly suspect), the “salary” (profit stream) was poised to shrink substantially, the “home” (company) was bubbliciously overvalued, and the “homeowner” (stockholders) had entrusted household financial operations to a “financial planner” (top management) whose “fee” (stock sales) was financed out of the net equity position of the “house” (company).
Also note that the debt on the BS isn’t the whole story. Through the magic of FIN 46(R), there can be truckloads of debt that the builder is ultimately liable for, but doesn’t make it onto the BS. Granted, there are also the assets related to that debt that don’t make on the books either, but its mostly land and housing inventories that could be impaired.
make that short term debt.
Everyone is getting a little crazy on this TOLL analysis. The HBs will be in okay shape IF they decide to stop buying as much land as they have the last couple of years. Without land repurchases, TOLL would have generated over $1.5 Billion in cash flow from operations (They increased land inventory by $1.2B). They still generated over $300M of cash flow from operations with the land costs and that is after paying interest on their debt. And a decent amount of this year’s revenues is already in its backlog. Land would have to significantly fall and orders would have to decrease even more than they have for TOLL to file BK anytime close to ‘07. Of course, they will inflate their own problems if all the HBs continue to add supply to a market that has enough of that already.
Comparing cash to debt is not the best analysis in the world and it isn’t the proper quick ratio also.
Just had to add this.
Thanks,
DebtVulture
BTW - I am short HB stocks so I am not a shill for the industry.
When the public builders put together a pro forma on a project, they are expected a 8-10% return on costs.
Of course, revenue increases offset by cost increases has made the publics look smarter over the past few years.
If you assume that they just hit their margins, their earnings will go down considerably. If you assume that prices drop 5-10% with lower volume, their earnings go down a lot, and especially for those builders who bought land in 2005-2006.
I think the concept of looking at a company’s land holdings and when they bought is a great idea, but you should recognize that land can drop in value significantly if fewer people are buying homes.
‘The question to ask any CEO of a public homebuilder is why it would be more attractive to buy land right now than their own stock,’
Neither. I would suggest first cashing out of the stock (like most of them did last August), then shorting the stock, then selling off all the land holdings
““The difficulty is that builders report only the costs of land on their balance sheets and typically don’t break out exactly when that land was purchased. What compounds the problem is that public builders themselves have made up a large percentage of the buyers driving up the land prices in recent years, so it’s hard to tell if the whole group is overpaying.”‘
********************************************************************
Let’s put that another way. The builders ARE the market for land. Now they are starting fewer houses. Hmm.. Just how aggressive can they be expected to be in buying more land. And if they don’t who will? And since essentially no one will, the price of land is going to plummet. Eventually, the builders will have to write down the land on their balance sheets. Of course, the optioned land will go back to the “sellers” who will have a tough time finding anyone to buy it at that point. If the builders are the market and the builders aren’t interested in buying it, the land will sit fallow for many years.
Here is an example of what TOL is facing in trying to sell their homes:
From the Sacramento Bee:
“Save up to $80,000
Get the home you want most and keep more money in your packet during ZERO Days — right now at all Sacramento area Meritage Homes neighborhoods.
Special ZERO Days savings on selected homes may include:
*ZERO closing costs!
ZERO payments for 3 months!
ZERO down on options & upgrades!
ZERO Mello Roos payments!
ZERO cost for full landscaping, washer, dryer, refrigeratior, window coverings & more!
ZERO H.O.A. dues for one year!”
Centex has been offering discounts on the prices of their homes ranging up to $100,000 in various parts of the country.
We all know that the inventory of existing homes has skyrocketed in many of the hot markets around the country…the very markets where TOL is building, as a matter of fact.
TOL has a tough road ahead.
ZERO Mello Roos payments!
That has to mean prepaid for a year or two at most. Getting rid of Mello-Roos isn’t practical. The present value many Mello-Roos fees could even reach 6 digits.
Robert,
five dollar fine
Is the $5 fine for not closing his italics tag?
I swear I did it correctly. I’ve been doing it right for longer than most knew it was even possible. A warning at most the worst.
BTW Larry Kudlow just called it the mini bubble in housing. LoL.
we play rough here
Mini-bubble! That’s something new…
This is an excellent point, and one that has been missed by the HB longs. Toll et al. are in the business of cashing in on stock options. If they stop buying land, Wall Street knows the game is over, so they keep optioning land and keep building hoping that the decease in demand is only temporary when they know that it is not. Why else would he have sold so much last summer? It sure wasn’t because he thought TOL was going to go up.
About keeping to the game plan, you’re right. I have posted many a time on this subject because in the old days, there wasn’t much to do but speculate on corporate communications, etc. All along the public builders have been very consistent that, yes, there will be a slowdown. But it will be brief and they will gobble up smaller firms along the way. Also, they expect to continue building and growing right through the slump.
If they stop acquiring land, or building, it will appear to wall street that the plan has changed and the financing for this game will end. It’s an all or nothing bet.
The bet is all-or-nothing for the company, but very well hedged for the top managers who run it, who cashed out their personal share holdings to make themselves richer than Croesus. What do they have to lose if the company eventually goes BK, especially if they can keep raping the shareholders all the way down to the bottom?
Seems like the “panic” is spreading. It will spread fast, it always does.
Is “LBO” Low Ball Offer?
Insert sarcasm above (my smiley didn’t show)
I disagree with theStreet.com’s analyst. Yes, buying back stock will improve EPS relative to other builders. However, revenue in the housing industry is no longer growing; at best, it’s stalling and may even be declining.
In response to declining revenue, builder competition will intensify within the industry. Accordingly, builders will lower prices, advertise more, offer bigger comissions, and provide additional buyer incentives.
These additional incentives and promotions increase operational costs and reduce profit margins. As profit margins decline so does EPS. So, why bother buying back shares now?
My advice to builders and housing stock investors alike is to wait until the price of housing stocks bottom out to their historical ten year lows and then wait some more. Wait until industry revenue starts to increase again then buy as much builder stock as you want.
And in the interim, sell the builder’s stocks short!
Exactly!