New home sales are up a less than expected, existing home sales fell 8.4% and yet the Dow Jones Industrial Average is trading through 13,000 for the first time ever. What's at work here? When do you buy a stock? To paraphrase an old cliché -- when no one else wants it. If patience is one of your virtues, then perhaps these home builders warrant your attention.
Out of the Money
Centex (NYSE: CTX), with its sharp focus on customer satisfaction, has a reputation for delivering a quality product, and it does so across 25 states in 86 different markets. Centex homes range from entry-level, move-up, second home and resort. Last year they sold over 39,000 of them.
Centex makes extensive use of options to buy land to build on. These are essentially, "call" options and Centex, like many others is over-extended and could be facing sizable write-downs or write-offs as prices fall. The price on the land for these options is now "out-of-the money." Its inventory at the end of 2006 was a whopping $10.2 billion, a six-year supply, double what it normally has. The write-off in 2007 could be around $400 million.
Centex has taken a number of steps to stem the tide. It has divested itself of its construction products business, along with its manufactured-home and sub-prime lending divisions. Likely, it will also walk away from much of its optioned land.
The Low-Cost / High Margin Builder
D.R. Horton (NYSE: DHI) is the United States' largest homebuilder as measured by the number of homes sold -- just over 56,000 in 2006. It operates in 83 markets across 27 states and focuses on value-oriented buyers such as entry-level and first time move-up customers. The company prefers to have a hub from which it expands outward, taking advantage of infrastructure that is already in place. It's clearly working. D.R. Horton is one of the lowest-cost builders, yet its operating margins are among the highest.
Because DHI's focus is on first-time or, at least lower-cost buyers, the company is also dependent on a buyer's ability to finance the purchase. Rising interest rates and closing costs are very real problem, as well as a general credit crunch with lenders ceasing to underwrite loans, particularly sub-prime.
Where most builders prefer to have an order in hand before they start to build, D.R. Horton will build "on spec". While this may work in bull markets, it can exacerbate any existing problems in a soft market. In addition, DHI also has a six-year supply of optioned land, double what it would ordinarily have.
DHI's balance sheet is in good shape however, with 42% in debt and an investment-grade credit rating. (Not sure what that means? Check out What Is A Corporate Credit Rating? )
The company has reduced its "headcount" from 10,000 to 7,300 and is in the process of renegotiating contracts with a number of its subcontractors.
Will This Baby Boom?
Pulte Homes (NYSE: PHM) is an industry heavy-weight, closing well over 41,000 home sales in 2006 and operating in the 20 largest metropolitan areas in 15 states. Pulte has a reputation as an extremely high quality builder that can do everything from entry-level to active-adult homes in age-restricted communities. Pulte's brand name probably gives it a competitive advantage in what is, to a degree, a commodity business.
Pulte did well with its $1.7 billion acquisition of Del Webb in 2001. Combined with its Sun City operation, PHI is now ready, willing and able to serve the housing needs of the baby-boomers -- all 78 million of them.
Like its competitors, Pulte has a dearth of optioned land. Only time and the affluence of the baby-boomers will determine the outcome of that land. The company also has a captive finance subsidiary and some exposure to first-time buyers.
All of these builders share some systemic risks: the length and depth of this housing slump is "the" major unknown; they all have far too much optioned land; the credit crunch in general, and sub-prime lending in particular, is becoming a serious problem; finally, the inventory of unsold property is hovering around one-million homes.
We all know the stock market is a leading indicator, not a lagging or coincident one. Therefore, the big question is: to what extent has all this news been discounted? Once it's in print -- it's in the price.
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