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Homebuilders Get Back In The Game

Posted: Sep 24, 2009 13:22 PM by Eric Fox

Tickers in this Article: HOV, LEN, TOL, MTH

After years of what seemed like panicked retrenchment by the homebuilders industry, many companies are starting to acquire land again through open market or purchases of raw land and finished lots. These purchases will lead to higher returns as the housing cycle turns up.

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Many homebuilders have done an excellent job the last two years of reducing balance sheet risk through restructuring debt maturities, or paying down debt through the generation of cash flow by turning over or liquidating inventory. Toll Brothers (NYSE:TOL), for example, has boosted its cash balance to $1.6 billion in its most recent quarter. Its inventory has been reduced as well, from $6.1 billion in October 2006 to $3.4 billion as of July 31, 2009.

Planning Ahead
The public builders have done such a good job that some of them are taking the plunge and buying finished lots to fill their own immediate need for inventory or maybe to position the company for a future rebound in the housing cycle.

Meritage Homes (NYSE:MTH) disclosed extensive land acquisition when it reported second-quarter earnings in late July. Steven J. Hilton, the CEO, said that during the first six months of 2009, the company purchased 550 lots at "deeply discounted values."

"Many home builders and land developers have gone out of business and the industry is consolidating. Lots once owned by these companies are coming back onto the market at greatly reduced prices," said Hilton.

Hovanian Enterprises (NYSE:HOV) reported that it was buying land at such a low price that the acquisitions would give them an unlevered internal rate of return in the 20% range using current prices. The return would be much higher once the cycle turns up.

Ara K. Hovnanian, the CEO, said, "If prices were to move in our favor, plus an additional pick-up in velocity, returns could be even more significant. This is precisely what occurred with our acquisitions at the bottom of the market in the early 80s and the early 90s."

The root cause of the acquisitions is simple. The industry is bumping along the bottom of the cycle, and demand is starting to increase. As Stuart Miller, the CEO of Lennar Corp. (NYSE:LEN) put it during the company's earnings conference call, "There has been a discernable increase in traffic reported in many of our communities." The company also disclosed that it has been buying land in Texas, California and Florida.

The Bottom Line
The land acquisitions are the homebuilding equivalent of value investing and by buying at the trough of the cycle and holding until the market values increase to more normal levels, the industry is set to boost returns as those lots move through the income statement. (To learn more, check out Measuring The Benefits Of Home Ownership.)

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By Eric Fox

Eric J. Fox, is the founder of Brittain Capital Management, LLC., which manages the Alesia Fund, LP., a Value oriented long/short investment partnership. You can read more of his views on investments at his blog - Stock Market Prognosticator.

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