Tuesday, August 30, 2011

Home Builder Opportunity?

Many US home builders continue to lose money, and sentiment in this sector is decidedly bearish. But it is often among unloved, cyclical companies that value can be found. To that end, a number of home builders trade at discounts to their book values.

Of course, book values can fall in value if conditions deteriorate such that properties have to be written down further. Nevertheless, book value is a good first indicator of a home builder's worth. This article depicts how closely the market caps of a few large home builders have tracked their book values over the last 25 years.

During the housing bubble, many home builders were trading at 2-3 times book value, which seems ridiculous in retrospect but at the time their earnings prospects made their stocks look attractive. Isn't it funny how cheap forward P/E's always look when expectations are high?

The biggest risk to home builder book values today are potential write-downs of their properties. Risks of write-downs are at their highest when inventory levels are bloated, so it's worth looking at the industry's inventory level to get a handle on the magnitude of the potential risk. The following chart illustrates the number of new homes for sale throughout the country over the last year:


New home inventory is not just down over the last year, however. Consider what inventories look like relative to those of the last 15 years:


Despite the low new home inventories, there still remains a 6+ month supply at current sales rates. This is because sales rates are very low due to low demand combined with the high availability of foreclosed homes. But at least we know there isn't a ridiculous supply glut that will weigh down on prices

If home builders fall further in price, a great opportunity may confront those willing to go against the herd.

Disclosure: The author holds no positions in US home builders

8 comments:

gullchasedship said...

The challenge, of course, is that people don't just buy new homes, and there is an oversupply of cheap housing available in many markets. If the housing supply is cheaper than building costs, that environment will make it very difficult for builders.

SFHM said...

I am mystified how anyone can safely assume that the land values are properly reflected on the balance sheets. Most of this land was bought years ago at inflated prices in poor locations. The builder face competition from purchasers who buy at bargain prices in better locations. Since the builders do not break out "land profits" and probably have no way of doing so, there does not appear to be any way to assess whether the inventories are properly valued. Which is probably why the companies all trade at such discounts to book. But the bigger problem is that inventory is the largest assets on the balance sheets, and many of the builders have huge amounts of debt which must be refinanced -- often before they can liquidate the inventory.

Anonymous said...

Homebuilding will eventually rebound (Warren Buffett, in a recent Charlie Rose interview, said there is a chance it will rebound by the beginning of 2013).

Rather than try to figure out which Homebuilder is going to thrive, why not play the supplier (i.e., USG).

I think this is a much safer play (unless you have a deep understaning of the homebuilder).

Long: USG

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