Re: House Builders
Homebuilders have appeared cheap since last year. Their earnings were at a cyclical peak, and still the homebuilders were all trading at less than 10x earnings. Now those earnings have dropped substantially and stock prices have followed. It may be overdone, I don't have an opinion because I haven't done any research.
Here is an article about some of the issues from the Wall Street Journal.
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Risks Pile Up for Builders
Shares Remain Vulnerable
As Impact of Surety Bonds
Could Bring Down Values
March 28, 2007; Page C16
Earnings at Lennar, the largest U.S. home builder by revenue, fell by 73% in the last quarter. Home-building stocks, inflated by the housing bubble, have given up all the gains they've made since 2004. They are selling now for little more than the value of the assets on their balance sheets. So they might appear to be bargains. But investors should beware. The home builders' book values rest on shaky foundations.
Development land weighs heavily on the builders' balance sheets. In the fourth quarter of last year, the five biggest builders by market capitalization -- D.R. Horton, Lennar, Pulte, Centex and Toll Brothers -- wrote down their land assets by a combined $1.5 billion. Lennar alone lost $26.5 million on recent land sales. There's the danger that land prices will continue falling, leading to further writedowns. That potential is visible on the builders' balance sheets. But another risk is less apparent.
The top five have almost $13 billion in commitments to local authorities, having promised to build the necessary infrastructure for new housing developments. They back these commitments with surety bonds, which are pledges to pay a municipality a big slug of money if a builder doesn't finish a project. These surety bonds total between a quarter and a third of the book value of the leading home builders. Centex's $6 billion of surety bonds actually exceeds its book value, though it estimates it has just $2.5 billion of work left to complete. In a recent regulatory filing, Lennar revealed it had $1.8 billion of these commitments. However, they won't affect its balance sheet unless they are triggered.
The surety bonds make it tough for home builders to walk away from projects. With land prices falling, disposing of development land and dealing with surety bond commitments is costly. This leaves home builders with one option -- to keep building. But that's not appealing either, as home sales are falling and inventories keep rising. In more than one way, the builders have dug themselves a hole.
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