WaMu is having a bad day (see news on WaMu). I rang the alarms on WaMu twice -most recently in early October - Washington Mutuals Mortgage Division Posts 5th Straight Quarterly Loss and initially in early September - Yeah, Countrywide is pretty bad, but it ain't the only one at the subprime party... Comparing Countrywide to its peers. You see, you don't even have to be a client to like me:-) This upcoming quarter marks the 6th consecutive quarterly loss for their mortgage division. They saw this coming more than a year and a half ago, and so did I. Unfortunately, I covered that short on WaMu a few weeks ago to raise cash, but luckily reinstated it just in time to catch the big drop. I need to write a piece on handling extreme market volatility and holding on to positions. Many of the stocks that I am bearish on have become volatile momentum plays and have detached significantly from their fundamentals. This makes them more than twice as risky, and quite expensive to hold on to - but also offers significant profit opportunity when traders push a proximal bankruptcy candidate up to $30 per share on the call of someone like Stephen Kim from Citibank. I digress (especially since WaMu hasn't been that volatile), and back to the point - I believe that WaMu, like Countrywide, are not the only banks at the subprime underwriting party (the problem is not subprime loans, but subprime underwriting - which spreads the effects throughout the lending industry that includes consumer, corporate, retail and wholesale - and fails to confine it to any one sector of low FICO mortgages), but we will cross that bridge when we get to it.

As for the severity of the situation, peruse:

  1. Bubbles, Banks and Builders
  2. Bubbles, Banks, and Builders, Pt. Deux
  3. Bubbles, Banks & Builders: Pt.III - "Do or Die, Bed Stuy" and
  4. Bubbles, Bank, & Builders - Pt IV: I can't believe this guy

Ramble off, 'nuff said!

One of the major aspects of my blog series was that land was worthless... I copied and pasted the Lennar CEO quote from big builder magazine and a link if you want to read the whole article...

Lennar CEO quote below

For the quarter ending Aug. 31, Lennar wrote off deposits and pre-acquisition costs on 15,000 home sites it no longer plans to buy. That adds up to a total of 24,000 home sites the company has abandoned in the first nine months of this year.

"We look at costs to develop a parcel of land and actually develop home sites and include in that the cost of building a home, and you get to the point where the residual value of the land itself-even in well located areas-is close to zero," says Lennar CEO Stuart Miller.

"Lennar has mothballed some large projects because the effective result of selling currently implies the land has zero value," says Stephen East, an analyst with Pali Research. "It also provides the company some accounting breathing room. By mothballing the projects, LEN is able to avoid taking impairment charges on the land that would reduce the value effectively to zero."

So the next time some clown laughs at you and says "oh yea, right that land is worthless... grunt... it has no value... grunt".... just attach the link

Key points on raw land

- time value of money has a cost and it is steep

- interest expense (leverage) has a cost and it is steep

- property taxes and insurance have a cost

- your original feasibility determines what you will pay for land... so if you run the feasibility at a high price and pace and it is much lower price and pace, then the 3 points above will bury you

My example - A real deal in Florida

The deal is 600 raw lots at multiple sites. We start with 6 months of entitlement, followed by 6 months of development, then we would sell finished lots at 36 a quarter from the different sites. It takes around 4 years to get out of all the positions (sell all the finished lots). I ran the numbers and we could only pay 34,000 per raw lot to make this deal work (meet our profit threshold)............ but guess what..... if you ran the same deal and you entitled land for 6 months, followed by 6 months of development..... however, KEY POINT... found one or multiple builders to take down all 600 lots at the end of development instead of over 4 years... we could pay up to 67,000 per raw lot (twice as much)... this is why so many people lose their a$$ in the land game... if you make the wrong assumptions and you paid the 67,000 and couldn't unload... you are dead... this is no different from a builder who paid for land based on the wrong sales price and pace assumptions and now finds he can't meet those expectations

Tuesday, 06 November 2007 00:00

Straight Talk From the ex-Homebuilder CFO: Divergence

Written by

Quick note: The "CFO" series are postings of a guest, anonymous author whose opinions I value. It is not me (Reggie) and I do not necessarily agree with everything posted, but his input is considered valuable. I think the diversity of opinion adds to the value of this blog.

