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Homebuilders Are Either Dead or Dead Money


There's no re-inflating the mother of all bubbles.


Minyanville reader Paul writes:

Dear Fil Zucchi,

Beazer Homes (BZH) received an upgrade today from JPMorgan (JPM) along with Pulte Homes (PHM) and KB Homes (KBH); Toll Brothers (TOL) was downgraded because of valuation. JPMorgan expressed the opinion that homebuilders in general are now reasonably valued. I remember that quite a while ago you had shorted Beazer at 4'ish and so was wondering what your view is now on homebuilders? They have had a good run recently but signs are still quite positive for the housing market in many areas of the country. What is your outlook for the group, and do you have any favorite picks from this group going forward?

I assume that what you are referring to is a buzz (subscription to Buzz & Banter required) from June of 2010 where I wrote the following:

Last August I offered that housing is about to enter the horizontal part of a multiyear L bottom and that any opportunity in the homebuilders would reside in the bonds and not the stocks. If only I had put my money where my brain was . . . But I digress.

So over the last 48 hours we magically discover that excluding folks buying homes with yours and my money (in the form of tax credits and financing from government agencies), no one really is buying homes, and indeed, months' supply of new homes are again skyward bound. Worse, here is a little anecdote for you. I receive automatic e-mails for every listing of condos under a given price in certain Washington area zip codes. The number of new weekly listings they receive are about twice what they were three months ago, and one-fifth of the listings are "short sales." So much for a recovery.

So short the homies? Not for me (Emphasis added). Yes I am convinced that the Beazer Homes and Hovnanian (HOV) of the world have no current or future value for equity holders, and if the capital markets hold up for them the best they can hope for is to stay out of bankruptcy by replacing debt with more senior debt. This eviscerates equity and Junior debtholders. But shorting $4 stocks hoping for a $0 is not for me. I hear the argument that these are precisely the stocks to short because they are intrinsically worthless and ultimately will go to zero, and I agree. But trading is a hard enough game when one encounters an "easy" trade, and the "easy" money in shorting homies was made a while ago.

That said, the realization that not only there is no housing recovery (and there won't be one for many many years), and that we may well see another leg down in that industry, has [the bears] with an unshakable grin on [their faces].

Fast-forward two years and my impression is that not an awful lot has changed. Yes, on the margin housing statistics are improving, but to extrapolate that to argue that the stocks of homebuilders may be good investments seems a rather long stretch. The "L" bottom that I envision is one that may last perhaps into the next decade. There may be better and worse years in between, but the herd of publicly traded homebuilders will have to be thinned considerably before they can once again emerge as an investable asset class.

Looking at specific names, Beazer and Hovnanian are still around only because the corporate bond market is so desperate for yields that it will lend money to anyone and anything. The moment this dynamic changes both these companies will likely disappear. Consider this: Hovnanian and Beazer each has approximately $1.5 billion (net of cash) of debt and preferred securities, many of which carry double digit coupons. And both have had negative cash from operations over the last 10 quarters. Anything is possible of course, but short of the second coming of the last bubble it seems difficult to model any scenario where there will ever be any value for current equity holders. The Toll Brothers and Pulte Homes of the world are obviously in much better shape, but even among those names, where will the upside for the stocks come from?

I continue to see good investment opportunities in buying individual properties. Even in the Washington, DC, area, which has been touted as immune from the national debacle (nonsense, but that's for another article), my firm has been successful in purchasing B-class condos in A+ locations and renting them out for 5%-plus cash on cash returns, assuming only 10.5 months of rental income every year. Considering that after expenses and depreciation the net after-tax yield is about the same, that is not such a bad deal considering the alternatives. That said, we are avoiding multiunit properties, which have been bid up too high, and we are certainly not even looking at residential Real Estate Investment Trusts where the yields and returns seem more a function of leverage and financial engineering than actual cash generation.

Net-net there are probably a dozen different sectors in the equity markets more attractive then even the best homebuilders.
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