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A Dose of Reality on the Housing Market


A look at D.R. Horton's conference call transcript...with a bit of writer's embellishment just for fun.


Several months ago, as the Philly Housing Index (HGX) was breaking below the 200 level, Toddo asked me which homie stock would I buy if I had to buy one today. Without much thinking or hesitation, my answer was D.R. Horton (DHI). In a business replete of smoke and mirrors and less than candid characters, DHI has always carried the flag for being as straight forward and common sensed about its business as anyone might expect.

Over the last couple of months the recurring debate-du-jour in mainstream media has been whether the housing market has bottomed, and if it is time to scoop up some bargains. As I am the one who, since early 2004, hammered away at the fact that the housing market would implode in a mushroom cloud, my thoughts on this debate are not very relevant: being two years early in this business = being wrong. So I offer up for your contemplation some portions of yesterday's conference call with the trusty DHI folks, with a bit of writer's embellishment just for fun. The questions are from various analysts, the answers and comments from DHI's officers.

Question: Many of your peers continue to build specs more aggressively now than Horton is ... I'm just trying to figure out; what is your strategy going to be this year? If you don't start to build specs in the spring, there is a risk that you won't get as many closings...
Writer's embellishment: The answer to this question is given later; I just thought this was illustrative of the state of denial still permeating the group. With months supply at levels not seen in decades, this Tier 1 firm analyst is actually concerned about a lack of spec construction; that's usually not the kind of concern you see at bottoms.

Question: You mention that in looking at the next round of cost cuts that you still have on the shelf, it depends on how sales turn out. I know you guys are not providing an outlook and I respect that: forecasting less, delivering more. But some of your peers have allowed themselves to be more optimistic and so just internally in terms of looking ahead or how you are managing things, are you also allowing yourselves a little bit more optimism or are you still looking at this as an early leg of a multiyear downturn?

Answer: The latter. I think we are in the very early stages. As Mr. Horton and I were talking the other day, we're about 12 months into this slowdown and we have been in business together for 23 years. This is unfortunately my fourth downturn I think. But nevertheless, it is just a function of most of these downturns [running] longer and deeper and right now we don't see anything on the horizon that would change that opinion.

Question: [What] total number of lots [in inventory] would [you] like to get down to?

Answer: I would say to you that right now we are sitting at about 300,000 lots and I think we'd be happy to be somewhere around 200,000 lots right now.
Analyst: That much lower[?!]. Okay
Writer's embellishment: Yes Mr. Analyst-in-Denial (another one by the way), that much lower.

Statement by DHI's officer: Colorado still is a very challenging market as evidenced a bit by the charges that we had this quarter in the state of Colorado. The pricing environment there is definitely more challenging than it was a year ago as well. Which is absolutely amazing to me, but it is. In Colorado specifically, we thought Colorado would start to firm this year and that is not happening.
Writer's embellishment: OK Mr. DHI's officer, now you are really messing with the poor analysts-in-denial.

Question: I thought you guys had said [previously] that you would expect hitting the bottom around midyear. Is that correct?

Answer: What I said was, and I've said this for two quarters, it's going to take two
to three quarters for the market to bottom out. And so as a result, I would say somewhere midyear we expect the market to begin to bottom out. We also said clearly that we don't expect any rapid improvement in the market thereafter. We expect the market to remain relatively flat to slightly up commencing in '08. That's just our feeling at this point in time
Writer's embellishment: Which of course is how, for example, Japan's real estate hell began, with one year of flattening, followed by the second, the third...ninth, eleventh...

Comment on the company's refusal to buy back stock: As I've said before, I will reiterate one more time... during a softening environment in the industry, we believe the preservation and the accumulation of additional liquidity is the right thing to do.
Writer's embellishment: Mr. DHI's officer, it will be easier for a camel to pass through the eye of a needle than for a sell-side analyst to grasp the concept of what you have just said.

Comment on pricing trends: As we move forward, as I mentioned, we're trying to drive down our price points across the board and recover our gross margins by driving down all of our cost components because clearly we've got affordability issues in the industry.

Question: What do you see or what do you hear as it relates to private companies, smaller companies? I know we can all see here the public builders but what do you see as to... the suffering going on within private companies that might be more leveraged than all you public players?

Answer: Actually, Horton and I were talking about that the other day and I don't think they are suffering nearly as much as they are going to be suffering in the next 12 months because the large homebuilders are just now beginning to put back the lots to the developers. I don't believe the banks have cut back nearly as much as they are going to on those small and medium-sized builders. I think they are operating in a period of euphoria currently and I think that is about to change because clearly as we drive down our prices and drive down our incentives and so forth, I think we are going to make the market much more competitive on them and as you know, they don't have the staying power. I think at some point the commercial banks have got to say you are not going to get the next loan. It is going to happen, but it just hasn't happened on a large scale yet.
Writer's embellishment: Ouucch!

Question: I guess where I'm confused is answering one of the questions, you said that you believe that a lot of the land developers, the smaller builders, private builders, maybe are going to be more financially constrained. And if that is the case in the next 12 to 18 months, then we're going to see another whole layer of distress and then prices will fall. So it seemed like you should be cleaning up your lot count earlier rather than later.

Answer: Believe me, (same analyst-in-denial-who-asked-the-very-first-question), I think you are exactly right. We would love to clean it up a lot faster than we are even cleaning it up right now. It is just a function of how quickly we can clean it up. When you say clean it up, we've got 100,000 lots that we have under option. We've got about 200,000 lots that we own. The issue is as those option lots come to us, there are attractive option lots that we are going to want to close. We have got an owned section of 200,000 lots and unfortunately, the only way we can work through those is for our sales to increase at a faster pace than what they are increasing and that is the only way we can clean up the problem faster. We are doing as much as we can do and have been doing it longer than everyone else, trying to clean up the lot position vis-à-vis sales.
Writer's embellishment: Why do I get the feeling that analyst-in-denial and DHI's officer are like two ships passing in the night?

I doubt that even pinning this transcript on one's fridge and forcibly reading it twice a day will sway anyone debating this issue. The housing bubble, like all other bubbles, came about because of that pesky, incontrollable limbic system of ours, combined with a seemingly infinite supply of easy debt. The last thing someone caught in that brew cares for are facts.

To complicate matters further, we know that we must distinguish between the housing market and the housing stocks as the two are very different animals. For my money, I am choosing to sit out the show for now, except for some nickel-and-dime puts. Players' limbic system's feel still firmly in control of the game, and I just don't have it in me to fight absurdity for two more years. I do still believe that ultimately housing stocks as a whole will bottom out at less than half of where they are right now; but unless they ring some kind of bell to jump on the southbound train, my sense is that these are some of the toughest shorts Boo could play with.

Position in XHB
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