Thursday, February 23, 2006

Contra Costa Times: Home builders

"Depending on where the builder builds ... a great tailwind now becomes a major headwind. It was a great ride up but it could be an ugly ride down," said Zelman.
Even while their earnings were skyrocketing and the shares were soaring, publicly traded home builders didn't win investor respect. Home builders have had years of double-digit earnings growth, through several interest-rate cycles and a mild recession.
They have been taking market share from private developers, and are up to around 30 percent from 8 percent in 1990, according to Zelman. What's more, they have great returns: Industry leaders' return on capital tops 20 percent.
Despite that, investors refuse to pay anywhere near what they pay for the average stock in the major indexes, based on earnings.
Home builders' shares as a group are now trading at six times projected per-share earnings. That means only one thing -- the market doesn't believe the earnings. And at the heart of it, they fear builder bankruptcies, as happened in the early 1990s. "If you talk to a hedge-fund manager, (the home builders) are going from 50 percent growth to 20 percent to down 50 percent. It's totally manic-depressive behavior," said Margaret Whelan, an analyst for UBS who has a far less gloomy view herself.
That's why the bulls need this housing slowdown. They are expecting that the companies will be able to have some earnings growth, grab more market share, and throw off enough cash to buy back stock to shore up their share prices.
"For five years, we've been waiting to see how bad it's going to get. It's honest now. We are going to find out whether bears are right and there's no business at the bottom, or I am right and there's a good business and good earnings at the bottom," said Einhorn, who runs Greenlight Capital, a hedge fund with more than $2 billion under management.
Einhorn has been a fervent home-builder fan for years. At the end of last year, his firm owned 4.4 million shares of builder MDC Holdings, making the midsize builder his second-largest position. His firm is the company's largest outside investor.
He hasn't been alone among elite money managers. Legg Mason's Bill Miller has been buying. Lone Pine Capital, one of the premier practitioners of old-fashioned stock picking, was one of the early bulls and still has major home-builder positions. Ospraie Management added to its position in Lennar in the fourth quarter, according to SEC filings.
How bad is it going to get? Zelman sees a substantial profit squeeze coming. Over the past year, home-builder operating-profit margins were around 17 percent; she said she thinks those margins will fall in the next three years and eventually return to a more typical 10 percent.


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