Sign(s) of The Times

The change in tone struck several analysts in the Dec. 5 conference call, which came less than a month after the company’s last briefing. “You seemed like a very…I guess broken man last time. And here you are a new man,” Ivy Zelman, an analyst at Credit Suisse First Boston, told Toll Tuesday. “I’m wondering which Kool-Aid you’re drinking because I want some. No one else in the industry is willing to stick their neck out.” Business Week

Never underestimate the ability of corporate insiders to multi-task. Filling out sell tickets while simultaneously boasting about business prospects is considered best practices in many corner offices.  Homebuilding executives reaped huge windfalls from insider sales over the past two years.

Watch what they do not what they say.

As promised, we recently spoke with Wayne Nef of Sniper Research. Wayne has published equity research on the homebuilders longer than nearly all of the talking heads regularly trotted out on CNBC, and we hope his comments help you make sense of the endless spin.

Feel free to contact him at

UTC: Tell Me about your background. And how is business?

I have covered homebuilders for about ten years and building materials stocks for about 16 years.  I started my career at Value Line in 1991, and I worked as a buyside analyst for Merrill Lynch and Circle T Partners before starting my hedge fund consulting business in 2003. Don’t believe what you read about independent research dying out, our business continues to grow sequentially, primarily from hedge funds. They are good clients to have!

UTC: Fair enough. Do you talk to management teams or prefer to focus on insights drawn from independent sources?

Generally, when I begin to drill down into a sector I like to talk to my contacts within the industry. For the homebuilders this would include some of the management teams, realtors, contractors and contacts at buildng material suppliers.  I also find a lot of pertinent data in the 10-Qs and conference call transcripts.

UTC: Where do you stand on Industry Fundamentals?

I believe the bulls are buying the stocks on the hopes that they will see a turn in the fundamentals this spring, and not on the fundamentals.  Fundamentals are weak currently and all of the homebuilders have been cutting their guidance.  Many of the homebuilders were presenting at the NYSSA 10th Annual Homebuilding Confererence (12/6/06) today, and while all were bullish about their long-term prospects, none were bullish about their prospects for 2007.  Many spoke about further charges for writing off optioned land and for writing down the value of land already on the books.

Two of the companies that presented, TOL and HOV said that they may be nearing bottom in some selected markets, but that they expected things to just bump along the bottom and not be moving up anytime soon.  The recent rally has brought many of these stocks back up above book value.  Due to the number of charges being taken within the industry, book value is a bit of a moving target right now, thus for me to turn more bullish on this group I would need the stocks to trade at a discount to book value rather than at a premium.

There is an old saying with the bulls, “don’t try to catch a falling knife”. I think the opposite is true too “don’t stand in front of a bullet.  At this juncture I would wait for the momentum to start to fade and then I would look to short a basket of the builders keeping my stops fairly tight.

I do not expect a strong turn in the spring.  About $1 trillion in adjustable rate mortgages are due to reset next year and I think that while some will be refinanced, some of the riskier credit risks will not be able to do so.  This could lead to higher inventories of houses on the market and lower prices.  This scenario would be very bad for the homebuilders, particularly if the economy is slowing or we are heading into a recession.  Here are some sample price targets for a few of the homebuilding stocks if a spring rebound failed to materialize.  BZH ($48.19), target: $37; CTX ($57.84), target: $43; DHI ($27.53) target: $22; TOL ($33.01), target: $25. Readers who would like to see my 12-month projected Hi/Lo price ranges for these homebuilders should contact me at

UTC: Given where we are in the cycle, how attractive are valuations compared with historical precedents?

Sticking with the four homebuilders I have already mentioned, valuations have not troughed yet in my opinion.  Beazer Homes, for instance, is trading at 1.14x estimated book value (2007 consensus estimate of $42.51) and 1.34x the 2008 consensus book value estimate.  By this measure, Beazer last troughed at 0.54x book value back in 2000.  In 1999 the Price/Book was 0.59x so it wasn’t just a one-off.  In 1988, 1990 and in 2000 CTX troughed at about 0.62x book value.  CTX is currently at 1.33x the consensus book value for 2007. TOL and DHI have also troughed below 0.7x book (DHI, 0.70x in 2000 and TOL 0.67x book in 1991).

UTC: What are you telling your clients to do with the stocks here?

Again, I would not join in to the rally at this point, I believe this is a dead cat bounce.  Once momentum starts to wane I would look to enter short positions across a basket of these stocks since I believe this downturn has further to go. Absorbtion rates in many towns in the Northeast have more than doubled and I believe there is good potential for more houses to hit the market in the spring. Housing prices have been headed down over the past year and I believe they still have further to drop. 

The Japanese real estate market took ten years to drop 50% from their highs, and so far, no one has convinced me that it can’t happen here.  The U.S. housing markets have just had an unprecedented move higher since 1998. I am a firm believer in mean reversion, and unfortunately, when markets overshoot to the upside they oftentimes over correct in the opposite direction as well.  All said, I am a housing bear.

UTC: Thanks Wayne.  Given how the sector has become full of Battleground Stox our readers should find your comments timely.

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