Homebuilders Take Another Hit

Shares of industry players dipped Tuesday after Hovnanian posted a big quarterly loss on a hefty land write-off

Optimists may wish to dwell on a recent trickle of good news for the housing sector—including a report issued on Dec. 19 showing a 6.7% jump in new-home construction in November (see BusinessWeek.com, 12/19/06, "Housing Starts Perk Up in November"). But the third-quarter results issued by homebuilder Hovnanian Enterprises (HOV) after the close of trading Dec. 18 were a brutal reminder that the industry remains mired in a big slump.

Not surprisingly, Red Bank (N.J.)-based Hovnanian reported a 1.5% fall-off in revenues for the three months ended Oct. 31, to $1.7 billion. But the eye-opener for Wall Streeters was that the company reported a loss for the period of $117.9 million—$1.88 per share—after $355 million in charges related to inventory impairments and land option write-offs. That's in sharp contrast to the company's profit of $165.4 million, or $2.53 per share, for the same period a year ago.

Investors took note, and sent the shares of Hovnanian and other industry players lower on Dec. 19. Hovnanian stock shed 1.9% in late trading Dec. 19 to $34.59, leading the S&P Homebuilding index to a loss of 1.5% for the session. Industry peers also slumped, with DR Horton (DHI) down 1.5%, KB Home (KBH) slipping 0.6%, and Centex (CTX) losing 1.7%.

"Although our deliveries and revenues increased over the record year of 2005, our gross margins fell 330 basis points—as we cut pricing and offered incentives to improve affordability and remain competitive in a period of a slower housing demand," said CEO Ara Hovnanian in a press release. "We did not anticipate the suddenness or magnitude of the fall in pricing that occurred this year in many of our communities."

Homebuilders are suffering through a difficult period, after years of fast growth. In November, Toll Brothers (TOL), the Horsham (Pa.) company that builds luxury homes all over the country, lowered its guidance for the quarter and offered a mostly pessimistic outlook for the sector. "We continue to look for signs that a recovery is imminent but can't yet say that one is in sight," said CEO Robert Toll (see BusinessWeek.com, 11/7/06, "No Housing Recovery in Sight").

Blame balky buyers and swelling inventories. CEO Hovnanian said that profits and sales continue to be adversely impacted by high contract cancellation rates, increases in the number of resale listings, and a rising inventory of new homes available. The homebuilder's contract cancellation rate for the fourth quarter was 35%, compared with 25% in the fourth quarter of 2005 and a 33% rate in the fiscal 2006 third quarter. "[M]any homebuyers [are] on the sidelines waiting for an even better deal on a new home," Hovnanian added.

The company's chief sees "a glimmer" of hopeful signs its markets may be stabilizing—declines in resale inventories, improving consumer confidence, and "healthy" levels of buyer traffic at many of its developments—allowing him to be "cautiously optimistic that some of our more challenging markets will begin to experience decreasing cancellations and an improved sales pace." The jury is out, however, until the all-important spring selling season. Until conditions improve, the company will "assum[e] that current conditions [will] remain with us for the foreseeable future."

The big factor behind the quarterly loss was the write-off. "We decided to walk away from $141 million in land deposits and predevelopment costs and took impairment charges of $174 million," said CFO J. Larry Sorsby. The company booked the charges rather than take an even greater financial hit by building the properties out at subpar rates of return, or even losses.

The company provided initial guidance for fiscal 2007, ending in October. "Assuming that the economy remains reasonably healthy and mortgage rates remain stable," the company is predicting fiscal 2007 EPS between $1.50 to $2.00 on 16,000 to 18,000 home deliveries, including 1,000 to 1,500 deliveries from unconsolidated joint ventures. For the first quarter of fiscal 2007, it expects to post a "modest" profit of 5 and 10 cents per share.

Sorsby also voiced some cautious optimism: "We believe that the overall U.S. housing market may hit the bottom in the first half of 2007. However, the housing market is likely to bounce along the bottom for several quarters before pricing and sales pace improves."

Homebuilding, of course, is epitome of a cyclical industry, and CEO Hovnanian tried to hammer the point home: "We have been through downturns in the housing industry many times during our 47 years of operation. Each time, we have emerged as a stronger and better company, with an improved market share. We are confident that we will weather the current slowdown with a similar result."

Standard & Poor's equity analyst William Mack still has a dim view of the stock. In a Dec. 19 research note, he maintained his sell rating on the shares, saying he thinks further charges for large land impairments will be necessary amid continued soft home demand. He lowered his fiscal 2007 EPS forecast to $1.20, from $3.50, though he did tweak his 12-month target price for the stock upward to $25 from $22.

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