Homebuilders destroyed... buying opportunity?

[Jim T]

"... expects next year's recession to ... during next year's recession..."

Sounds like a mighty confident prediction. A little lacking on evidence though.

[Groty]

ARMS are a ticking time bomb. $1 TRILLION set to reset next year. Foreclosures are already skyrocketing, and only $300 billin of ARMS will reset this year.

http://biz.yahoo.com/ap/060619/foreclosure.html?.v=2

[DesertCat]

So I spent some time looking at Toll Brothers. I picked them because they had a low debt/equity ratio, and because I like their business model and target market.

They are very cheap, around 5-6 PE. But they just reported that contracts written last quarter declined by about one third. I'm having trouble getting a gauge on what that means to future sales (they effectively have 12 months sales under contract), but I'm guessing that if their sales decline by about 20% and their margins drop about 25%, their forward PE is really around 10.

Still sounds cheap, doesn't it? But for some reason homebuilders always seem to trade at a low PE, so 10 isn't really cheap for this sector. I'm trying to understand why and I've got a theory. Looking at Toll (and also briefly Ryland, a comp), they aren't producing much free cash flow. Toll has earned almost $2B in the last five years, but FCF over that period was zero.

The difference is massive increases in inventory. Essentially Toll is reinvesting almost all of it's profits into growth. So far it's seemed to be a good decision, based on their ROE. But Buffett, for one, has warned about businesses that appear profitable, but are forced to reinvest heavily in the business just to run in place (i.e. GM).

My guess is the market penalizes these companies because they are poor FCF generators, and their earnings are overstated. Some of these may be due to the investment required by rapid growth, so if growth slows maybe FCF will improve. I couldn't really find any relationship in Toll's numbers that convinced me it was true though.

I would bet Toll has further to fall. It really hasn't reported bad sales or earnings yet. The decline in new contract volume leads me to believe it's likely they'll have a significant decline in sales and profits. It is likely the time to buy is after they report a really bad quarter, probably late this year or early next. And you'll also have three or four quarters more data on how they are navigating the new real estate market when you do it.

Of course, if they navigate well and show just flat earnings and sales, you'll probably get a nice pop buying them today.

[Jim T]

Yes, there will probably be a problem in many housing markets. Yes, there are people who are going to be strapped to pay their ARM mortgages.

I'm not sure how those factoids lead you to be so confident that GDP is going to plummet next year, when this year has started so strongly:

[ QUOTE ]
Real gross domestic product -- the output of goods and services produced by labor and property
located in the United States -- increased at an annual rate of 5.3 percent in the first quarter of 2006,
according to preliminary estimates released by the Bureau of Economic Analysis.

[/ QUOTE ]

BEA

[Groty]

[ QUOTE ]
Yes, there will probably be a problem in many housing markets. Yes, there are people who are going to be strapped to pay their ARM mortgages.

I'm not sure how those factoids lead you to be so confident that GDP is going to plummet next year, when this year has started so strongly:

[ QUOTE ]
Real gross domestic product -- the output of goods and services produced by labor and property
located in the United States -- increased at an annual rate of 5.3 percent in the first quarter of 2006,
according to preliminary estimates released by the Bureau of Economic Analysis.

[/ QUOTE ]

BEA

[/ QUOTE ]

Start with this:
http://www.forbes.com/investmentnews...apbox_inl.html

The looming housing problem, I believe, is under-appreciated. Did you read the link about the guy from Colarado Santa Fe found elsewhere in this thread. I think he has it right.

The situation is this:
Foreclosures are already spiking;
The $1 trillion in ARM resets next year will push foreclosures even higher;
The number of homes for sale, both new and existing, are at all time highs;
Inventories on HB balance sheets are at record highs;
the inflation threat will cause the FED to continue increasing rates, making homes even more unaffordable;
40% of the new jobs created since the last recession have been housing related. With the homebuilding industry contracting, many of those jobs will be lost.
With homeownership rates already at all time highs, and with job growth slowing or turning negative, who is left to buy all those unaffordable homes?

The seeds for the '07 recession have been sown. Next year will be one butt ugly economy.

[lastsamurai]

I would wait ed. When it rains it pours... Don't look too much into PE Ratios.. Do you have a subscription to IBD? Go read "how to make money in stocks". The stock market is driven by earnings. Its all about EPS! There are alot more other great opportunities out there.

[buffett]

[ QUOTE ]
I'm not even remotely suggesting that housing is going to be a rosy business in the next couple years (though, I can't predict the future, and I don't know what will happen).

The question is, will the times be as bad as the prices say, or are people overreacting a bit?

[/ QUOTE ]
Ed's right. This is the key.

[ QUOTE ]
I want an indication of when the turnaround will be before investing in something for value.

[/ QUOTE ]
I'm not saying this person is wrong, but this phrase has been repeated by untold numbers of investors who never had a chance to invest in whatever sector they were talking about, b/c the prices had already run up ahead of the uptick in fundamentals.


Here are two interesting ETFs I just learned about today. ITB is a pure play on the builders, while XHB also contains the beaten-down retailers (HD's EV/EBIT is ~6x right now), Mohawk, etc.

The hugely negative YTD returns in both of those ETFs makes the Kneejerk Contrarian in me sit up and take notice.

[NoTalent]

There's the first drops of rain. DHI warns, slashes estimates 33%. Whoops... :P

I hope you had some puts, or just wait this one out. I don't think the housing stocks are done falling yet because more are going to have to readjust their earnings.