"The Walmart of Homebuilders"

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By RodgerRafter
January 25, 2005

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I listened to the D.R.Horton (DHI) conference call with great amusement today. They kept talking about how much bigger and better they were than other homebuilders, but to me they just seemed more arrogant and overconfident.

They boasted of being the first builder to close on 40,000 homes in a year (2004) and promised repeatedly that they'd close on over 50,000 next year. They're confident that they'll close on over 100,000 homes in a year within the decade. They can do it if they keep growing at their total 2004 rate of 16.84%. However their Q4 closings were only 4.74% higher than the year ago quarter, so things appear to be slowing down.

Several analysts questioned that and other red flags in the trends within their numbers. Their standard excuse was "We're not going to give a weather report." I took that partly a cheap shot at Hovnanian and partly as just a way of dodging questions. They used it about 10 times, and when analysts were more persistent, they fell back on the old standard "We had a great quarter," and the less standard dodge of "There isn't anything to be ashamed about in these numbers." One investor who pointed this out to them late in the call got a very hostile response from the execs, who added that the shareholders would be the judge of whether or not they were giving enough information.

DHI says they now have about 290,000 lots under control, which they claim is a 4 year supply. One analyst quoted their founder as saying that 3 years was the limit of what was safe. Management told the analyst that they were wrong and that they'd hold 50 years worth of supply if they could do it all under options. They did admit earlier in the call that holding land was the riskiest part of the business. Land controlled went from 60% to 52% options this quarter because of a huge land deal in Arizona that moved lots from the options to the owned category.

I've often heard options given as an excuse for why homebuilders aren't taking on much risk. Still, if there is a slowdown in the housing market, land goes down in value, the loss is a relatively small percentage of the total asset value. If they bail on a contract, then everything they've spent on the contract and preparing the land for development is a write off. They don't seem nearly as safe as they are being made out to be.

On the other hand, they were asked if they thought the Florida market was "sophisticated," to which they replied yes, because they were able to negotiate more land options there. They complained about California, where they had to purchase much more land, because landowners weren't as interested in options. If the options are such great deals for DHI, what makes the options sellers "sophisticated?"

According to DHI all of their markets are strong. Nationwide cancellations were up from the historical upper teens to the "low twenties, err, umm, twenties (read high twenties) entirely due to Las Vegas." The Las Vegas situation, nevertheless, would reverse itself soon because "5000 people are moving there every month," and "We're not going to give a weather report." When asked if Arizona could face a slowdown like Vegas because virtually every major builder was expanding there like crazy, they simply said it wouldn't.

At one point they said their goal was to be "The Walmart of Homebuilders." While they are slightly larger then #2 Lennar, they still only make up about 2% of the entire US market. They are hardly in a position to dominate. One of their goals for expansion is to try and muscle in on the markets that aren't served by the other big national builders and undercut the established local builders to squeeze them out. While this may contribute the growth they seek, they are probably going to find that they are late to the party and that they'll be taking losses on their expansion efforts.

They kept talking about how great their regional managers were, and gave them credit for their growth and success. They gave themselves credit for creating a set of incentives for regional managers who improve profits and sales. Of course this probably means that the regional managers are being overly aggressive and presenting a rosier outlook than is warranted because that's what the top brass wants to see and its what will get them their bonus checks. These same regional managers are being asked to lead the charge into the smaller markets from nearby larger bases.

I've listened to 3 homebuilder conference calls in the last week. The MDC guys seemed overconfident and set on expanding aggressively to boost profits. The Ryland guys were lower key, but had action done a better job on execution, mainly because the bulk of their development was in the faster growing Southeast. The DHI guys have the most development in the West and their numbers are showing the most signs of weakness, nevertheless they were bar far the most brazen, arrogant and overconfident of the bunch. If they do meet their goal of selling 50,000 homes, they are going to have to do it with a lot of discounting or through acquisitions because their markets are saturated. It'll be a pleasure listening in on their future meetings to see them face tough questions and go deeper into denial.

Most homebuilders are down more than the market averages today. I'm gradually moving a bigger percentage of my shorts out of builders and into mortgage lenders. 10380 looks like support for the Dow, so it would be a good point to buy back a few builder shares and then short some more financials after the next little rally.

Hey Mike. I expected that mortgage bankers report on my desk 2 days ago! ;-)

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