http://seekingalpha.com/article/30795

Is It Time to Buy the Homebuilders? 13 Stocks to Consider

Posted on Mar 27th, 2007 with stocks: BZH, CTX, DHI, HOV, KBH, LEN, MDC, MTH
, NVR, PHM, RYL, SPF, TOL

Toro submits: We are value investors. In the short-term, we'd trade anything
- if we traded, that is. But for investment purposes, we fall soundly in
the value camp.

One of our favorite strategies is to by a basket of stocks in an industry
that has been completely blown out of the water and left for dead. Buying
small pieces in a raft of crappy Internet companies that were trading below
net cash in 2002 produced returns of 200%, 300% or even 400% over the next
12-24 months, depending on what you bought and when you did so, even though
many of the Talking Sock Puppet Companies eventually went under. I used to
execute this strategy with the semiconductor capital equipment stocks, a
group which has become absolutely @%^%$#&$@#!@?! boring, akin to watching
paint dry.

I expect a similar fate to befall the homebuilders, and I was wondering if
we were at that point yet. Steve Kim over at Salomon Smith Barney Citigroup,
amongst others, has been making the case that homebuilders bottom at 1x
book value, which is, according to Kim, where they are approaching now. If
the group is trading at a cyclical low to book value, then I am definitely
interested.

I use book value for this group because earnings estimates are meaningless
as the imploding housing market - or at least imploding in the five states
where Credit Suisse's top-notch homebuilders analyst Ivy Zelman estimates
her group generated 75% of its profits this decade - is putting severe
pressure on net income. The group, after all, was trading at 4-5x estimates
a year ago and is now something like 20x today. So price/earnings [PE] doesn
't tell me much at the moment. Also, we truly have no idea what normalized
earnings through the cycle will be as the prior top may represent the
biggest housing bubble of all time.

The following are 13 homebuilders, yesterday's closing prices and the
current price/book (PB) value.

Beazer (BZH) $32.32, 0.77x BV
Centex (CTX) $43.17, 1.05x BV
DR Horton (DHI) $22.79, 1.10x BV
Hovnanian (HOV) $27.34, 0.97x BV
KB Home (KBH) $45.99, 1.21x BV
Lennar (LEN) $44.54, 1.24x BV
MDC Holdings (MDC) $50.25, 1.05x BV
Meritage (MTH) $33.50, 0.87x BV
NVR (NVR) $712.66, 3.41x BV
Pulte (PHM) $27.25, 1.06x BV
Ryland (RYL) $45.60, 1.29x BV
Standard-Pacific (SPF) $22.34, 0.82x BV
Toll Brothers (TOL) $28.85, 1.28x BV

Average 1.24x BV

Several of those valuations look enticing, if you assume that buying the
stocks at 1x book value is a good strategy. The group is at 1.24x. If you
exclude NVR, the average homebuilder PB is 1.06x.

Back up the truck, right?

Not so fast.

First, let's look at how the group traded in 1999/2000, when everything but
TMT (tech, media and telecom), the Talking Sock Puppet companies (companies
that had little revenues, boatloads of losses, and nothing but a web site
and marketing plan), and big cap growth stocks (which, apparently, weren't
in a bubble, or so I'm told). In 1999 or 2000, the stocks bottomed at the
following valuations.

Beazer 0.60x BV
Centex 0.76x BV
DR Horton 0.79x BV
Hovnanian 0.49x BV
KB Home 1.20x BV
Lennar 1.00x BV
MDC Holdings 0.70x BV
Meritage 0.51x BV
NVR 1.08x BV
Pulte 0.60x BV
Ryland 0.57x BV
Standard-Pacific 0.64x BV
Toll Brothers 0.94x BV
Average 0.76x BV

So, in fact, if you bought the stocks at 1x book value before the bottom in
1999/2000, you lost 25% of your investment. And remember, the housing market
was healthy and about to get a whole lot healthier.

If the stocks were to revisit their lows of the turn of the decade, how much
would you lose if you bought them now?

Beazer -22%
Centex -28%
DR Horton -28%
Hovnanian -49%
KB Home -1%
Lennar -19%
MDC Holdings -33%
Meritage -41%
NVR -68%
Pulte -43%
Ryland -56%
Standard-Pacific -22%
Toll Brothers -26%
Average -33%

But this assumes that book value won't change. Ivy Zelman estimates that
there is another $6.5 billion or so in charges and write-offs coming. If
those charges occurred today, another 15% of book value would be wiped out.
What would PB for each stock be if the charge-offs were equally distributed
across the group (an unrealistic assumption, for sure, but for simplicity's
sake) and what would be the downside using 1999/2000 lows?

Beazer 0.90x BV -34%
Centex 1.24x BV -39%
DR Horton 1.29x BV -39%
Hovnanian 1.14x BV -57%
KB Home 1.42x BV -16%
Lennar 1.46x BV -31%
MDC Holdings 1.24x BV -43%
Meritage 1.02x BV -50%
NVR 4.02x BV -73%
Pulte 1.25x BV -52%
Ryland 1.51x BV -62%
Standard-Pacific 0.96x BV -33%
Toll Brothers 1.50x BV -37%
Average 1.46x BV -44%

But why look at the lows from 7-8 years ago? The housing market today far
more resembles 1990 than 2000, and my guess is that housing will eventually
fall more than in 1990/1991. So what were the homebuilders trading at when
they bottomed back then? Of the 13 homebuilders listed above, nine were
publicly traded in 1990. Here are the low PB valuations of 1991/1992, and
the losses from current levels if stocks traded to those levels after Ms.
Zelman's charges.

Centex 0.53x BV, -57%
Hovnanian 0.29x BV, -75%
KB Home 0.80x BV, -44%
Lennar 0.14x BV, -91%
MDC Holdings 0.22x BV, -82%
Pulte 0.50x BV, -60%
Ryland 0.57x BV, -62%
Standard-Pacific 0.48x BV, -50%
Toll Brothers 0.71x BV, -53%
Average 0.47x BV, -64%

Now, one can make a very cogent argument that the group will never hit 0.50x
book value - there is an ocean of liquidity in the world, the homebuilding
industry is more rational, the companies are better financed, market share
is more consolidated, land is less of a percentage of the balance sheet,
interest rates aren't as high, etc. And I certainly am willing to concede
all that. However, one should not count out the real possibility that the
group certainly could be cut in half, at least. The one thing that never
ceases to amaze me in financial markets is that markets can go a lot farther
for a lot longer - on both the upside and the downside - than one could
ever have imagined.

So, no, I do not believe the time has come to buy the homebuilders. I think
there is still significant downside to come. But that's just my opinion.

My guess is that the group will bottom higher than the 0.47x book value it
hit in 1991/1992 but lower than 0.76x it bottomed at in 1999/2000. Maybe the
group bottoms at 60%-70% of book value. If it does, I plan to close my eyes
and buy. And when they double, I'll sell because the group may move
sideways for years thereafter.

¶ 4:25 PM

 CP said...
Standard Pacific (SPF) Book Value Impairment Scenerio  

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