Hovnanian Conference Call - And A Look Back At Housing Bubbology, 2005 Style

By Dr. Duru written for One-Twenty

September 12, 2006


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Once again, a flurry of housing news has hit the market in the past week. Lennar (LEN), KB Homes (KBH), and Hovnanian (HOV) have all delivered the familiar refrain of bad news about the deepening housing slump. I checked out the conference call for HOV because I had heard on a news report that the CEO had expressed frustration that the housing market should be much strong given the strong economic backdrop. Those were strong terms, so I had to see for myself. As you might have expected, I heard no such frustration in the call. But what I did hear is yet another homebuilder executive explain that his industry was caught by surprise because housing slumps are supposed to be caused by a decline in the economy...and we have yet to see such a decline. This stated surprise is our surest indicator that we just witnessed the latest bubble in the U.S. economy. Economic fundamentals did not drive stratospheric housing prices. They went up simply because there existed a surplus of folks, supported by historically cheap money, willing to pay ever higher prices. Now, sentiment has notably changed. The word is out. Housing will be cheaper tomorrow, so why buy today? A classic deflationary spiral is taking hold. The last element missing is the willing seller who gives in to the deflationary demands of today's buyer. This popping sound is only a surprise if you believed that houses that go up in price 20-50% a year truly increase in value by that same amount.

Anyway, while doing some small research, I stumbled upon a great article from March, 2005 that laid out the case for a continuation in the boom for housing. It was called "A bubble? Not for housing stocks." Given that the article came three our four months before these stocks did peak, I found it a very instructive reminder on how the bubble mentality seeps into acceptance. Basically, the author made the economic fundamentals argument and the "everyone's paying these prices" argument. There was a smattering of the fallback position of taking market share from hapless, smaller builders as well (I cited an article earlier that indicates the smaller builders are not yet ready to roll over and play dead.). Read up...if you have not already.

Without further delay, here are my highlight notes from the Hovnanian earnings conference call - mainly from the Q&A session following the reading of the financials. The executives did a pretty stand-up job calling the market as it is and how they see it (all emphasis mine):

  1. HOV described a process of prices spiraling downward with the use of incentives
  2. Spike in cancellations has created net contract per community levels at 10-year lows
  3. Cancellation rates at a 3-year high - thinks these rates will level off
  4. Unsold homes per community at 8 1/2 year high, but this is 2.9 months of supply at current sales pace...
  5. Homebuilders surprised by size and speed of slowdown because economic backdrop is still strong
  6. Managing business in expectation of a long downturn
  7. Pricing strategy set to market conditions of each specific community
  8. Walking away from many options contracts for land purchases
  9. There are not many investors in the market today. Most buyers are pretty serious given the "significant" deposit requirements. However, California requires a fixed 3% deposit which means it is easier for folks to walk away. Texas is lower. Northeast deposit is 10%. Deposits in Florida are about 6%. So, Cali cancellation rates are much higher than national average.
  10. Analyst challenged the premise that we can expect cancellations to moderate because it is really driven by folks who cannot sell their current homes. Company explained that what can now happen is that folks get more realistic about what they can get for current homes and what they can afford for new home.
  11. Sales and absorption rates have not stabilized - would take 5 to 6 months before they could tell. Won't get active in M&A until that point.
  12. Returns on equity and cash over past two years were not sustainable nor reasonable and should not be used as guidance for future projections. HOV execs claimed they warned about this at the time.

In the meantime, be careful out there!

DrDuru, 2006