Housing Risk Factor: Keep an Eye out for December Data

Until a few days ago, homebuilder stocks had been taking a much needed breath of fresh air above their 50-day moving averages on optimism from the White House "teaser freezer" plan. The overall affect is illustrated by movement in the Dow Jones U.S. Home Construction Index [$DJUSHB]. This was a major victory for homebuilders, as the 50-day moving average had been serving as a major psychological barrier for over six months. Then, this Tuesday, homebuilder stocks were hammered back down to where they came from upon a disappointing pending home sales index and KB Home's (KBH) painful fourth quarter earnings report. The results, which showed no indication that the housing market was improving, gave investors good reason to worry. One thing many investors may be forgetting, however, is the fact that the White House Mortgage Plan, as well as a subsequent federal rate cut, took place in December. The Pending home sales index data released on Tuesday tracked November's sales and KB Home's earnings report covered its fourth quarter ended November 30.

Consumer confidence currently plays a large part in the housing market. Potential customers have been worried about mortgage payments and the idea that home prices could continue to plummet. The key part of the White House mortgage plan and the December rate cut is the motivation they will give buyers. There has virtually been no mention yet about how well December faired for homebuilders, except for statements made by Hovnanian's (HOV) management during their December 18 earnings report and conference call that sort of slipped under the radar. According to them, "home sales increased significantly" during the first three weeks of December, seemingly as a direct result of the White House plan and federal rate cut.

The reality of the housing market right now is that an abundance of consumers want to buy homes, but the conditions have just not been right. Home prices and mortgage rates are so much lower now than they were a year ago that investing in a new home is a very tempting proposition. Something tells me the flood gates may have been pried open a bit in December. That is why I am expecting a surprise increase in December home sales. Whether you agree with me or not, the fact remains December will be make-or-break for homebuilders. Be ready for a big short term swing in stock prices when the next round of sales data rolls in starting with existing home sales on January 24.

Listed below are my investing guidelines:

Safe Bets: Toll Brothers (TOL): A luxury homebuilder, this Company has limited exposure to the sub-prime market, and mortgage lending plays a small role in its customer base. Copious returns are not likely as it has not suffered as large of a loss in value.

Low Risk: D.R. Horton (DHI), Ryland (RYL), Centex (CTX): Diversification away from problem regions and/or strong liquidity positions makes these Companies stable and more able to weather the storm.

Risky: Hovnanian (HOV), Pulte Homes (PHM), K.B. Home (KBH), Lennar (LEN): High debt levels and/or exposure to problem regions make these stocks volatile, meaning they are less likely to emerge in full form, but they have large upsides.

Very Risky: Standard Pacific (SPF), Beazer (BZH): Large fluctuations in stock value have attracted many bottom fishers to these stocks, but be wary of the fact that large upswings leave the potential for equally large downswings. These Companies are immersed in debt obligations and complications, and face a real risk of default.

Disclosure: none

David Urani is Wall Street Strategies Research Analyst with concentrations on the homebuilding, staffing, medical devices, and logistical services industries. David specializes in analyzing economic data and has a keen eye for key fundamentals that keep companies running efficiently.

Comments

[Bottom Line]

Brave call, houses are certainly cheaper than a year ago, but look at where they are vs. prices 6 years ago and there's still a long way to go.

[John Ryskamp]

"Home prices and mortgage rates are so much lower now than they were a year ago that investing in a new home is a very tempting proposition."

You must be a shill for the real estate industry. Why would anyone want to buy an asset which declines in value the day after it is purchased? Answer that one, stupid!

[can'tchange therulesmidgame]

hey I am definitely not a believer in a home builder rebound, but you make an interesting case.

The only question I would like you to clarify is are you talking about a TRUE increase in sales -- YEAR OVER YEAR -- the benchmark way these stats have been compared for years -- or are you saying the HB's will be a good buy if sales improve DEC VS NOVEMBER 2007?

I agree that the way the NAR and other pumpers for the HB's have tried to shift investors forcus from year to year to this month vs last month, there would likely be a bounce in stock prices when these #'s are released -- but it will only cost investors in HB's that much more money when the market realizes the trend for sales continues down and has not bottom in site.

You have stepped up and made a bold prediction and I respect it--please clarify the basis for your decision so we can see your reasoning in full.

[Is thisRight]

I made the same reasoning last week and will add 2 comments:
1/ HOV showed data that as homebuilder they had substantially decreased their prices ALREADY and existing Home sellers are the laggards in adjusting prices. This input says that new home buyers will buy the comparative value inherent of in new homes. So the HB will be able to liquidate their inventory EVEN if the market rate of sales stays low. The HB just have to stop acquiring or developping NEW LOTS. Lots are abouit 25% of the fixec cost of the homes.
50% is variable cost ( building the home) and the balance is interest on debts and profits.
2/ in 4Q07 KBH sold for $2B worth of homes from inventory. An analyst complimented KBH for this level of sales from inventory. The reading there is that this sales level, eventhough lower than yty by $1B, it is still a higher level of sales than the analyst expectation.
My call: the HB are making bottom here. The duration of the bottom flat curve line is what we should start observing in 1H08 and not expect a V type recovery. But at least some 'rational value' should be assigned to these companies.

[Terry Finn]

I could never recommend buying a stock that has gone from over 35 within the past year down to 16 now. Buying Toll Brothers (TOL) is definitely the same as trying to grab a falling knife. NO THANKS !!!!!

[JohnnyBitchdog]

If Urani is singular for Uranus this might make sense.....because I think that's where he get's his so-called analysis.

How in the world can stocks which have lost 2/3 of their value be credibly called "low risk" ?

Seeking Alpha is a good forum but I think this guy's comments are about as ill-advised and poorly substantiated as I've seen to date.

JBD.

[manohmanoh]

I'd love to see what you guys were saying about builders in July, 2005. Quite frankly, if you buy a builder that isn't going out of business (which requires a lot of DD, balance sheet and cash flow analysis), how can you "be wrong" in 5 years? Of course, it might be quite a ride between now and then!

[JohnnyBitchdog]

well, there's that little problem about not knowing which builders will go out of business. usually when you buy a company there is some non-zero risk that it will fail.

all the due diligence in the world does not prevent the possibility of future bankruptcy.

leverage can kill in a downturn...that is a lesson that is retaught repeatedly.

when the residential re market settles into a multi month bottom without getting worse, only then would it be wise to bottom pick.

V is nowhere to be found.

JBD.

[David Urani]

The purpose of this article was to show that December data will be vital. A lot of you seem to think that I was claiming a trough, which I never said. December should show a surprise increase as a result of a spark of consumer confidence, not year over year, but above what the street is expecting. The sustainability of that demand will be highly questionable though. Investors can potentially play a swing in homebuilder stocks when the next sales data gets posted. In fact, my guidelines are viable for both long and short positions, so for you pessimists a short swing may be plausible.

I am not going to forecast a trough within the next 1H08. I do think a turnaround will occur within the year though. As far as home prices: they will likely fall more but at this point they are good long term investments.