Despite the overall "upbeat" housing data we'd been seeing during the past few weeks, today's S&P/Case-Shiller figures, noting another 1.2% decline in a 20-city index of housing prices, is just a simple reminder that our structural issues have yet to be resolved.
To hypothesize a fundamentally sound housing outlook, we need to take a look at a number of items. From my point of view, it's basically impossible to be bullish on housing, and as a result, most real estate stocks. The reality is that while we may begin to see signs of bubble-reinflation (a positive short-term, decidedly negative long-run occurrence), a return to a "normalized" housing market is fundamentally impossible.
While the Federal Reserve has been busy trying to artificially stimulate the housing market by buying mortgage backed securities, keeping interest rates at zero, weakening the U.S. dollar, and attempting to push investors into risky assets, housing prices have continued to weaken. In another tale of how desperate our Fed is to get the bubble reinflated, our policy makers have failed to recognize the structural deficiencies that have resulted as a consequence of the boom.
Instead of allowing for the malinvestments (driven largely by low interest rates in the early-mid 2000s) to clear, Fed intervention has extended the duration that it will take for the housing market to return to equilibrium. Further still, legislation has made it difficult in some parts of the country for lenders to proceed with the foreclosure process. While questions of "fairness" regarding foreclosures may be warranted, I'd argue that the legislative measures are nothing more than temporary measures that only drag out the pain for the aggregate economy.
Some members of the Fed have argued that we haven't stimulated enough, thus our housing market has yet to recover. Once again, these short-sighted members ignore the facts that:
- Few lenders are willing to lock up large sums of capital for 30 years at a 4% interest rate, especially when they can speculate heavily in financial markets at almost no cost
- Few consumers have enough savings to put down as a down payment, and a shaky labor market makes it difficult for most to assume long-term employment with significant wage growth
- Housing markets, unlike financial markets, take significantly more time to bottom. Transactions take several months to occur; finding price support takes years.
- Dodd-Frank, amongst other pieces of legislation, requires even more capital to be locked up, and forces banks to make sure they have easy exits with their cash. 30-year mortgages at 4% rates offer horrendous risk/reward profiles, especially when capital needs to be liquid.
- Lenders looking out into the future are worried by the global fundamentals.
What we're left with is little demand from consumers to buy a home, even at remarkably low rates, and a very small supply for credit, given the risk/benefit analysis. Stimulus will continue to have an insignificant effect on U.S. home prices.
These three stocks offer fantastic profit opportunities from the short side. As a result of recent "positive" headline numbers, they are trading near their 52-week highs:
D.R. Horton (DHI): Trading at 55 times trailing earnings, this home builder has been pumped up during the recent optimism. The company is primarily engaged in constructing single-family homes, town homes, condos, etc. Single-family home sales have been particularly weak over the past several years, as mutli-family households have increased in number. While the company managed to generate positive free cash flow in the third quarter (only about $86 million), the company has burned through cash and cash equivalents surprisingly quickly, burning through more than $500 million in cash over the last four quarters. Granted, some of this has gone to paying down debts, but their weak cash flow is worrisome. DHI is tremendously overvalued here, and upside risk is tremendously limited.
Lennar Corp (LEN): Lennar's main business is the construction of single-family homes. LEN also invests in distressed real-estate assets, attempting to flip them at a higher price later on. Lennar is trading at 40 times this year's earnings, and analysts expect a 60% jump in earnings next year. This estimate is pure fantasy; nothing fundamentally backs that prediction up, and a decline in earnings shouldn't surprise anyone. Lennar had negative $120 million in free cash flow in 3Q, burning through more than $200 million in cash. Nearly the entire float is held by institutions, creating a scary scenario if they want to unwind. The company has a debt to equity ratio of 125%, and $4 billion in total debt. Once again, upside risk is capped.
KB Home (KBH): KBH isn't looked at particularly favorably by the market, trading toward the lower range of its 52-week price movements, but I believe there is legitimate bankruptcy risk going forward with KBH. KB has rarely been profitable on a quarterly basis for several years, and its cash has dropped from over $1 billion to about $420 million in less than a year. The company has a mind-boggling debt-to-equity ratio of 357, though it is still paying nearly a 4% dividend. Though the company is almost worth as much its cash, the company owes $1.6 billion, and is not cash flow positive on a yearly basis, with negative $300 million in FCF over the last three quarters. There is some risk of a short risk, with almost a third of the outstanding shares being shorted. Considering the outlook on housing, KBH's fiscal position, and rapid cash burn, KBH has plenty of room to drop.
Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in DHI over the next 72 hours.
No comments:
Post a Comment