Ryland, Toll Brothers: Waiting for a Pullback

The Wall Street Transcript recently interviewed David Goldberg, a Director covering the building and building products sector of UBS Investment Research. Key excerpts, including his outlook for homebuilding stocks, follow:

TWST: Is where we are in the residential construction cycle still the biggest issue?

Mr. Goldberg: Yes, I think people are trying to figure out how close we are to the bottom and where the inflection point is. We have to figure out if the valuation in homebuilding stocks makes sense. I think that's what most people are looking at.

TWST: Do they make sense?

Mr. Goldberg: Maybe we can start with the first question. One has to do with the other pretty significantly. The first thing I'll tell you is, I think we are getting closer to the bottom of the cycle. We've been saying for some time that we think the fourth quarter 2009 will be the trough in housing. We really look at both price and sales pace. From a sales pace perspective, which a lot of folks are looking at now, I probably agree that it is not going to go down dramatically from here. We have to get some price stability and that's not going to happen until we start to see supply let up and we just don't believe that that's going to happen until the end of this year. So with that in mind, we think we are probably six to eight months away from the trough in housing. Now the second question is what we think of homebuilding stocks in relation to that time frame. We know the stocks have historically tended to rebound five to six months ahead of a turn in fundamentals, and that would suggest that now would be a pretty good time to buy. The problem that we have and the issue that keeps coming back is that we think the group is expensive relative to what we think their book values are worth. It's hard to justify owning the stocks today.

TWST: What do you tell your investors to do at this juncture?

Mr. Goldberg: Like I said in the beginning, I think valuations have gotten too high. We are waiting for the stocks to pull back.

TWST: When they do pull back, who would you be looking at?

Mr. Goldberg: Ryland (RYL) and Toll (TOL) are two of them. We had liked Centex, but obviously the acquisition changes the dynamic there a little. So now we're focused on Toll and Ryland, which we think are pretty defensive names in the group.

TWST: What is the appeal of Toll?

Mr. Goldberg: We think Toll has the ability to withstand the downturn because of its liquidity and great balance sheet. In fact, Toll just issued debt recently with an 8.9% coupon. I think the rest of the other builders would be well above this level. You combine that balance sheet with a good land position. We believe Toll's land, in time, will prove to be quite valuable. We refer to it as non-fungible; it's not easily replaced. And there is the fact that it is on the luxury end of the market. With so many builders migrating to the entry-level, Toll's main competitors are private homebuilders, and we don't think there is a lot of financing for them in the next three to five years. So the opportunity is there for Toll to gain market share, if for no other reason than the fact that they have a lot of liquidity and a lot of their competitors don't.

TWST: But with tighter credit standards and banks being much more careful, is that luxury end going to be as strong as it was?

Mr. Goldberg: I don't think any part of the market is going to be as strong as it was before. Again, we are not going back to the 2005 level. The real question is not so much is the market as strong. The question is, is Toll's position within that market as strong as it was before? Again, if a lot of the competition drops out, we think that there are certainly opportunities for market share gains. Are margins are going to be lower? Certainly. You are not going to see the price appreciation you saw before. But again, the bigger question is, can Toll grow, can it begin to recognize a lot of the value that we think is inherent within its land over time? We think the answer is yes.

TWST: You're waiting for the stock to come back in?

Mr. Goldberg: We have a longer-term time horizon when we set price targets, 12 months specifically. We have a $25 price target. We'd recommend owning the stock here for investors with long-time horizons.

TWST: The other name you mentioned was Ryland. What's the appeal there?

Mr. Goldberg: It's a very defensive name, a company that was not really as focused on the land side of the business. Ryland's strategy focuses on buying land later in the process and trying to be more of a manufacturer. This model, which everyone now refers to as an asset- or land-light strategy, is what Ryland has executed for many years. It's the kind of model that we think makes a lot of sense in this environment with so much uncertainty. I think a lot of other builders are now trying to be more defensive, to transition to land-light models and focus on manufacturing, but Ryland has the advantage of having done this for a while.

TWST: So it is not a new part of the business for them?

Mr. Goldberg: It's not a new strategy for them.

TWST: Is there anybody that is not going to make it through this?

Mr. Goldberg: Certainly, from a private builder perspective, that's the case. I think among the publics, it is a pretty cloudy picture. A lot of it is going to depend on what happens in the housing market in the next six to 12 months and with the credit market.

Comments

[HardwoodFlo...:]

I just don't see the big home builders as well positioned for the turnaround. Their whole model runs contrary to the future of the home building market as I see it.

It is back to the future as far as homebuilding is concerned. It will be "mom and pop" shops building houses to suit rather than big home builders rolling out 10K houses in a market. People will be more decerning rather than less in the future. They will want to pick thier prodcuts not be forced in to them with the classic bib builder mentality offering them bad, badder and worst in terms of prodcuts for their new homes.

I would be investing in companies that provided building products, for example Weyerhouser, that have strong balance sheets and are fueled for the recovery because they have spent the last 5 years leaning out- moreover, their stocks have been under siege. There has been so much attrition in that business and there are so few suppliers right now that their pricing on the back side is going to provide fat margins for the future (all predicated on a mild recovery).

In short, the big builder model, is antiquated and irrelevent for the future.

May 04 11:33 AM

[Onecent:]

Please, homebuilders will be the last sector to recover in this recession and anyone trying to pick the bottom is a fool.

Half of today's pending sales were forclosures. There are planty of luxiry homes out there at bargain prices which isn't helpful toToll. How many more of them have yet to hit the market when you look at the unemplyment picture?

I see nothing that gives me optimism that Toll hasn't got many bad quarters in front of them.

May 04 01:54 PM