Pulte's Good News Not Good Enough

The company says its homebuilding business is holding up this quarter, but nervous investors still sold the shares Monday

Even as some market players wonder if the housing sector is close to hitting bottom, shreds of good news from homebuilders get overwhelmed by a torrent of bad news and a rising level of anxiety.

Pulte Homes (PHM), for example, says its fourth quarter is on track, but Wall Street merely shrugged at the news. Pulte's stock price opened a bit higher Nov. 27, but was off almost 4% by mid-afternoon, trading below $9 per share.

Pulte chief executive Richard J. Dugas Jr. said in a statement that the company would stick to previous earnings guidance. "We continue to improve our already strong balance sheet," he said.

But the firm's earnings guidance doesn't include the impact of impairments, the big charges that homebuilders take, for example, the falling value of their land holdings.

Starting in 2006, the top 14 publicly traded homebuilders have written off more than $16 billion in those charges, according to Standard & Poor's equity analyst Kenneth Leon. It no longer makes sense to consider these as one-time charges, he says, but as a cost of doing business as the housing sector spirals downward.

On Nov. 27, two separate measures quantified the pain homebuilders, as well as home sellers, are feeling. According to the U.S. Federal Housing Finance Board, the average purchase price in October for a one-family home was $295,573, down 3.5% from a year ago. The U.S. Case/Shiller Home Price index saw prices in 20 cities fall 4.95% in September from the year before.

Homebuilders like Pulte have already cut prices in order in an effort to boost sales. Prices on new homes are already down about 15% from their peak, says Deutsche Bank (DB) analyst Nishu Sood. Prices on new homes may already be so low that further cuts won't be effective in attracting more buyers, Sood says.

The big worry is that existing home prices might have much further to fall. The typical American homeowner is often much more reluctant to cut their asking price. Rather than sell, they find ways to stay in their home longer.

"Homebuilders are way ahead on cutting prices," Leon says, noting that existing home price declines often lag by six to nine months.

Eventually, homeowners may be forced to sell their homes at a discount. And that's why there is a growing suspicion that home prices will actually accelerate their drop next year.

The National Association of Realtors says the median home price will fall 1.7% this year and hold even in 2008.

But many analysts disagree with this optimistic outlook. Not only might many homeowners decide to accept lower selling prices, many other homeowners might be forced to sell as millions of mortgages reset to higher interest rates in 2008.

Lombard Street Research analyst Gabriel Stein expects house prices to fall for another year, off more than 10%, or possibly even more than 15%, from their peaks.

If existing home prices start to plunge, homebuilders could feel even more pain. "The adjustment process will shrink demand further for the builders," Sood writes. While many builders offer homes in the outer suburbs, homebuyers may instead prefer "more centrally located existing housing stock" as prices fall. Sood predicts orders for new homes could fall another 10 to 15% in 2008, from already low levels.

The key, S&P's Leon says, is whether homebuilders' impairment charges start to slow down. If that happens, "that's the earliest indicator market conditions are starting to stabilize."

Dugas, Pulte's CEO, added the company is doing all it can "to generate cash and give Pulte maximum flexibility entering 2008."

With the public debt markets reluctant to lend them money, homebuilders are hoarding cash. They're trying to get ready for the next housing rebound, when they'll need the money to buy up land. (S&P, like BusinessWeek, is a unit of the McGraw-Hill Companies.)

By stock market value, Pulte is one of the top five U.S. homebuilders, along with DR Horton (DHI), Toll Brothers (TOL), Lennar (LEN), and Centex (CTX).

So far, the large, public homebuilders have the most cash, putting them in the best position to profit from a recovery, Leon says.

The problem is that recovery now feels a long way off.

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