When to invest in homebuilders
Sacrilege! How can we possibly be talking about homebuilders when we are barely into the 3rd inning of a housing market collapse?
Because homebuilders understand what is happening and they will move to dump the properties, take the loss, preserve the cash flow, and move forward.
Back in the late bubble crash (the dot.com days) many companies took advantage of their bad numbers to do write-downs and otherwise get the books cleaned up. That way, when they emerged, their balance sheets would look pretty good.
Homebuilders are really cash management companies. The business model is to take out loans, build homes, and use the cash to pay off the debt. As long as the cash flow exceeds the debt liability, then the can be successful.
Lets look at Toll brothers:
ASSETS
Cash: $553M
Inventory (mainly houses): $6.1B
Long term investments (probably land): $430M
LIABILITIES
Current Liabilities (What has to be paid now): $1.5B
Debt: $2.3B
(As an aside, their debt has grown ~$700M in less than 1 year.)
Question #1 for a cash management machine: Can you service your debt?
Answer: yes
Question #2 for a generic company: Can you pay your other bills?
Answer: only if TOL sells a lot of houses. They need $1B to pay off current expenses ($1.5B current liabilities - $550M cash)
Question #3: Are current operations generating enough revenue to cover expenses?
Answer: Barely. Sales have dropped to $1B per quarter.
On the one hand, as a company, TOL is just able to make ends meet: sales equals operating expenses. For a while at least, it's likely that they can maintain this position. I expect operating costs to drop as sales and building slows. The wild card to watch is sales.
On the other hand, TOL is somewhat pressured by debt servicing. I assume that they have pretty good terms, but $2.3B of debt probably costs ~$100M to service each year. That's precious cash that they need to keep the doors open.
Everything depends on home sales: it provides the cash to pay the debt and it provides the cash to cover operating expenses. Newsflash: sales will continue to drop and faster than these experts imagine. When TOL faces a scenario where they can't cover costs, they will drop the prices on their homes. (Anyone who imagines that TOL will be a landlord is mistaken.)
What we'll see is TOL running down their inventory of homes and adding very little new inventory. They will continue to stay afloat because that $1M home is still profitable to them at $600K. But these measures will play havoc with their account balances.
If I were TOL, I would write down the inventory - take a paper loss. It will crush paper earnings, but what is the option? Continue to sell $1M homes for $600K and take a writedown each time? Or write these homes off and call them $0 in value, and then sell them for a massive profit at $600K.
It's a foregone conclusion that they will be squeezed and start sellinghomes at reduced prices. I am suggesting that they will also take massive writedowns of inventory and blow holes in their earnings. Then, 2 quarters later, the earnings look so much better.
I think this is likely and will happen in about 12 months. When they do this writedown, that's when you get in.
Because homebuilders understand what is happening and they will move to dump the properties, take the loss, preserve the cash flow, and move forward.
Back in the late bubble crash (the dot.com days) many companies took advantage of their bad numbers to do write-downs and otherwise get the books cleaned up. That way, when they emerged, their balance sheets would look pretty good.
Homebuilders are really cash management companies. The business model is to take out loans, build homes, and use the cash to pay off the debt. As long as the cash flow exceeds the debt liability, then the can be successful.
Lets look at Toll brothers:
ASSETS
Cash: $553M
Inventory (mainly houses): $6.1B
Long term investments (probably land): $430M
LIABILITIES
Current Liabilities (What has to be paid now): $1.5B
Debt: $2.3B
(As an aside, their debt has grown ~$700M in less than 1 year.)
Question #1 for a cash management machine: Can you service your debt?
Answer: yes
Question #2 for a generic company: Can you pay your other bills?
Answer: only if TOL sells a lot of houses. They need $1B to pay off current expenses ($1.5B current liabilities - $550M cash)
Question #3: Are current operations generating enough revenue to cover expenses?
Answer: Barely. Sales have dropped to $1B per quarter.
On the one hand, as a company, TOL is just able to make ends meet: sales equals operating expenses. For a while at least, it's likely that they can maintain this position. I expect operating costs to drop as sales and building slows. The wild card to watch is sales.
On the other hand, TOL is somewhat pressured by debt servicing. I assume that they have pretty good terms, but $2.3B of debt probably costs ~$100M to service each year. That's precious cash that they need to keep the doors open.
Everything depends on home sales: it provides the cash to pay the debt and it provides the cash to cover operating expenses. Newsflash: sales will continue to drop and faster than these experts imagine. When TOL faces a scenario where they can't cover costs, they will drop the prices on their homes. (Anyone who imagines that TOL will be a landlord is mistaken.)
What we'll see is TOL running down their inventory of homes and adding very little new inventory. They will continue to stay afloat because that $1M home is still profitable to them at $600K. But these measures will play havoc with their account balances.
If I were TOL, I would write down the inventory - take a paper loss. It will crush paper earnings, but what is the option? Continue to sell $1M homes for $600K and take a writedown each time? Or write these homes off and call them $0 in value, and then sell them for a massive profit at $600K.
It's a foregone conclusion that they will be squeezed and start sellinghomes at reduced prices. I am suggesting that they will also take massive writedowns of inventory and blow holes in their earnings. Then, 2 quarters later, the earnings look so much better.
I think this is likely and will happen in about 12 months. When they do this writedown, that's when you get in.
posted by Andrew at
8:50 AM
1 Comments:
I know lot of folks started buying homebuilder stocks in anticipation of Fed rate cut. I fully agree with your point that there is still a lot of bad news left to hit this segment of market.
I will closely look at REIT’s like VNO, PLD than touching any of the home builder stocks in near future.
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