Market spotlight: Homebuilders

Judging by the stock performance, investors seem certain homebuilders reached a nadir in January.

The sector has been the stock market's best-performing one since then after the woeful housing market sent the industry index down 39 percent in 2007.

In past housing busts, homebuilder stocks have turned six to nine months before the industry itself. That would mean at least the start of a recovery is due sometime in the second half of this year. But all signs point to a prolonged slump, at least into 2009.

Investors facing these conflicting signals may want to avoid homebuilders, at least for now, some analysts say.

"We do not believe builders will see a meaningfully higher rally" until the housing market improves, Wachovia analyst Carl Reichardt says. And that is "decidedly not the current case."

Sales of both new and existing homes continued to fall through the first quarter, and selling prices dropped at record rates. Meanwhile, the number of homes facing foreclosure spiked 65 percent in April, according to industry research firm RealtyTrac.

That leads to an increase in the number of houses on the markets, contributing to a deepening slide in home values. The cycle perpetuates itself, as prices fall and more buyers stay on the sidelines, scared to purchase a property that may continue to lose value.

At the same time, it has become more difficult for would-be buyers to get loans as lenders tightened standards. Mortgage lenders are having trouble borrowing money themselves to finance loans.

Add the slowing economy to the mix, and the housing sector is clearly mired in a slump that is unlikely to end soon.

"No homebuilder we cover has confirmed any signs of business trend improvement," Reichardt said.

All major builders have reported losses in the January to March quarter. The culprit in each case was a hefty charge to write down the value of unsold homes. Quite a few also reported operating losses as home sales, orders and the average selling price all fell sharply.

Many, including Lennar Corp. and KB Home, cut home prices below cost just to generate cash. That is important because the companies have certain capital requirements tied to their lending agreements. Hovnanian Enterprises Inc., Standard Pacific Corp. and Beazer Homes USA Inc. have had to get waivers from their lenders allowing them to be out of compliance.

If the lenders get more stringent, they could force a default situation, which would force the early repayment of any debt and could lead to a cash problem.

Still, Lehman Bros. analyst Megan Talbott McGrath expects builders may be able to turn the corner on profits soon. "While we expect (higher profits) will be challenging in a declining price environment, we do look for trends to begin to improve next quarter," she said in a note to investors.

Reichardt said the stocks may have had their run for a while, though.

"Homebuilder shares (are) likely to perform more in line with market averages in such an environment," he says.