"CFO" post starts here:

A few of the homebuilders are actually getting their $hit together and can weather the worst of storms.  I will present my builder stock ratings last.  When it comes to investing and even how I play caps, I am a top down investor.  I want to be 80-100% certain that everything in an industry is going one way... either up or down...  I hate divergence.  Why?  because now you have to figure out who the good companies are from the bad... In the case of builders, you already have knowledgeable people bidding up the strongest 2-4 stocks and lemmings bidding up all the crap or shorts covering...  I don't like it when bulls and bears are in mass battle... why?  it means that no one knows which way the effing industry is about to fall.  You may be thinking "Bill, are you saying its time to buy?".... not yet, but soon if you are going after a top 5 builder stock and only if we don't go into a recession

If we go into a recession then of course, you can red thumb all the builders again along with 70% of the stocks in the market... but we aren't there, and I am not in the predictions business.  If some bad "new" macro event occurs to builders then yes, I would red thumb all of them again... but the macro event I am waiting for hasn't happened 

I have to call it what it is... a technical bottom, divergence, no recession.  However, I see oil at $93 a barrel, I see housing in the crapper through 2009, and I bought a meal for myself and my 5 year old at McDonalds that cost $12 bucks.............. are you kidding me? all this macro news sucks, however, with all of this crap going on, guess what... the DIA, the SPY and the QQQQ are all full steam ahead moving up...  not me brother, I'm almost all in cash with some gold... The builder stocks have one more $hit sandwich to eat in the next 3 months... it is either going to be a market correction or a major bankruptcy/reorg...  so at that point I might plop a few long coins on a select builder...  however, this is only a good move if you believe we are not going into a recession...  If you think the economy is going to tank then ignore some of what I say in hear from an investment standpoint... again, I don't predict recessions.... I look at any oversold builder stock in a non-recessionary enviroment as a buy if it is a good company... why? volatility pops

Bankruptcies in process and done deals

On my Sept 25, 2007 blog post I stated that a top 30 builder would go under within 60 days (I have just under 30 days left)... quite a prediction given that we were 26 months into the downturn that began in July 2005 (the peak).  Additionally, up until Sept 25, 2007 only one top 200 builder had filed for bankruptcy.  Kara homes.  Kara was ranked #127 during 2005

This past week 2 private builders and 1 public threw in the towel

LEV... oh I know this linked article doesn't say chapter 11.. but the eyes and ears around Florida are telling me the homebuilding operation is finished... i would expect an announcement soon... they will then have to sell land assets and battle their creditors... LEV has a very complex legal structure, however, the courts might decide that the legal structure is not valid and that LEV corporation will have to pay back the creditors of LEV homebuilders.  I'm not sure how the market will react to a chp 11 filing on LEV stock or builder stocks.. why? because a lot of people in the know saw this coming anyways... 

LEV's equity placement bought them time, but they still need to battle the banks over whether or not they are liable for the homebuilding operations.. by the way, LEV was the #51 largest builder in 2005

Neumann Homes.... Neumann, Neumann, Neumann... what were you thinking!!!! expanding in Detroit in 2005...  Gee and you wonder how you made it into chapter 11 so quickly...  Neumann was the #46th largest builder in 2005... still not a top 30!

Hacienda.....the #97 largest builder in 2005... was rolled by their bank... the bank wants their money back and wants this recapitalized via sale.... pressure from banks?  yea, how about... your done, your cutoff, no more construction (vertical) loans

I told you bankruptcies were coming when I saw that Lennar report in Sept...  one top 200 builder in the first 26 months... and within 60 days of that Lennar report we have 3 builders rolling over...  this goes back to what I stated early on.... its all about the cash, the debt to capital ratio, and that land is illiquid and not worth book (can't sell and raise cash)....  Will the market take notice when LEV makes it official?  Neumann is bigger than LEV and the market didn't take notice...  Neumann is also bigger than DHOM, AVTR, and CHCI from a homebuilding standpoint

 

Worst in show - These Builder Stocks are red thumbs no matter what

This grouping of builder stocks blows even if we don't go into a recession...  however, I think the harvesting game is over on builder stocks... draw a line in the sand and stick with it... Go red and wait... you can also play the technicals (e.g. red thumb at the 50 and wait until it is over sold)...

WCI -  in their prior quarter they had gross margins prior to impairments of 11% and SG&A expenses of 21%... 50 net orders!!!!! and they own and control 31,000 lots....  their debt to capital ratio is 67%... banks and bondholders get nervous when you are  cruising over 45%....  the average price of their bonds is trading at 80% of par...  Think Miami condo towers... what does WCI do... condo towers in Florida and single family homes around 750k more or less....  It will be interesting to see what Icahn does... in the meantime this is a total dog

DHOM - Kentucky and Ohio... do you really need more information?  If so, I would suggest a mutual fund

CHCI - didn't do any research on this one... but its a penny stock now after being as high as 30 a share.. you can't red thumb it in caps anyways, so who cares

LEV - again, the complexity of their legal structure will beat those banks off for a little bit... but they still will have cash burn and they still have to actually beat the banks in court... throw on top of that going from 15 million to 90 million shares outstanding... well lets say, they aint making any big EPS money any time soon

