Ben Bernanke strikes again. And for the home builders, his $200 billion injection into the financial markets was the equivalent of manna from heaven-more money thrown at a mortgage market in crisis.
As a result, all of them rallied sharply today in the wake of the latest cash dump courtesy of the Federal Reserve.
However, that planned deluge of dollars managed to completely overshadow more troublesome news from the downtrodden industry.
Amid the glee, Hovnanian Enterprises Inc.(NYSE:HOV) reported a net loss of 130.9 million for the quarter, while Toll Brothers also warned that its joint-venture partners are failing to meet their obligations and could cost them big time in the future.
Nonetheless, a whole new round of “value investors” pushed the builders higher as they, completely ignored what David Seiders, the chief economist of the National Association of Home Builders(NAHB), said only last week.
“Housing,” Seiders warned last Tuesday “is in its deepest, most rapid downswing since the Great Depression.”
But more often than not those former big winners will likely turn out to be nothing more lead weights around the ankles of those bargain hunters as the shares of those companies continue to get “cheaper”.
That, of course, is one of the big dangers these days when it comes to investing in the shares of home builder stocks , even though most of them have fallen as much as 90% off of their all time highs.
So in short, that makes them all classic value traps.
Home Builder Stocks Have Fallen for a Reason
The challenge then for all “value” investors is in determining if a company’s misfortune is either temporary or if it reflects protracted problems with the business itself.
That’s what makes the home builder stocks so difficult to buy even at these levels, because as a heavily cyclical industry the builders are ready made value traps as their revenues decline and their earnings turn negative.
Here’s why.
At the height of the bubble, builders carried P/Es and profit margins that will never be repeated. Lennar Corporation (NYSE:LEN.B) for instance, carried a PE as high as 14.10 on margins as high as 9.7% during its peak.
Those are numbers that are historically unheard of but are typical of what was going on within the industry as Wall Street came to believe that these were growth stocks instead of cyclical companies.
The result has been an overvaluation that continues to this day, even though these stocks look like “bargains” now.
In fact, according to historical analysis, on average the sector still has a risk of about 50% to the downside as gross revenues fall, margins shrink, and their PE’s return to “normal”.
That’s because when you eliminate the distorting effects of the housing bubble on these companies, they have historically carried price to earnings ratios of 5-8 on margins of 3-6%.
And by applying those figures to an anticipated reduction in revenues of 20% for the next two years, even at these “low prices” the sector is still heavily overvalued at present.
In fact, that’s completely in-line with the NAHB’s latest forecast which calls for new-home sales to drop 22% this year, bringing sales 55% under the peak reached in late 2005. Next year, will likely be no different.
So Where’s the Value?
Here’s what that same analysis shows when it’s applied to six of the nation’s biggest home builders. In short, it leaves you wondering…where’s the value?
Hovnanian Enterprises, Inc.(NYSE:HOV)
- Avg. 5 yr. Pre-Bubble Profit Margin………………………3.62%
- Avg. Pre-Bubble PE…………………………………………5.84
- Estimated 2009 sales w/ 20% yoy declines……………$2,582,400,000
- Estimated Net Profit 2009 @ 3.62% margins………….$93,482,880
- Estimated EPS 2009………………………………………..$1.50
- Implied 2009 Share Price………………………………..$8.77
Lennar Corporation (NYSE:LEN.B)
- Avg. 5 yr. Pre-Bubble Profit Margin………………………6.18%
- Avg. Pre-Bubble PE…………………………………………7.47
- Estimated 2009 sales w/ 20% yoy declines…………..$5,800,000,000
- Estimated Net Profit 2009 @ 6.18% margins…………$358,440,000
- Estimated EPS 2009………………………………………$2.23
- Implied 2009 Share Price………………………………..$16.65
Centex Corporation (NYSE: CTX)
- Avg. 5 yr. Pre-Bubble Profit Margin………………………4.32%
- Avg. Pre-Bubble PE………………………………………….7.16
- Estimated 2009 sales w/ 20% yoy declines……………$7,692,000,000
- Estimated Net Profit 2009 @ 4.32% margins………….$332,294,400
- Estimated EPS 2009………………………………………..$2.73
- Implied 2009 Share Price………………………………….$19.57
Pulte Homes, Inc. (NYSE: PHM)
- Avg. 5 yr. Pre-Bubble Profit Margin………………………..4.18%
- Avg. Pre-Bubble PE…………………………………………..5.95
- Estimated 2009 sales w/ 20% yoy declines……………..$5,830,000,000
- Estimated Net Profit 2009 @ 4.18% margins……………$243,694,000
- Estimated EPS 2009………………………………………..$0.95
- Implied 2009 Share Price…………………………………$5.66
DR Horton, Inc. (NYSE: DHI)
- Avg. 5 yr. Pre-Bubble Profit Margin………………………5.26%
- Avg. Pre-Bubble PE…………………………………………6.4
- Estimated 2009 sales w/ 20% yoy declines…………..$6,330,000,000
- Estimated Net Profit 2009 @ 5.26% margins…………$332,958,000
- Estimated EPS 2009………………………………………$1.05
- Implied 2009 Share Price………………………………..$6.76
Beazer Homes USA, Inc. (NYSE: BZH)
- Avg. 5 yr. Pre-Bubble Profit Margin………………………3.2%
- Avg. Pre-Bubble PE…………………………………………6.06
- Estimated 2009 sales w/ 20% yoy declines…………..$2,260,000,000
- Estimated Net Profit 2009 @ 5.26% margins…………$72,320,000
- Estimated EPS 2009………………………………………$1.84
- Implied 2009 Share Price………………………………..$11.06
Those historical calculations, of course, assume that these builders can not only remain solvent, but can eventually return to profitability by the end of 2009.
But given that margins in the business continue to shrink and that for the most part earnings have all turned negative returns to profitability within two years at this point seems a bit unlikely.
So are the home builders attractive at their current levels?
Well, not exactly, especially if you take a realistic look at their future numbers while listening to David Seiders whisper in your ear.
In fact, at this point they still look like they are nothing more than dead money value traps.
So don’t fall for them. Leave these “bargains” in the basement where they belong.
Not even the great Ben Bernanke can save them.
Need more proof? Click here for six more reasons why the bottom in housing is nowhere in sight.
By the way, those “joint-ventures” that Bob Toll warned about this morning are one of the industry’s dirty little secrets. The debts are held completely off the balance sheets! Scary.
