Dueling Fools: Bearish on Homebuilders

Let me share some of the ads I found in the latest issue of the Miami New Times:

  • "Want your condo deposit back? Want out of your contract? You may have rights!"
  • "Condo deposit problems? You may have legal rights to get it back!"

Maybe I'm biased. This is Miami, after all. Like many hot coastal markets, Miami is a former speedster that's now in a funk. The condo-building cranes dotting the skyline are bowing their heads in dormant defeat.  

Still, I didn't hesitate to blast WCI Communities (NYSE: WCI  ) for rejecting Carl Icahn's $22-a-share buyout pitch back in May. The stock now trades at one-third of that dissed offer. I was right to be bearish.

Before that, I singled out leading homebuilder Toll Brothers (NYSE: TOL  ) as one of three stocks to sell in 2006. In what turned out to be a respectable year for the market, with the S&P 500 notching a 14% gain, Toll shares fell by 8%. I was right to be bearish.

So why am I suddenly wrong to be bearish now? I'm not. In fact, if I set aside my free weekly local read and fetch national headlines, this is what I see:

  • Lennar (NYSE: LEN  ) posted the worst quarter in its 53-year history last month.
  • D.R. Horton (NYSE: DHI  ) shocked investors on Tuesday by announcing a 48% cancellation rate on new home orders.
  • Last week, Centex (NYSE: CTX  ) talked down its sales targets, while warning that it would take a nearly $1 billion charge to write down the value of its assets.

Your inner vulture may instinctively assume that the permeating pessimism is a sign that things can't get any worse. Do yourself a favor and cage that bird. It can get worse. It will get worse. Too many investors have been burned by approaching homebuilders as a turnaround sector under that exact flawed assumption. You can't turn around while you're still turning down, my friend.  

Don't take it from me. Take it from the people with the most to lose. The National Association of Home Builders has a housing-market index to gauge its outlook for near-term home sales. On Tuesday, that index hit a historic low. Before you come back with "buy low, sell high," keep in mind that the index has declined for eight consecutive months.

Then you can turn to the realty industry. The National Association of Realtors expects new home sales to fall by 23% this year. You have to go back 10 years to find a year with fewer home sales. With many of the leading developers posting even steeper declines in their backlogs, expect that figure to get even bleaker in 2008.

So pull up a chart on leading homebuilders like Toll, Pulte (NYSE: PHM  ) , and NVR (NYSE: NVR  ) . Despite the recent dips, see how much higher they're all trading now than they were in 1997? And remember, things will get worse.

Granted, that may be a flimsy argument. The well-positioned homebuilders are in better financial shape now than they were back then. Consolidation has strengthened the heavies, while bankruptcies have obliterated the pretenders. Homes are also selling at higher prices, though let's not forget that the Commerce Department announced last month that the median home price fell by 7.5% year over year in August -- the biggest percentage decline in 37 years.

I won't suggest that the residential real estate developers will revisit those 1997 price levels. I'm simply suggesting that there's no reason for the shares to head higher.

Don't buy these companies. Not now. At least the unlucky bulls of the past had graces like low trailing P/E multiples and attractive price-to-book ratios. That's all gone now. Earnings have become losses, and you're not a developer if you haven't taken a jackhammer to your book value in writing down your shareholder equity.

I promise to look at my friend Anders' bullish argument with an open mind, but it won't be easy. Not with all these caged vultures and sleeping cranes looming overhead.

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8/18/2009 4:00 PM
CTX $11.95 Down +0.00 +0.00%
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