Quote of the Day - Centex Corp. (CTX)

Quote of the day comes from the Centex Corp. (CTX) conference call that was held on July 30, 2008.

"Conditions in the housing market worsened in the quarter and we don't see any improvements in market conditions for remainder of this fiscal year. Foreclosures are arising dramatically in most markets, employment growth is slowing. Mortgage rates are on the rise and we're seeing stricter mortgage qualification requirements for home buyers. Energy costs have increased substantially for our subcontractors, suppliers and customers."

Timothy Eller - Chairman and Chief Executive Officer of Centex Corp.

The Good Ole Days

I just reviewed earnings for Lennar Corp (LEN) and as expected they were atrocious. I don't mean to pick on them since they have enough problems as it is, but while I was on the company web site, I came across a presentation from a sell side conference back in February 2006. The stock was at $60 back then as you can see below:



One of the slides in the presentation detailed the secular bull case for Housing. The reasons given were:

1) Demographics favor continued strong demand.

2) Land supply is constrained.

3) Strong balance sheet & liquidity drive expansion.

4) Market diversification.

5) Professional management teams.

6) Competitive advantage – economies of scale.

It's astounding to me how many institutional investors bought into this thesis. It's very difficult to resist the call of a bubble.

In defense of Lennar, they did present an alternative scenario in the next slide:

1) Rates rise.

2) Economy falters.

3) Unemployment up.

4) Affordability down.

5) Demand weakens.

6) Margins compressed.

Anyhow, I don't have to tell you how it ended and which scenario won out:






If you look at the last housing cycle for Lennar, it also shows a pretty interesting ride, and a great way to make a lot of money if your timing is right.



Disclosure - No Position in LEN.

Charts courtesy of Big Charts.

Legend Homes

Legend Homes filed for bankruptcy protection on June 10 in U.S. Bankruptcy Court in Oregon. Legend was a small private builder, with only 770 lots owned, and its woes will not have a major effect on the Housing situation.

However, there was an article a couple of weeks ago in Builder Magazine, that shed some detail on the causes of the filing.

One interesting fact was that Legend Homes had a positive net worth when it filed. The court papers list $258 million in assets and $198 million in liabilities. Of course the asset value may have been stale at the time of the filing. Also, Jim Chapman, the president of Legend Homes, said in the article that the company was current with all loan payments to banks. So why am I writing about this? Chapman went into detail about how Key bank, one of Legend's lenders, tried to squeeze the company to put up more collateral:


"He points specifically to Key Bank, from which Legend has borrowed $22.3 million. Chapman says that Key attempted to use an earlier margin call to coerce cross-collateralization. “They wanted to take 100 percent of the closings on homes they didn’t even have construction loans for,” says Chapman. “And their approach has been to reappraise the land, say ‘here’s the margin’ and then ‘please remit $9 million.’ They’ve been very difficult.”

I assume this same thing could happen to a major publicly traded builder as well. Could this trip housing down even further? What if thousands of lots were forced onto the market suddenly? Just something to think about.

A Picture is Worth a Thousand Words

I was on vacation in Florida last week and saw the following sign in front of a half finished development.



I almost pulled off the road causing an accident when I saw the 2 for 1 special sign. It's hard to believe that new houses are being discounted 50% off list from a year ago.

Robert Toll on the Sub Prime Bailout

A few excerpts from the Toll Brothers fourth quarter conference call held last week courtesy of Seeking Alpha

Robert Toll had some interesting comments on the new plan announced by the Federal Government.

Comments on Sub Prime Loan Plan

"With respect to what do I think about the most recent announcements, to be a wise guy, not much. There is no such thing as a sub-prime loan. There’s a sub-prime borrower; that is a borrower who hasn’t got the credit, the respect for his credit in the marketplace that’s equal to what you would consider to be necessary, which we call now prime. A little misnomer in the use of the words."

