Are the Homebuilders a Bargain?

Housing starts fell more than 10% in September. It was the worst drop since 1993, according to data issued by the Commerce Department. Not surprisingly, housing stocks continued to crumble. Back in August, I wrote about the homebuilders, the majority of which were trading substantially below book value, examining the possibility that despite seemingly cheap relative valuations, there was no margin of safety to be had.

Beazer Homes (NYSE: BZH  ) was making plenty of headlines back then, so I used it as an example. At the time, Beazer was trading for less than one-third of its book value, and shares were trading hands at around $11 a stub. However, when the company's assets were examined and assigned conservative valuations in light of the deteriorating economic fundamentals in the industry, book value came in lower than the share price at the time.

Since then, housing stocks continued to head south. I have no interest in implying that I made an accurate forecast; I merely wanted to examine the housing securities from a different angle. I don't own any housing stocks, and unless a heavy dose of volatility occurs, I probably won't own them anytime soon. Nonetheless, since August, all the major homebuilders, many of which were then trading below book value, have declined significantly. Beazer now trades at $9.50 a share, Hovnanian (NYSE: HOV  ) has slid from about $12 to just more than $11 a share, and Pulte (NYSE: PHM  ) is down to about $14 from around $19. The same goes for the likes of D.R. Horton (NYSE: DHI  ) , while Centex (NYSE: CTX  ) is down more than 30% since August. These declines would make any value investor examine the landscape once more for hidden gems (no pun intended!).

Over the past months, I've examined just about every major homebuilder's financial statement and read each annual report. One thing is certain: Every homebuilder is feeling the pain of the excess capacity and saturated lending market. No matter how good you are, you can't escape the laws of supply and demand, and right now there is lots of supply and very little demand.

Yet NVR (AMEX: NVR  ) displayed some data points that caught my attention early on. First, the company is still profitable, although at a much lower level than last year. Second, the company's land exposure is very manageable, as it doesn't carry a lot of it relative to its size on the balance sheet. As a result, NVR still trades at a premium to book value. However, since August, the company's stock has gone from more than $600 a share to nearly $400, which is down from an all-time high of more than $800 a share. Is NVR a baby being thrown out with the bathwater?

Better approximately right than precisely wrong
It's not hard to see why NVR trades at nearly twice book value. The company has a debt-to-equity ratio of about 27%. Land write-offs have come in at much lower rates than for the other companies. Shares outstanding have declined from 11 million in 1997 to about 5.5 million today. Chairman Dwight Schar owns more than 9.9% of the shares. Reading the latest proxy, you find out that he requested his salary be reduced to zero in 2007 and that executives are required to own stock equal to six to eight times their annual salary.

The company has earned about $27 per share already in this half of 2007, yet the industry is so mired in excess capacity right now that future earnings are likely to decline still further. Nonetheless, NVR seems to have solid management at the helm, and the company earned almost $90 a share in 2006. If NVR can achieve similar numbers in 2009 or 2010, at today's price you're looking at a well-capitalized company with a P/E of about 6. If the company continues reducing share count like it has over past the decade, the P/E goes even lower.

Still, while I like this company and the activities of management, I'd want a higher margin of safety given the industry turmoil. I'd rather be approximately right than precisely wrong. At one-time book value, the investment thesis becomes very different. Yet I do feel that NVR, once housing demand stabilizes, presents an opportunity to get a growing company at an attractive price.

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