Homebuilder Fundamentals: 2 (More) Classic Examples Of Shareholder Dilution

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 |  Includes: DHI, HOV
by: Brian Gilmartin, CFA

Hovnanian (NYSE:HOV), a highly-respected homebuilder located in the Northeastern United States, reported their April, 2013, quarter before the bell on Wednesday, June 5th,with both revenues and earnings per share (EPS) beating expectations.

HOV is a classic example of the dilution occurring in the homebuilding sector, which makes us very leery of investing in the group despite the dramatically improving fundamentals we have seen in housing in the last 15 months.

HOV, while it is a great company with a long history of homebuilding success, could be a lesson in frustration for shareholders of the common stock.

Here is a history of HOV's revenues, operating income, net income and fully diluted shares outstanding

Hovnanian's history of diluting common shareholders
'14 (est) '13 (est) 10/12 '11 '10 '09 '08
Rev's($'s bil) $2.34 $1.89 $1.48 $1.13 $1.37 $1.6 $3.3

Op inc ($'s ml)

$87.4 ($17) ($3.2) ($176) ($208)
Net inc $73 $15 ($66) ($286) $26 ($717) ($1.12bl)
f/d shares o/s 150 150 126 100 80 78 70
EPS

$0.49

$0.10 ($0.52) ($2.85) $0.00 ($9.16) ($16.00)
L-T debt ($'s bl) $1.56 $1.56 $1.6 $1.6 $1.77 $2.5
Credit rating (S&P) B-
Credit Rating (NYSE:M) Caa2
Click to enlarge

*Estimates from Thomson Reuters - current consensus

* The data is for HOV's fiscal year ending 10/31 each year

The issue with Hovnanian and one reason why I think continued shareholder dilution is might be inevitable is their long-term debt load, and the fact that shares will likely have to be issued to continue to improve the balance sheet from its precipitous state. To be fair, HOV has been on the "edge" for a while in terms of their debt load, and managed through the 2008 Great Recession and housing crisis very well. HOV did have the first big debt payment of $800 million coming due in 2016, however that balloon has been refinanced and in fact HOV's debt has been extended out to where the next big debt maturity is $577 million in 2020.

Here is quick look at HOV's debt maturity schedule by year:

HOV's debt maturity schedule by year
2022 $195
2021 $220
2020 $577
2019 $0
2018 $87
2017 $121
2016 $218
2015 $85
2014 $37
2013 $0
Click to enlarge

This looks like a more manageable debt schedule.

HOV has doubled their fully diluted common shares outstanding in the last 6 years. At this pace, they are crushing the common shareholder, and it makes it very difficult for the stock price to gain headway.

It may in fact pay to be holder of the bonds rather than the stock over the next few years.

By comparison: DR Horton (NYSE:DHI)

We wanted to take a look at DHI, just for comparative purposes so readers can see how another homebuilder looked, that has a better balance sheet than HOV.

DR Horton's Revenues, Net Income and Fully Diluted Share Trends
'14(est) '13 (est) '12 '11 '10 '09 '08
Rev's $8.1 $6.2 $4.4 $3.6 $4.4 $3.7 $6.6
Op Inc $250 $65 $176 ($452) ($43)
Net Inc $625 $435 $956 $72 $245 ($549) ($2.6) bl
f/d shares o/s 368 359 359 319 319 317 316
EPS $1.70 $1.21 $2.80 $0.20 $0.80 $1.70) ($8.30)
L-T debt $3.0 bl $3.0 $2.4 $2.1 $2.0 $1.6 bl
Credit rating (NASDAQ:SP) BB-
Credit rating (Moody's) Ba2
Click to enlarge

* Revenue, EPS and Net Income estimates from ThomsonReuters

Commentary: for both HOV and DHI, we backed into the "shares outstanding" estimate for fiscal 2013 and 2014 by using the current consensus EPS and net income estimates, since dividing the two would provide an exact share count.

DHI has the far better balance sheet and might find less of a need to dilute shareholders going forward.

We do find it interesting that for both HOV and DHI, analyst estimates are actually expecting less dilution going forward, than what we have seen the past few years.

A recent article we published here on Seeking Alpha discusses our issues around the homebuilders. We have sold all but two positions and the XHB given the concerns around dilution and valuation.

Our favorite homebuilders are Toll Brothers (NYSE:TOL) and Lennar (NYSE:LEN), although we have sold the majority of both positions.

Given housing fundamentals, and given the strength and speed of the housing recovery, we don't want to ignore the homebuilders completely, but we do want to give the group time to correct, and become more reasonably valued.

Disclosure: I am long TOL, LEN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.