Are We There Yet For Homebuilders - An Update?

In September we blogged about the dangers of using stated book value as a buy signal when evaluating Homebuilders for purchase. The original post is here at this link:

Are We There Yet for Homebuilders - Part II?

My advice was not to believe the book values being used in quarterly balance sheets.

"do not use price to book yet as a buy signal. Book value is in flux and will continue to go down quarter after quarter. The safest thing to do is take the latest quarters book value and write off 30% and then slap a .75 multiple on it and then buy them there."

Well, it seems that a 30% haircut is not enough. Lennar Corp filed an 8-K disclosing that it sold some of its lot and land inventory at a haircut of 55% off the book value that Lennar thought it was worth just eight weeks ago.

The full filing can be read here at the SEC site.

The relevant quote is:

"As of September 30, 2007, the acquired properties had a net book value of approximately $1.3 billion and the sales price was $525 million."

Lennar Stock Last Cycle

One problem with Wall Street is a lack of institutional memory. It seems that no one even remembers the last big downturn in housing that occurred in the late 1980's and early 1990's. I am posting a series of charts of different Homebuilders from that era. The first up is Lennar.

Two things are clear from this chart. First, this is not the first time that Homebuilders have gone down 75%, and second if you time this right on the upside, these stocks will be the buy of a lifetime.

It's hard to see in the chart but the stock looks like it bottomed out in October 1990 at around $0.55. This is down from the peak of about $2.05 in early 1987. Also, you will notice in the chart that there was a false rally after the crash of 1987. If you bought Lennar after the crash in October 1987 at $0.78 you saw your investment almost double in two years, before the stock fell to its true trough in October 1990. It would be interesting to see when the book value of Lennar stabilized in this downturn. Unfortunately, the SEC web site only goes back on line to 1994.

Are We There Yet for Homebuilders - Part II?

Are we there yet? Are we there yet? My kids yell this in the car all the time. So are we there yet for Homebuilders? Is it time to buy? First here is the damage to some of the Homebuilder stocks since the peak, which for most of the stocks occurred in July 2005.



I am going to spend a majority of my time figuring out when to buy Homebuilders, but for now here's a quick list of what you shouldn't do.

Don't listen to anyone on the sell side. Most of them told us for years that it would be different this time. Remember that tripe? Access to capital, immigration, consolidation in the industry, better balance sheets, yada, yada, yada.

Second, don't rush out and buy because you see a "cult" investor on CNBC talking the sector up, or a rumor hits the wire that another cult investor is buying. In July, rumors hit the tape that Buffett was buying shares of Hovanian. Let's hope he didn't because the stock was at $16 then and its now at $11. Do your own work. Don't blindly follow someone else. You'll feel a lot better afterwards. This does not mean you or I will ever be as smart or as rich as Buffett, but there's nothing worse than losing money because you listened to some talking head on CNBC instead of doing your own research.

I used to be an equity analyst at a bank and my boss wanted to buy shares of Arrow Electronics (this was late 1998). I took a look at the stock and felt like the trough had not yet been reached, and I told him that. He looked back at me with a sneer and said "What do you know that Bill Miller doesn't know."

So I said to myself, "Well why don't you go out and hire Bill fucking Miller as your analyst then." Instead I just looked at him dumbfounded and swore that I would never pick stocks the way he did.

Third, do not use price to book yet as a buy signal. Book value is in flux and will continue to go down quarter after quarter. The safest thing to do is take the latest quarters book value and write off 30% and then slap a .75 multiple on it and then buy them there.

Last, think about avoiding individual stocks and buying the ETF or index that tracks Homebuilders. It is likely that a few of these homebuilders may get into enough distress that the equity becomes worthless. There is a SPDR that tracks the industry under the symbol XHB. It's not a perfect substitute since it has Home Depot and Lowe's in it but it may be a safer option to play the industry.

Bye Bye Book Value

DR Horton (DHI) reported earnings this morning and is the first of the homebuilders to finally recognize reality - that its main asset - land, is not worth anywhere near what it says it is. They took an impairment charge of $823.8 million to the value of the land on its balance sheet. As a comparison, last quarter DHI wrote down only $ 67.3 million for inventory impairments. While it may seem that DHI just reported a "kitchen sink" quarter, remember that total inventory on its balance sheet is $10.6 billion, and home and land prices are still dropping in many states.

The conventional wisdom on Wall Street has been to buy Homebuilders at book value, which incidentally, virtually every analyst said would never happen. But here we are about 18 months into the downturn and many of them are bouncing off tangible book value, with some well below. This belief that book value is the bottom is ingrained in the industry as well. I remember attending a Homebuilding marketing tour in Atlanta about 5 years ago and during the question and answer period an investor asked the management if they would consider making any acquisitions. The group was trading at around 1.5-2.0 times book value at the time.

The speaker looked dumbfounded for a minute and then said simply that the only value to him in a competitor was the value of its land – he already had a brand established and the infrastructure to support it – so why would he pay two times what its land is worth? Now did it occur to him at that time, that this was exactly what he was asking us as investors to do? To pay twice what his book value was? I’ll never know the answer to that and I can’t recall which homebuilder it was.

So is it time to get in the group? Investors need to get their hands around several issues before jumping in here. It will be tempting because you will start reading articles soon about how Value investors are “sniffing” around the industry. Value investors love to sniff around stocks and industries. There are stocks that I have been watching for years without buying. I stalk them, watching and waiting for the 100-year flood to come.

The first issue is book value. It’s great to buy something at book value because it makes you feel warm and cuddly at night but what happens when you wake up and type that stock ticker into the box and you find out that the company just wrote down 20% of its book value? Oops. Sorry, you no longer own a homebuilder at book value anymore. An analyst report released last week from Deutsche Bank says that on average a group of 13 publicly traded homebuilders have written off 11.1% of its equity base. Is this enough for what may become the worst cyclical downturn in the last 50 years? My opinion is no.

The second issue is what sort of hidden bombs are there that are not on the liability side of the balance sheet of homebuilders. Homebuilders utilize off balance sheet partnerships and joint ventures fairly frequently. Have these all been disclosed to investors and do we understand completely the ramifications of them?

Third, the biggest boom in the history of residential housing deserves the biggest bust. The excesses need to be washed out of the system before things get back on track.

Fourth, the sub prime reset wave has not peaked. What happens when these hapless homeowners go to refinance, as they were promised, but they have negative equity so can't get a lender to touch them. Back to renting I guess and the house is put up for sale. Inventories have not peaked.

Fifth, the industry can trade at a much lower price to book value than the conventional wisdom believes. Stocks traded down to 0.5 times book value back in 1991. I think we can all agree that this downturn is worse than that one.