Hovnanian's (NYSE: HOV) very existence might hinge on whether or not the housing crisis is behind us.
With the markets in recent weeks breathing life into the stocks of builders such as Toll Brothers (NYSE: TOL) and KB Homes (NYSE: KBH), as well as heavy-equipment manufacturer Caterpillar (NYSE: CAT), Hovnanian is praying that the newfound optimism is more than just a mirage.
The company, which used to be one of America's largest homebuilders, reported earnings last night, and to put it bluntly, it wasn't pretty. Revenue of $387 million for its third quarter was down 46% from last year's quarter, and net losses totaled $168.9 million, or $2.16 per common share. More than $100 million in pre-tax land impairments and other write-offs insulted its bottom line, but even without the noncash charges, Hovnanian still would have lost money on the quarter. However, the non-cash impairments have left the company's balance sheet in a precarious position.
Honey, they nuked my equity
Evidence supports the theory that small caps outperform during recessions, but this is one company you probably want to avoid. Hovnanian now has negative equity, which means it owes more than it has -- a situation that some people refer to as insolvency. Furthermore, it has only a little more than half a billion dollars in cash to offset its $1.8 billion in debt.
Most of Hovnanian's outstanding bonds are high-yield corporate notes underwritten by Credit Suisse (NYSE: CS), Bank of America (NYSE: BAC), and JP Morgan Chase (NYSE: JPM), and they're subject to covenants that limit the company's ability to repurchase further debt. But that's not among Hovnanian's chief concerns.
Please buy a home!
It's one thing to be a profitable company with a sick balance sheet, because that situation can be remedied. It's another scenario entirely when a company is insolvent and continues to lose money. If the homebuilder doesn't start turning profits soon, it could default on its debt, and if that happens, it could start down the road to bankruptcy. If it goes that route, it might be snapped up by a competitor.
So if you're thinking about buying Hovnanian, you're either bullish on a fairly quick housing market turnaround or you believe it could be purchased at a premium when it's in trouble. I'm skeptical of both strategies. Mortgage defaults and foreclosures are still happening across the country, and if Hovnanian should slide toward bankruptcy, its stock price still has plenty of room to fall.
Am I wrong? Let everyone know what you think below.