Horton Hears A Boo

Bearish investors say the builder's land bets will hammer earnings. Management is listening

The question for D.R. Horton Inc. (DHI ), the nation's largest homebuilder, is this: Will pretty bad become even worse? This year the Ft. Worth company's stock is down 35%, it slashed its 2006 earnings forecast 30%, and on Oct. 10 it said that fourth-quarter home sales dropped 25%. Some analysts figure there's more trouble ahead, since Horton made huge investments in land over the past couple of years. Unwinding that bet could mean massive write-downs and sharply lower earnings. "I think 2007 is going to be very painful," says Daniel Oppenheim, a housing analyst at Banc of America Securities.

Donald Ray Horton founded the company in 1978. Over the years he has used acquisitions and aggressive internal growth targets to amplify the effects of the housing boom. From 1995 to 2005, houses sold sprang from 2,500 to 53,200; revenues, from $437 million to $13.6 billion; and profits, from $20 million to $1.4 billion. Those results helped the builder win the No.26 spot on the BusinessWeek 50 ranking of the best-performing large companies. Horton, now 55 and chairman of the company, still inspires his troops with slogans known as "Hortonisms." Among them: "Out of your foxholes--attack!" and "It's a quick trip from the penthouse to the outhouse."

Like a lot of fellow builders, however, as the market roared ahead, Horton began to buy into the notion that land in key markets was in short supply and housing demand would stay brisk. In fiscal 2005 the company increased its land position by 46%, to $5.1 billion, even though the number of homes it sold rose only 18%. In the first nine months of fiscal 2006, Horton hiked inventory an additional 25%, to $6.4 billion, even though home sales went up only 6%.

Worse, Horton's land is heavily concentrated in the markets where home sales are falling the fastest. Holdings in Arizona, California, Florida, and Nevada make up more than half the company's assets. Based on current sales it will take the company seven years to liquidate the land, figures Credit Suisse (CSGKF ) analyst Ivy L. Zelman. That's well ahead of Horton's stated desire to have only three to five years' worth on hand. Much of the land was bought recently, and thus at higher prices. Zelman estimates about 48% of Horton's holdings were purchased in 2004 and 2005, versus 28% on average for the other big builders. "Every piece of land they bought in 2005 is under water," she says.

Horton is now scrambling. The company has reduced the number of lots on which it can build from 396,000 to 340,000. It recently walked away from options it had on 22,000 lots, a move that prompted a $57 million write-off. Management has vowed to cut $200 million of expenses from the company's $1.4 billion in overhead through head-count reductions and better purchasing.

At the same time, company managers are accelerating strategies that they think will differentiate Horton from rivals. It is expanding into smaller markets, using the staff it has in place in San Antonio, for example, to build more homes in nearby Laredo. The hope is that sales in those small markets will make up 10% of Horton's business, up from 5% this year. Prospective home buyers will also be offered more customization, like turning a garage into a home office or putting a screen around a patio.

Some on Wall Street have spotted a buying opportunity. The argument is that interest rates appear to have stabilized, as has the overall number of new and used homes for sale. At a recent 23.89 per share, Horton's stock has rebounded since its July bottom. But the optimists are neglecting another Hortonism, as did, it seems, the company itself. Horton once told an interviewer: "Walk through the builder graveyard and all the tombstones read ‘long and wrong on land.'"

By Christopher Palmeri

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