Homebuilding Outlook, Part II: Home Closings and Revenues Through 2011

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Includes: BZH, CAA, DHI, HOV, KBH, LEN, MDC, MTH, NVR, PHM, RYL, TOL
by: Consumer Contrarian

Today’s note is the second installment (see the first part here) for a multi-part discussion of the fundamentals for the housing industry, and my outlook for homebuildng stocks.

Closings seen moderately lower through 2011

With a handful of weeks until yearend, it looks as though the 12 builders I follow will close about 3,000 more homes in 2010 than in 2009. On a base of almost 90K homes, that represents a modest 2-3% increase.

In 2011, I expect unit settlements will fall 5-6% from this 2010 forecast, to about 87K homes. Virtually all of the anticipated decline results from the June expiration of the first-time homebuyer tax credit. By providing a one-time stimulus to demand, the government’s initiative pulled forward sales that would have occurred in late 2010 and early 2011.

Unit Closings

11E

10E

09

08

07

06

BZH

4,181

4,645

4,330

6,697

10,160

17,909

DHI

18,788

20,875

16,703

26,396

41,370

53,099

HOV

4,690

4,810

5,659

11,281

14,928

17,940

KBH

8,359

8,573

8,488

12,438

23,743

39,013

LEN

10,911

11,191

11,478

15,735

33,283

49,568

MDC

3,231

3,314

3,013

4,488

8,195

13,123

MTH

3,840

3,938

4,039

5,627

7,687

10,487

NVR

7,053

7,234

9,042

10,741

13,513

15,139

PHM

16,664

18,016

15,013

21,022

27,540

41,487

RYL

4,507

4,873

5,129

7,352

10,319

15,392

SPF

2,340

2,600

3,581

5,025

8,051

10,763

TOL

2,703

2,772

2,965

4,743

6,687

8,620

Average

7,272

7,737

7,453

10,962

17,123

24,378

Total

87,266

92,840

89,440

131,545

205,476

*330,039

*Centex contribution included in 2006 total.

Click to enlarge

Since the tax credit’s expiration, new home sales have resumed their slide. In fact, the recently reported new single family home sales figure for October, of 283K annualized, approaches the current downturn’s low. Recent order rates among the large builders confirm the hangover effects from the tax credit ending will continue into 2011. During the September quarter, new home contracts – units that typically close in three to six months – fell 25% industry wide from the prior year. Builders catering to first-time buyers (BZH, DHI, KBH, RYL) will be the most impacted. KB Home, with almost three-quarters of its FQ3 (ended August) homes sold to first-time buyers, had among the group’s steepest order decline at 39%.

Builders buying cheap land

A weaker run rate for new home sales does not appear to have slowed builders’ appetite for new land, though. In fact, overall inventories (land and homes) in Q3 are around the same level as at yearend 2009, when home sales were at these higher, government-primed levels, and the industry was preparing for the tax credit’s extension. The table below indicates that the number of lots (i.e., homesites) on builders’ balance sheets is 5% higher today than in late 2009.

Lots

2010 (@Q3)

2009

Total

Owned

Total

Owned

BZH

28,996

23,176

30,638

25,317

DHI

119,400

89,700

116,000

89,500

HOV

32,485

17,692

27,820

16,477

KBH

41,000

31,039

37,465

28,363

LEN

105,580

84,062

104,426

82,703

MDC

11,939

7,194

8,967

6,383

MTH

14,843

11,488

12,906

9,989

NVR

51,600

46,300

PHM

149,253

133,380

154,694

152,481

RYL

24,539

16,300

15,866

11,830

SPF

23,250

17,468

19,191

15,826

TOL

35,800

29,200

31,917

26,872

Total

602,885

431,499

574,273

438,869

Click to enlarge

Business models evolving with lower demand

Homebuilding managements reconcile the recent lot accumulations by pointing to the higher profitability of new land deals. They say gross margins on land bought in the past two years are 200 to 500 bp’s higher than homes sold on land purchased prior to 2009. (This suggests that either land values are falling faster than relative home values or that the value of older land on builders’ books remains above its market value, despite past impairments.) Compelled by these higher profit margins, the build to order model is losing ground, and more spec homes are being sold.

Most builders are underwriting land purchases to about a 20% gross margin, providing a cushion for price diminution. Of course, no responsible builder tries to predict home prices. But with overall home prices still trending down, builders are finding other ways to cope with deflation in the industry, especially by reducing their cycle time. For instance, Meritage (NYSE:MTH), has cut the time from sale to close in half over the past few years. Quicker cycle times mitigate home price deflation and reduce cancellations – which are still at worrisome levels.

Community counts climbing in 2011

The most recent outlooks provided by public building companies suggest the overall number of active subdivisions will soon head higher, in spite of modest buyer interest evident today. Standard Pacific (SPF) is aiming for a 10% increase in communities next year, even though its most recent order data show a nearly 40% drop. Similarly, D.R. Horton (NYSE:DHI) reported a 21% decline in orders, even as the country’s largest builder closed FY 10 (Sept.) with 17% more communities than in the prior year. KB Home (NYSE:KBH), following one of its most difficult quarters (mentioned earlier), is talking about a 25% increase in average communities open next year.

By opening more neighborhoods, the industry is aiming to reduce land positions that remain high after Q3 sales that suffered from weaker traffic and lower absorption rates. Despite recently improved employment figures and consumer confidence, home buying demand is unlikely to meet the supply of homes available over the next few months. While demand should improve over the course of next year, the spring selling season will be challenging.

Revenue outlook

In “Housing Outlook Part I: Home Prices”, I forecast a 3-4% decline in 2011 home prices, after a 2-3% rise this year. Combining these price assumptions with the above unit volume forecasts, results in my homebuilder revenue projections below.

Revenues ($M)

11E

10E

09

08

07

BZH

898

1,010

1,005

1,814

3,467

DHI

3,852

4,401

3,658

6,646

11,297

HOV

1,289

1,391

1,596

3,308

4,799

KBH

1,735

1,874

1,825

3,034

6,417

LEN

2,696

2,911

3,119

4,575

10,187

MDC

902

949

898

1,458

2,886

MTH

1,007

1,070

970

1,523

2,344

NVR

2,139

2,186

2,744

3,693

5,129

PHM

4,373

4,899

4,084

6,289

9,256

RYL

1,040

1,105

1,284

1,976

3,052

SPF

877

953

1,180

1,549

2,906

TOL

1,473

1,590

1,755

3,148

4,647

Average

1,857

2,028

2,010

3,251

5,532

Click to enlarge

Disclosure: No positions