"What I understand has been offered to the congress to consider and pass is a break for sub-prime. So if you’ve got -- sub-prime borrowers, so that if you are not credit worthy, we’ll give you five years at your present rate but the next door neighbor, who decided he liked the teaser mortgage and went for four for the first six months and six for the next six months and then according to an index with a differential, he would be pushed to eight and then to 10, he’s stuck because he had prime rating."

"I think what would have made more sense, if I were running the zoo, is I would have said we are going to stop teasers, not just sub-prime but for everyone at a rate and pick a number. If we think a -- we’ve done it in the past. The rates used to be regulated in this country up to the elimination of Regulation Q. I think that was in the ‘70s when disintermediation took place."

"I think it wouldn’t be a great feat for us to say that for the next two years, we are going to cap the rates for teaser mortgages at 8%, or 8.5%, which has been approximately the 40-year average rate that we’ve lived with."

Toll Brothers Conference Call

A few excerpts from the Toll Brothers fourth quarter conference call held yesterday courtesy of Seeking Alpha

Interesting that he said that 1974 was a rougher downturn than the current one.

Comments on Current Conditions

"By many measures, fiscal 2007 was the most challenging of the 40 years that Toll Brothers has been in business. 1974 was perhaps rougher, but the difficult times only lasted one year."

"Since going public in 1986, we’ve just reported our first quarterly loss this fourth quarter after 85 consecutive profitable quarters. The loss was driven by $315 million of non-cash pretax inventory related impairments and related write-downs."

"The creation of projections is difficult at any time. In the current climate, it’s particularly difficult to provide guidance for fiscal 2008, given the numerous uncertainties related to items such as sales paces, sales prices, mortgage markets, cancellations, market direction, and the potential for and size of future impairments. As a result, we will not provide earning guidance at this time."

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."

Highly Recommended

I just found a blog that is probably one of the best I have seen on Homebuilders and the related mess that is going on in that area. It is written by Reggie Middleton and is located here:

Reggie Middleton's Boom, Bust & Bling Blog

He brings a lot of insight into an area that is usually full of hyperbole. I would recommend subscribing to his feed.

Things We Are Glad We Said but Wish We Had Listened To

California's Housing Market: How Much ‘Froth’ Is Out There?

A conference held in October 2005 sponsored by the Milken Institute.

"Angelo Mozilo of Countrywide Financial Corporation predicts that the market will slow and even decrease by a couple percentage points “so that incomes can catch up with the price of homes.” His concern reflects the historic low affordability level that prices many potential buyers out of the market unless they resort to creative financing, which is inherently riskier."

"With new-loan originations now being comprised of 60 percent adjustable-rate mortgages and 40 percent fixed-rate mortgages, Mozilo concedes that his company “may be selling products to individuals who can’t manage risk.”

Things We Wish We Never Said

California's Housing Market: How Much ‘Froth’ Is Out There?

A conference held in October 2005 sponsored by the Milken Institute.

"Although the market is cooling off, the demand for housing is real, and we will continue to see modest single-digit gains below 6 percent, he said."

-Emile Haddad, President, Western Region, Lennar Corporation

Private Homebuilder to File Bankruptcy

Another one bites the dust.

"Neumann Homes, one of Chicago's largest homebuilders, announced on Monday that it intends to file for bankruptcy.

The company said in a press release at 5 p.m. that it had been "unable to procure adequate funding" to operate its business. Marketing director Jean Neumann said that despite other published reports, the bankruptcy had not been filed, though "it will be done shortly."

The company, ranked among the top 10 in Chicago, also builds in Wisconsin and Colorado. Company CEO Kenneth P. Neumann said in the statement that "significant downturn in the Detroit, Chicago and Denver housing markets resulted in this situation. ... Even after the significant help we have received from our lenders this year, the company can no longer weather this storm."


