Homebuilders destroyed... buying opportunity?

[DesertCat]

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The attached article was written by a senior exec at PIMCO, a firm that runs literally hundreds of billions in fixed income investments. He analyzes the current and future state of the housing market and assesses its impact on the economy. It's interesting that he recently sold his home to become a renter.

http://www.pimco.com/LeftNav/Regional+Ma...ale_06+2005.htm

And the guy in this article has spent the past 20 years building a real estate empire. (The Colorado Santa Fe website says he personally owns over $200 million of real estate). He expects next year's recession to contract GDP by over 3%. He claims he plans to sell all his real estate holdings and short the homebuilders, REITS, mortgage companies, copper, and other stuff peripherially related to homebuilding. He thinks the shakeout will present some outstanding buying opportunities in 2008 thru 2010. FWIW, my best case scenario pretty much matches his.

http://www.financialsense.com/editor...2006/0609.html

Finally, earlier this week Cramer touted homebuilder WCI as a stock that couldn't go down any more, in part because it's trading at 4x earnings and in part because they are buying back their own shares. Just for kicks, I pulled up their most recent 10Q. Levered over 5x on a funded debt/EBITDA basis (I took actual 1Q EBITDA and annualized it). Way too much leverage for a cyclical industry going into a recession. Next I went to the cash flow statement. They USED $144 million in cash in operations during the quarter, mostly to finance receiveables and inventory. My gripe about the homebuilders is that they print these phenomenal EPS numbers quarter after quarter, but CFO is always negative. As Cramer mentioned, they did buy back some stock, but to finance it they had to lever their balance sheet even more. My stomach isn't strong enough to be at the bottom of this capital structure when there is absolutely no sign the industry is ready to turn.

If you decide to buy into the HBs, I'd urge you to do exhaustive credit work. At the very least, make sure they have very long dated debt maturities and plenty of undrawn, easily accessible capacity (i.e., loose covenants) on their bank lines. The capital markets will seize up during next year's recession, making it difficult for risky borrowers like WCI to refinance their debt.

Good luck.

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Nice post. Thanks for highlighting the hidden risks.

[leto333]

Buying homebuilders now would be like buying cisco in june 2000.

[Ed Miller]

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Buying homebuilders now would be like buying cisco in june 2000.

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The excellent discussion in this thread notwithstanding, a quick look at P/E multiples pretty much scuttles this analogy (not to mention the 40% YTD across the board crash in price).

[eastbay]

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Buying homebuilders now would be like buying cisco in june 2000.

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The excellent discussion in this thread notwithstanding, a quick look at P/E multiples pretty much scuttles this analogy (not to mention the 40% YTD across the board crash in price).

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Does it scuttle the one that says there is no market for their product now?

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That's kind of a silly thing to say. Housing is not pet rocks or "Frankie Says" T-shirts.

eastbay

[Ed Miller]

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Does it scuttle the one that says there is no market for their product now?

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Bad times ahead are already built into the prices. 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? And almost all of the stocks seem to be in freefall, almost in synch. Are some destined for major balance sheet headaches while others are just getting pulled down by association?

I've gotten a lot of interesting feedback so far. This weekend I plan to spend some time and sort through it to see what I can see.

[kazana]

I haven't been active in the markets for almost a year now, but I've done a lot of studying the markets and investing in earlier years. A key factor for weighing KB Homes stocks' potential would also be where the markets are in terms of sector rotation. If the p/e ratios look reasonable (difficult times ahead already priced in) then that would be my main concern.

[Peter666]

I want an indication of when the turnaround will be before investing in something for value. As of now, that is up in the air.

All I know is that Americans are in the greatest amount of debt they have ever been in due mostly to their homes, and interest rates are on the rise.

Great time to sell a home though while you can!

[leto333]

My statement certainly may contain a bit of hyperbole, but I share Desertcat's opinion of this sector.

The sector could see a relief rally over the next 18 months if hurricanes destroy enough homes, the fed stops raising rates, and industry consolidation begins, but I think the whole sector is in for hard times in the next 4 years.

While I am not sure that we will see a recession next year, I am very sure that we will see a substantial recession by 2010, and feel that the phenomenon that George Soro's describes as reflexivity (http://www.geocities.com/ecocorner/intelarea/gs1.html) will play a role in the home building sector suffering some pretty dramatic down drafts reminiscent of the internet bubble's implosion.

[Cubswin]

I found this to be very interesting:

Link