It is important for investors to remember as the US housing recovery continues, that not all home builders are created equal. Some are overvalued some are undervalued and some are just plan bad investments. Beazer Homes (NYSE:BZH) falls into the last category. In 2012, Beazer was the 8th largest builder in the US by closing volume. To the credit of company management, Beazer is still standing today which can not be said for a number of builders that were outside of the top 5 in size and many of whom succumbed to the housing crash. While Beazer survived, it emerged from the housing downturn wounded. If housing continues to recover Beazer will participate in the recovery, and will show growth in a number of key metrics that will be touted as evidence of a turnaround. The story is not as simple for Beazer as it may be for other home builders. This is a KISS (Keep It Simple Stupid) introduction to Beazer. Investors need only know 3 things about this company, and afterwards they will realize why they should leave Beazer alone and look for other housing related investments if they are seeking an investment tied to the housing recovery. In no particular order, the mountain of debt, inability to fully utilize the tax losses generated during the housing downturn, and significant land sitting idle on the balance sheet should keep investors away from Beazer. Until the company reduces its debt and begins to monetize its idle assets, this is not the homebuilder to own.
The 3 Reasons To Avoid Beazer
1) Debt, Debt, and More Debt
Beazer was caught in the perfect storm when the housing downturn hit, in the midst of hyper growth mode that was largely funded through debt issuance. As the housing downturn raged on, the company faced debt maturities. Needing to hold onto its cash balance, the company was forced to refinance its maturing debt often at unfavorable terms when compared to the existing debt.
Today, Beazer carries ~$1.5B in debt as of the quarter ended 3/31/13. This debt is not cheap, with about 1/3 of the debt carrying a 9% interest rate and the rest not much more favorable. The company is currently incurring about $29M in interest expense each quarter, equating to over $100M annually. A significant portion of this interest, over $16M in the last quarter, flows directly through the income statement. As Beazer has more debt than land inventory, it is unable to capitalize all of the interest incurred into its land inventory.
The debt is not a near term issue so much as the company will be unable to service the interest payments. There are also no maturities until 2016, and the company has almost $700M of cash on the balance sheet and would have no problem paying down a significant portion of its debt if it needed to or wanted to. However, the company is caught between a rock and a hard place as it needs to use its cash judiciously to add land and participate in the recovery. Which makes it likely the heavy debt load and associated interest expense will continue for the foreseeable future.
2) Tax Asset? What Tax Asset
A benefit to the archaic US tax system is that when companies go through a rough patch and experience losses, they are typically able to recapture those losses by reducing their future tax bill when they return to profitability. Unfortunately for Beazer, the company was caught by a section of the IRS code that was written to prevent profitable companies from buying unprofitable companies simply to take advantage of tax loss assets they had accumulated. Beazer was never acquired, but a certain amount of its stock changed hands over a defined time period, which put the company out of compliance with this specific IRS code.
That probably does not make a lot of sense, but this will. The company had about a $500M tax asset at the end of its last quarter. For simplicity sake, assume Beazer all of sudden managed to generate $1.5B in pre-tax income and owed $500M in taxes. If this were any other homebuilder, the $500M tax asset could be used to satisfy the tax bill, thus saving the company a significant amount of cash. It is not quite that simple, but that analogy provides the gist of the issue. Because of the change of control that occurred, the company is limited in how much of its tax asset it can effectively monetize. Per the Q2 2013 quarterly report, the following language is contained with regards to the ability to monetize this tax asset in the future: "Due to a combination of Section 382 limitations and the maximum 20-year carryforward of our NOLs, we will be unable to fully recognize certain deferred tax assets. As a result, as of March 31, 2013, our valuation allowance was $503.0 million and we expect to continue to add to our gross deferred tax assets for anticipated NOLs that will not be limited by Section 382." The company further believes that ~$87M of its tax asset is clearly impacted by the Section 382 rule and that upon a return to profitability, the majority of its tax asset will be available to offset cash taxes. Again, this does not hurt the ability of Beazer to participate in the housing recovery, but it keeps them from playing on a level playing field as the other builders who will keep close to 100% of their earnings for a number of years without having to pay any taxes.
3) Land Generating No Return On Investment
The last reason investors should avoid Beazer is that the company owns a significant amount of land, which it is not currently monetizing. Think of land as any other type of asset in a manufacturing industry. You buy inventory, turn it into a finished product, and sell it as quickly as possible to recoup your initial investment. Then you start the process all over again. This is how companies generate a return on invested capital.
In reviewing the last 10-Q report for Beazer for its quarter ended 3/31/13, we see that the company had a total of ~$1.1B in inventory (land and house). Of that total, $.35B was "Land Held For Future Development". The quarterly reports specifically defines this assets category as follow:
Land held for future development consists of communities for which construction and development activities are expected to occur in the future or have been idled and are stated at cost unless facts and circumstances indicate that the carrying value of the assets may not be recoverable
The layman interpretation of this definition is that this is land inventory that the company owns, but is currently not monetizing or converting to cash. In other words, this inventory is eating a hole in the balance sheet. To its credit, the company should not just dispose of this inventory at fire sale prices if it believes the markets where the inventory is located will eventually recover. The fact that the company has 31% of its total inventory classified as held for future development, in a recovering housing market, is cause for concern. The company would not be sitting on this inventory if it thought it could earn a decent profit on it. What does that tell you?
To reiterate, Beazer should be applauded for surviving the housing downturn. The company is fighting, its acquiring land and attempting to do everything in its power to take part in the housing recovery. In some ways the company is fighting with one hand tied behind its back, at least when compared to the other home builders. Until the company is able to significantly de-lever its balance sheet, and begins to monetize its idle assets, there are not significant catalysts that would make Beazer a more appealing investment opportunity.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.