I hate to kick a sector when it's down, but it's an easy target if you know it's going to be a while before it gets back up.
I'm turning my attention to the real estate sector this week, and no, it's not too late to be bearish on the banged-up industry.
As I do every week, I recommend a stock that investors should consider dumping from their portfolios. Every week, I also nominate three stocks to take its place. In other words, if you put up with the bulldozing, I'll be back with a few constructive stock ideas.
Who gets tossed out this week? Come on down, Toll Brothers
The bell tolls
Why Toll? It certainly isn't the most problematic developer. The luxury home builder has one of the healthiest cash/debt ratios, which means that if the malaise continues -- and it will, bub -- Toll will be one of the last residential builders standing.
Toll is also smart enough to roll with the changes. For instance, it is expanding its rent-to-own program as a way to get bodies into vacant properties.
However, just as all boats rise with the tide, they can also all be taken out by a killer wave.
Developers like Toll and Lennar
"Congress has allocated hundreds of billions of dollars to reset mortgages, help people who are in foreclosure, and protect those who have been the victims of rapacious lending practices," CEO Robert Toll notes earlier this week. "We believe all of these goals are very worthy. However, we believe that, if home prices are not stabilized, these efforts will be for naught, more mortgages will go under, and the taxpayers' money will have been wasted. We urge Congress to stimulate demand by reducing mortgage rates and fees and by providing incentives such as a buyer tax credit for the purchase of all types of homes. We believe these initiatives would offer the greatest benefit for the taxpayer's dollar."
The self-serving advice is awfully similar to what Lennar pleaded two months ago. "Although the Federal government has recognized that stabilizing the housing market is critical to solving the current credit crisis, the government has yet to act meaningfully to help stabilize home prices," Lennar CEO Stuart Miller said.
I hate to get all Jonathan Swift on these guys, but I have a modest proposal: Let's eat the home builders. The problem in stabilizing home prices is that we already have a glut of empty existing homes, and these guys don't have the Lucille Ball gumption to turn off the chocolate bonbon machine. At its very root, this is a supply and demand issue.
Why should the onus be on the demand when a baby step to a solution is for home builders to freeze operations for a year or two? They won't do it willingly, so let gravity take its course. Let the bodies hit the floor. Let the construction jobs move into fortifying the country's infrastructure instead of hammering away at some cookie cutter development out in the 'burbs.
It's going to happen anyway. Toll's latest quarter saw home building revenue, backlog, and net signed contracts fall 41%, 54%, and 27%, respectively, in dollars, and 35%, 48%, and 18%, respectively, in units. See how the drops are bigger on the dollar side? It means that Toll is not only moving fewer properties, but it's doing so at much lower prices. The average price of a net signed contract was for $495,000, well below the $579,000 that the luxury home builder was commanding last quarter. Construction costs aren't falling that quickly, so one can only imagine how ugly the bottom line will be. In even worse news for Toll, cancellations are still pouring in for the pricier homes.
It won't take months for the country to need -- or even want -- new homes. It will take years. Yes, Toll's stock is trading at a fraction of where it used to be, but there is no reason to believe things will get better.
As I have every week, I don't talk down a stock unless I have three alternatives that I believe will outperform the company getting the heave-ho. Let's go over the three fill-ins.
(NASDAQ:RATE)- It's hard to find a pure residential real estate play to recommend domestically, but Bankrate is pretty close. The undisputed leader in tracking mortgage rates is growing nicely these days. Revenue soared 77% in its latest quarter. Earnings didn't grow that quickly but still handily topped expectations. The key is not just a wide range of interest rate-monitoring listings, but lead-starved financial institutions who pay Bankrate for hyperlinks and advertising.
(NYSE:EJ)- You know where housing demand is going through the roof? China. E-House is the country's largest real estate agency. It won't report earnings until next week, but revenue and earnings through the first half of 2008 have clocked in 90% higher than last year. That's impressive, and so is a share price that is well below last year's IPO, pricing the stock at just five times next year's projected profitability.
(NASDAQ:ZIPR)- Expanding its agency at a time when sales are contracting is gutsy, but ZipRealy did manage to post a 12% increase in revenue this past quarter. The loss narrowed, too. The biggest selling point for recommending ZipRealty is that it is actually trading for less than the $2.60 a share in cash on its balance sheet. That is something that other potential dot-com turnarounds like RealEstate.com parent Tree.com (NASDAQ:TREE)and Realtor.com parent Move (NASDAQ:MOVE)don't offer.
Other headlines out of the weekly dumpster:
Do you like my substitutions? Would you rather stick it out with the tossed company? Are there other stocks I should look at in future editions of this column? Let me have it in the comment box below.
Longtime Fool contributor Rick Munarriz isn't hungry enough to eat a homebuilder. He does not own shares in any of the stocks in this story. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.