More Homebuilder Warnings Taken Seriously - Hovnanian, Lennar

By Dr. Duru written for One-Twenty

January 7, 2007

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"Market conditions continued to weaken throughout the fourth quarter and we have not yet seen tangible evidence of a market recovery. While we are hopeful that low interest rates, strong employment and a healthy economy will help stimulate a recovery in 2007, we have continued to focus on strengthening our balance sheet by delivering our backlog, selling inventory aggressively and renegotiating our land positions. We ended the 2006 fiscal year with zero outstanding on our $2.7 billion revolving credit facility and over $600 million of cash on the balance sheet. Given the steep decline in many of our markets, we are completing our asset-by-asset review and will adjust asset balances to reflect fair value in the current market environment. Accordingly, we expect to record pretax impairment charges of $400 million to $500 million." [emphasis mine]

This was the bleak news Lennar (LEN) had waiting for the markets to start the new year. Once again, the market was reminded that the news continues to get worse in the homebuilding sector. Typically, the market has glibbly bought on this kind of bad news. But in a week full of sellers anxious to lock in profits from 2006, few traders were in the mood to fight the currents. LEN was taken down 3.5% and most other homebuilders came down in sympathy. XHB, the SPDRs homebuilders ETF, ended the day with a 2.4% loss. (Mind you, some analysts did produce the typical "love the bad news" response: JMP Securities reiterated its market outperform rating and Lehman even saw fit to increase its price target from $53 to $56 while reiterating its overweight rating.) About five weeks ago, one of the biggest housing bears finally gave in to the market's willingness to bet on a bottom for housing. I still think his call was reasonable and am myself finally convinced that the market has little desire to break the homebuilder lows set in July. However, ever since October when Centex (CTX) announced the first warning that the market took seriously, I think I am observing a growing wariness. The problem is that the homebuilders have entered a new phase of their malaise; they have begun to write down assets. As I discussed before, these write-downs place chinks in the economic logic housing optimists were using to buy on the bad news. The book values that are supposed to put a floor on valuations may not hold up as well as hoped. The homebuilders are now effectively losing money with no imminent relief.

Since CTX warned of its write-downs, the stock has gone on a roller coaster roundtrip. After selling off as much as 8%, the stock rebounded to a peak about 5.5% above the warning level. It is now sitting right back where all the drama began back in October. Hovnanian (HOV) warned of sizeable write-downs in mid-December. It is still suffering the aftermath and is now down about 11%. LEN's warning has added weight to the selling, and we should now expect similar warnings from the rest of the public homebuilders who have not yet owned up to their write-offs ('s housing commentator Nicholas Yulico writes an excellent and sobering article on the growing troubles for the housing industry.)

In addition to the poor earnings news, Some technical damage is showing up on the stock charts. Here is a summary of what I see amongst the major names:

Below 50 and 200 DMAs: MTH, HOV, MHO, TARR, PHM
Below 200 DMA, above the 50DMA: BZH (has yet to break through the 200 since the rally from the bottom began)
Below the 50DMA, above the 200DMA: CTX
Teetering on breaking below the 50 and 200: KBH
Trying to hold 50DMA, above the 200DMA: LEN
Still above the 50 and 200DMA: TOL, DHI, BHS, MDC, RYL

The key stock to watch might be the homebuilder ETF. XHB is still in an up-trend and is just barely holding onto critical support with the convergence of the 50DMA, 200DMA, and the lower Bollinger Band. See chart below.

Stock chart of XHB

Note how the XHB has already bounced back from a "recovery scare" in November when it took a nosedive below the 50DMA. I suspect that the next meaningful correction in the homebuilder stocks will find some kind of support at these levels. But watch out if that support also fails. It will clearly signify the market has lost faith in the housing bottom. Stay tuned, and in the meantime, be careful out there!

DrDuru, 2006