No Spring Savior for Housing

By Dr. Duru written for One-Twenty

June 5, 2006


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Toll Brothers (TOL). Hovanian (HOV). And now Pulte Homes (PHM). The dominoes are falling just as the bears have long predicted. The homebuilders are now slashing and burning earnings and revenue projections en masse. Just to sound smart too, I will point out that I predicted more pain ahead when I finally gave up on a trading bottom for homebuilder stocks - just as the major stock indices were topping out for May. Anyway, after spinning tales hanging by a thread of hope for a stable and robust spring selling season, we have witnessed the executives of the homebuilders, one-by-one, throw up the white flag and admit defeat. But they have only lost the latest battle and not the war. The last quote in Pulte's warning says it all: "Given constrained land supplies and favorable population trends, we remain positive on the long-term demand conditions for the industry, but believe it is appropriate to adjust shorter-term expectations given the current sales environment."

Take careful note. What is missing here? No mention of a strong economy. No mention of a robust labor market with unemployment percentages at record lows. This is important. To rely on these pillars of strength would not be wise. Why? Well, how much better can things get? They can only get worse from here. If home sales are cratering while the economy is firing on all cylinders, imagine what could happen when the economy takes a stumble or two? Two things we can count on though. No one is building more land and immigration should continue to pump up America's growing population (current immigration legislation notwithstanding). Now, as long as these immigrants bring in fresh money and get caught up in the American dream, then the last threads of a bullish thesis just might remain intact. But such trends do not a resurgent housing boom make!

Now, I have frequently noted the long-term trends on the 10-year Treasuries. The yield dropped a whole tenth of a percentage point under 5.0% on Friday on the back of a weak jobs number. This marks an important failure at resistance - meaning that the long-term decline in yields remains intact for now. I thought such a failure would mark a buy signal for trashed housing stocks, but with the market fearing a Fed on the warpath against inflation, all bets are off. Market expectations matter more than anything else right now. However, as I suspected might happen, housing stocks look thoroughly beaten up just as these long-term yields are looking to maintain the downtrend. In particular, PHM got slammed for a 5% loss and now sits at 18-month lows and a 6.4 forward P/E. Not even the promise of its assisted-living centers is helping right now. The carnage can be seen everywhere: Other 18-month lows: Lennar (LEN), KB Home (KBH) and Meritage (MTH). HOV and Centex (CTX) are almost at two-year lows. Beazer Homes (BZH) is not at similar lows only because of a large dip it experienced in early 2005. Folks, we are truly in falling knife territory! Stick your wallet out at your peril. On the other hand, the negativity is so thick again that it is hard to press negative bets here. I bet there are lots of folks who are finally coming to the reluctant conclusion that Raymond James & Associates analyst Rick Murray did in an interview regarding Pulte's warning: "'I think it's safe to say the housing boom is over'." (see June 2, 2006, AP story titled "Pulte Homes Shares Fall on Lowered Outlook.") It may be safe for such belated conclusions, but to continue to bet that way is far from safe. Instead, it is time to ponder what could go right to ignite a counter-trend rally (that would open fresh shorting opportunities by the way). The main thing I see is the long-term interest rate story and the desparate hope that the Fed may choose to pause in late June. It will not matter what you think the odds are for such a thing (I think it is 50/50), only that the market builds confidence in such a scenario. And if the Fed actually does pause, you can bet that at a bare minimum, shorts in all these homebuilder stocks will ignite one of the bigger squeezes we have seen a while in these stocks. This knee-jerk buying will encourage and motivate other buyers who are trying to time a bottom.

According to Yahoo!Finance, here are some stats from May in terms of the number of shares short as a percentage of the float (anything above 10% is considered high):
  1. BZH: 20.30%
  2. CTX: 7.80%
  3. HOV: 14.80%
  4. KBH: 9.50%
  5. LEN: 7.70%
  6. MTH: 13.90%
  7. PHM: 7.60%
  8. TOL: 11.10%
Before we go searching for bottoms again, let's review where we stand in terms of the latest revised expectations:
  1. May 23: TOL reduces FY06 EPS guidance from $4.77-5.26 to $4.69-5.16 vs. $4.93 consensus. (Note that the market never believed TOL's optimistic scenario). Back in February, TOL issued FY07 EPS guidance of $4.77-5.26 vs. $4.90 consensus. No growth here, folks!
  2. May 31: HOV dropped guidance for Q3 to an EPS of $1.40-1.50 vs. $1.75 consensus. However, they dared to issue "upside" guidance again for the year, moving EPS up to $7.20-7.40 vs. $7.00 consensus. FOr proper perspective, three months ago, HOV issued guidance of 8.05-8.40 vs. $8.10 consensus.
  3. June 2: PHM warns that FY06 EPS will be $4.70-$5.00 vs. consensus $5.61, with Q2 EPS of $0.85-$0.95 vs consensus $1.09. In April, PHM expected Q2 EPS of $1.00-$1.10 vs (Reuters) consensus $1.34, and they re-affirmed full-year guidance of $6.00-$6.25 vs $6.01 consensus. That is a HUGE drop, folks!


Finally, the latest revelations from Bank of America (as reported by briefing.com on June 2, 2006) confirms that negativity in the housing sector now runs far and wide and deep: "Banc of America says according to their monthly survey of over 250 real estate agents, market conditions worsened sequentially in May. Firm's survey pointed to flat or falling home prices in 15 of 21 markets (equivalent to April). However, they note 39% of agents said home prices fell (from 35% in April), 45% said home prices were flat (up from 43%), and just 16% (down from 22%) said home prices increased. Their estimates, which are 2% below St for '06 and 22% below St for '07, assume only a modest price decline, but further pricing weakness could add additional potential downside. They say traffic was well below expectations and think 2Q orders are likely to disappoint. Agents noted that the time needed to sell a home increased again in May, indicating that incrementally the market saw more supply than demand; this will further pressure home prices in coming months. Firm's least favorite stocks remain Meritage (MTH), NVR (NVR) and Toll (TOL)." And for perspective, this is what they had to say last in March of 2006 (again, from briefing.com): "Banc of America reiterates caution on the Homebuilding Sector, and sees potential downside to their '06 ests based on their February survey of 283 realtors. Firm says buyer traffic remained well short of agents' expectations in February as their traffic index was flat at 38.3 (readings below 50 indicate traffic below expectations), driven by markets where affordability is streteched. Firm's earnings estimates are based on modest overall price appreciation in 2006, while agents on average saw falling pricing trends in February in 13 of 20 markets. They think large incentives in previously hot markets (relatively few incentives were offered in these markets a year ago) will negatively impact margins. Firm remains cautious on the group and see the greatest risk in Meritage Homes (MTH), MDC Holdings (MDC), NVR Inc. (NVR) and Toll Brothers (TOL)."

In other words, be careful out there...!

DrDuru, 2006