The housing market has been little more than a pile of rubble these days. New-home sales fell by 1.6% in May, according to the Commerce Department -- the fourth month of declines in the last five. Indeed, the median selling price of a house fell 2.1% from last year, to $223,700.
Two weeks ago, KB Homes (NYSE:KBH) reported a 36% drop in revenue with a concurrent 36% decline in unit deliveries. Lennar (NYSE:LEN), the largest homebuilder in the U.S., reported 28% fewer deliveries in June as it had to increase the value of incentives offered by 77% to as much as $43,000 to get deals closed.
Now, the latest builder to warn of foreclosure on its quarter is Motley Fool Stock Advisor recommendation Meritage Homes (NYSE:MTH), which builds housing primarily in the West, but also in Florida. Last week, it warned that it was going to be posting serious declines in sales this quarter and would end up writing off some $100 million in inventory. With housing apparently still not ready to recover, would investors be smart to write off Meritage?
Let's look at what the builder announced. When second-quarter earnings are formally announced at the end of the month, Meritage will report $569 million in housing revenue, $502 million of home orders, and $1.2 billion of backlog, representing declines of 37%, 28%, and 39%, respectively, from last year.
Not all of these results should be completely unexpected, considering the company's presence in California, Nevada, and Florida -- markets which have been experiencing some of the most protracted effects of the bursting housing bubble. For example, from October to December last year, the National Association of Realtors found Nevada's sales off 36%, Florida down 31%, Arizona off 27%, and California off 22% from the previous year. Those states were off 27%, 25%, 14%, and 13%, respectively, at the end of the first quarter.
Meritage has relied heavily upon the use of lot option contracts to keep its supply of homes comparatively low. The lot options allow a builder to quickly turn land into homes if demand requires it, and they can do so for relatively little money. Small sums are all that's necessary to keep the options open. But even this strategy has apparently carried some risks this far into the industry's fall.
The homebuilder reported that Florida's hard-hit housing market has caused it to back out of all of its lot option contracts in the southwest portion of the state. It was unable to renegotiate terms favorably on existing contracts and couldn't find new contracts that were reasonably priced. While that will cause the company to write off its losses on these contracts this quarter -- they typically run between 5% and 15% of the value of the land -- Meritage will no longer be on the hook for overpriced property. In the short run, it may hurt results, but the company will be better off in the long term.
At the end of 2006, Meritage had approximately 40,200 housing lots under option or contract worth $2.1 billion, representing a four- to five-year supply of housing. At the end of the first quarter, the number of lots had declined to 37,500 lots under option or contract. Despite the tough Florida markets (as well as those in the West), Meritage is taking the bleak period in housing now to do some late spring cleaning.
The company sits about 50% below its 52-week highs and trades at a discount to its book value. Throwing out the garbage when everyone expects a homebuilder to report poor numbers seems like a smart strategy. Investors may just want to do a little home inspection of their own on the company before things start showing any marked improvement that's obvious to all. Even if the housing crisis continues for the homebuilders, there appears to be little risk not already priced into Meritage.
Meritage is a recommendation of Motley Fool Stock Advisor. Build a firm foundation for your portfolio with a 30-day, risk-free trial subscription.
Fool contributor Rich Duprey does not have a financial position in any of the stocks mentioned in this article. You can see his holdings here. The Motley Fool has a disclosure policy.
