"Altruistica": Seeking a return to full financial disclosure and regulatory oversight. A financial market analysis blog for "entertainment purposes" only by an experienced CFA seeking new hedge fund engagements for investment writing and analysis. The author has experience investing internationally, running a hedge fund, making angel investments, and helping launch five startup companies. Investors should do their own due diligence.

21 November 2006

Meritage Homes (HOM) -$44-Looking to Sell- September 2006

After a truly amazing run for homebuilders in the wake of the Greenspan Federal Reserve’s “Great Money Giveaway” of 2002 with 1% fed funds, homebuilder stocks began to take pause last autumn. As the leaves turned, so did these shares- dropping a quarter into the year end close. High end, Scottsdale, AZ-based builder Meritage Homes (MTH-NYSE) encouraged significant analyst bullishness then as it expected to increase revenues by almost 30% to $3.9B and pushed 2006 EPS estimates up to $11.25-50. However, government statistics reported a 10% rise in average home prices in the U.S. during 2005 and prices continued to be reported as “rising” even as late as Q206.

Top Home Price Increases Through Q2 2006

Percent Change In House Prices Through Q2 2006





Since 1980

Arizona (AZ)





Florida (FL)





Idaho (ID)





Oregon (OR)





Hawaii (HI)





Washington (WA)





Maryland (MD)





US Average





Source: OFHEO Home Price Index

Since last fall, Meritage shares dropped by two thirds through the summer sell off, but its recent rebound to its 200 day moving average of $44.52 was a signal to open a short position, or better yet, buy leap puts. Financial news shows and broadsheets sparked the recent bottom-feeding rally by showcasing talking heads who have disparaged all warnings of a “national housing bubble” and reiterated the “rose-colored glasses” forecasts of the National Association of Homebuilders and their paid shills.

What’s apparent with this sector is that the hard landing scenario is unfolding. In mid-August, Bank of America warned that housing affordability was more stretched in Q2 than it has been since 1990 and said that homebuilders CHCI, LEN, MDC, MTH, NVR, SPF & WCI have the most exposure to housing markets with “stretched affordability”. Meritage is particularly vulnerable as a California and Southwest-focused builder where for-sale inventory has surged and average housing prices wildly exceeded local incomes in key MTH markets such as Phoenix and northern California. The builder response of offering incentives to buyers such as rate subsidies, free televisions or media rooms, leased autos or appliance upgrades have amounted to up to 10%, but are not factored into reported new home sale prices. And absurd “triple commissions” have even been offered to agents to move inventory- so much for professional independence…This artificial stimulus failed to prop the U.S. truck market in 2005 and it’s failing miserably in the resale housing market as cancellation rates soar.

MTH has cash flow and governance problems on multiple fronts. First, its “co-CEO” John Landon resigned in May after MTH increased its credit facility by a third to $800M and added an additional $250M “accordion” facility. In mid June, MTH bought back 1M shares from Mr. Landon for $52M and another Director Bill Campbell who resigned THAT DAY in the advance of a company warning of a sharp business slowdown. MTH announced a $100M share buyback (!!) two months later, just days after it expanded its revolving credit facility to $850M. On September 18th, MTH again warned for the current quarter just two months into it. Net new orders for 1,261 homes were off 38% compared to July and August a year ago, as order cancellations of 38% compounded a 21% decline in gross orders during the two months. Order backlog at August 31, 2006 stood at 5,451 homes, down 23% from the prior year, and falling fast. MTH’s CEO Steven J. Hilton told only part of the story when he explained that, “demand has slowed and resale inventories have risen in many markets, making it more difficult for our buyers to sell their existing homes, and in turn causing higher cancellations and inventories industry-wide.” Moreover, a loser’s game cycle is now underway, "home builders are offering greater incentives to reduce resulting inventories, pressuring prices and margins on top of slower sales," Hilton warned. New home supply increases are finally slowing as the Commerce Department reported this week that annualized home starts fell a deeper-than-expected 6% in August to the lowest rate since April 2003. Q3 estimates have fallen 20% since July to near $2.05 now and $9 for the year.

The ominous reality for the “value buyer” cheerleaders on CNBC is that impending deep writedowns of homebuilder inventories will chop the book values that supposedly support the current stock prices. By accumulating unplanned for and unwanted inventory as their backlog diminishes, these “homies” are suffering from a collapse in gross orders, foreshadowing a significant erosion of revenues and net income, and continued negative cash flow through the foreseeable future. And the more vertically-integrated homebuilders that are “land bankers” will have to write down the carrying value of the land and land purchase options on their balance sheets. Recently, the executives of two other high-end builders, Toll Brothers (TOL:NYSE) and D.R. Horton (DHI:NYSE) lamented. Robert Toll, CEO of Toll Brothers said at the early September Credit Suisse housing conference. “The market got ahead of itself in recent years, citing "greed on the part of buyers and sellers, and that the current level of speculative inventory is probably the largest ever.” Don Tomnitz, CEO of D.R. Horton elaborated, “We have never seen housing prices and demand slow as quickly as they have during this down cycle."

Uh, oh! The fallout of the desperate mortgage brokers, real estate attorneys, insurance brokers, title companies and subcontractors trying to return to 2005 business levels will be that many will fail and many will close up shop. This week, the National Association of Home Builders said its confidence index declined for the eighth straight month in September to the lowest level in 15 years. An eighth of subprime credit borrowers were late payers on their mortgages during Q2, the highest level in three years, while foreclosures on sub-prime adjustable rate mortgage (ARM) borrowers are now in double digits in the Midwest. This is called “the multiplier effect” and it works in reverse—the U.S. will officially “enter” a recession in mid 2007 as the ramifications of these job losses hits. If someone like ‘Booyah Boy’ Jim Cramer tells you to “bottom fish” on homebuilder stocks, tell them to “go fish” !!


At 5:02 PM, Anonymous Anonymous said...

Nice call- this company is on borrowed time. Keep up the good research !


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