Neumann Homes Bankruptcy

Hunting Bargains

Some of the best bargains during the trough of the real estate cycle may come in the condo market in Miami, where the word overbuilding acquired a new meaning. It's too early so don't get lured in by these auctions yet, but here's a web site to keep track of the foreclosure sales going on in that city:


Miami Dade County Clerk

Are We There Yet for Homebuilders? - Part VI

Since I mentioned the California unemployment rate as it relates to Housing in my last post, I figured I would post it here. The chart is from Economagic, a great resource for economic data.




As you can see the unemployment rate has started to tick up, but it is nothing compared to the last downturn.

Are We There Yet for Homebuilders? - Part V

One fact that argues for investing now in Homebuilders is the strength of the general economy currently as compared to economic conditions back in 1989 to 1991. The chart below from Economagic shows the decline in non farm payrolls during the last great Housing crisis. The revision this morning to non farm payrolls for August from a previously reported loss of jobs to a gain, is more evidence of general economic strength. I seem to remember back in the early 1990's California had an unemployment rate around 9%.



Just think how bad things would be for Housing if another 2 million Americans lost their jobs.

Homeownership Rate

One of the symbols of the recent Housing Boom was the increase in the Homeownership rate to above trend levels. Some debated the cause of this increase. A recent study by Matthew Chambers, Carlos Garriga, and Don E. Schlagenhauf entitled "Accounting for Changes in the Homeownership Rate," published as a working paper in September 2007 by the Federal Reserve Bank of Atlanta, concluded that the main reason for this increase was the growth of exotic mortgage products, and not demographic reasons.

A copy of the study is here.

"We find that the long-run importance of the introduction of new mortgage products for the aggregate homeownership rate ranges from 56 percent to 70 percent. Demographic factors account for between 16 percent and 31 percent of the change."


What does all this mean? If this study holds up under peer review, it would argue for a more prolonged housing downturn for two reasons - this demand will not be coming back anytime soon, and houses purchased by this group will swell inventories.

Are We There Yet for Homebuilders? - Part IV

Another issue to grapple with when buying the Homebuilders is the number of new home sales relative to previous peaks. As you can see in the chart below, if you declare a bottom for housing at the current level, one of the assumptions that you are incorporating into your analysis is that you are comfortable with the fact that the number of new home sales will trough above the peak of the last cycle.

New Home Sales Monthly (January 1963 - August 2007)




This is an important decision because during the last three cycles, new home sales never went above a 900,000 annual rate. During this cycle, they went much higher and peaked at an annual rate of 1.389 million in July 2005. If this extra demand was real demand, due to higher population growth or a more affluent population buying second homes, then this is fine. If it is speculator demand, then we are in big trouble.

So it remains to be proven whether the trough of this cycle should be above or near the peak of the last three when referencing new home sales. Months supply of new homes solves this problem in some ways since it transforms the data into time. If that is the case then we may not be at the trough yet as months of inventory peaked at much higher levels at the troughs of previous down cycles. (9.4 in January 1991, and 11.6 in January 1980.)

Housing Conference

I just got an e-mail on an interesting conference coming up in December. I am hoping that it will be webcast. It is the 2007 National Housing Forum to be held at the National Press Club on December 3. Here is the agenda.

OTS National Housing Forum

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 III ?

New home sales were reported yesterday by the government. Aside from the obvious problems with this measure that I discussed here:

http://marketprognosticator.blogspot.com/2007/08/housing-depression-is-not-over-yet-part.html


It may be a useful exercise to see when this and other metrics bottomed relative to the stock prices of the Homebuilders during previous cycles. New home sales bottomed in January 1991, at a seasonally adjusted rate of 401,000. Months supply of new homes peaked at 9.4 months also in January 1991. This data was not reported until March 4, 1991, due to the lag time in collecting it. Also, at the time that the January 1991 data was released, an investor would not have known it was the bottom until several more months of data had been released. The chart below is a monthly chart of new home sales from 1963 to August 2007.



Lennar bottomed out in Oct 1990, and had risen significantly by March 1991. Other Homebuilder stocks have shown similar patterns of recovery.

The bottom line here is that if you wait until these metrics to bottom as your buy signal, you missed significant upside.

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.