TOA - these clowns are still alive!!!!  I really need them to go under because they are a top 30 builder... fyi.... their portfolio is out on the street now... guess they are interested in getting some major cash fast.  with a debt to capital ratio of 70%... they are in major effing trouble... having a lot of land in Florida is not a bonus

OHB - I think they recently had approved their 100th amendment to their covenants... this is another reason why i am done red thumbing all builders... if banks are going to look the other way for a crap builder like OHB, then there is no way a good builder will ever get pushed under....  the debt to capital on OHB is 72%... puts them in good company with the other misfit toys here

Special Situation Crap....  Red thumb these dogs on bounces

This grouping of builders sucks too... however, they have special situations which might allow them to live a little longer... of course if there is a recession... lights out...

SPF.. 5 million in cash??? are you kidding me  if you take their cash plus what they have available on their revolver line of credit, they can pay down only 0.14 of their debt... fyi... that is a bad thing... only 23% of their revolver is available.  Their bonds are trading at 77% to par...  I wonder who bought at par?  debt to capital ratio of 60%... this blows, but there are a lot of crappy private builders below these guys... fyi.... most privates are probably 80% or worse... yikes!!!!!

BZH... SEC investigation... also, 15% gross margin on quarter ending June 07 before impairments!!!! P.U..... they had $123 million in cash then too... oh you are wondering why I am looking at June's 10Q.... that is because they still haven't provided their latest financials or any visibility... their public debt is trading at the worst level 74% to par... their debt to capital ratio was 58% in June... I'm sure it is worse now

HOV... their latest quarter had 13% gross margins before impairments and 12% SG&A expenses... lmao... you are not generating any cash with this awful spread... only 9% of their revolving credit line is available.. worst in the industry... something to be proud of.... they are also worst in the industry in land expenditures (money still being spent on land related items like development, etc...) another cash drain.... their debt is trading at 80% to par...  debt to capital ratio of 59%... blows.....

BHS...  if you take the half life of uranium and divide it by 10 that is how many years of land BHS has... 130 net orders....and I have information that shows they own 13k lots and control another 15k????  WTF...  hint... why did GM sell Delphi.... answer... because they were the last effing manufacturing company to realize vertical integration doesn't work.... land is an input!!!!!!!!!!!!!!!!!!!!!!  you are a builder for pete's sake...

Fat, Dumb and Happy... or How to lose Billions of market cap for investors and still keep your job

This groping of builders consists of our large, lazy and stupid friends... why groping?  because after investing in these stocks you feel like you were sexually violated...

DHI - oink... oink... A lot of you have asked me who is Donald Horton?  click the link he is laying there next to the boy with the gun....  If there was ever a reason for the 2nd amendment it is to shoot a pig like this....  DR Horton had 48% cancellation rate this latest quarter.... net orders were 6,374.... so does that mean that there could possibly be 6,300 spec homes in various stages dumped out onto the market? lmao... of course that is what makes following builder stocks so much fun....  We still don't have their new cash number, but it has to be higher than $4 million (end of June).... congratulations $10.5 billion in inventory... more than any other pig... and how did you get such a big appetite?  with debt... $4.9 billion in debt, more than any other pig...  the debt to cap was 46% at the end of june.. I can't wait for the 10Q...

LEN - oink... oink...  Now Lennar was the reason why I declared bankruptcies were upon us soon.. and maybe no one will give me props for this call, but I am going to say nothing bad about LEN here for showing me how to look so bad as to be my indicator that the builders are going to $hit...

PHM - oink... oink... Oh Mr Dugas... please tell me... they aren't making land any more are they.... lmao....  think of DHI except 2 pounds thinner... yep, that is PHM

I don't know what to think about these builders list?

In this grouping we have builders that aren't big fat pigs, but then again, aren't lean mean fighting machines...  So I am going to say one nice thing and one jerky thing for each of these builders.. would I play them long on oversold conditions or short on overbought conditions?  I don't know, that is why they are in this box

CTX - absorption pace of 3/month per community... wow... every other builder is between 1.1 and 2.3... just sucking wind... and lets be clear, you really want to be around 6 or more to be considered doing good... so 3 means you have a heartbeat.. interesting, a CTX contact said mgt is adamant about getting 3/month...  On the bad side 3.9 months of backlog is 2nd worst to Lennar!!!!!

MTH - only 7,500 owned lots and 22,500 controlled lots... not quite NVR, but hey I love how they aren't land pigs...  the negative? 50% debt to capital at 6/07...  I'm sure its worse now

MHO - $2 million in cash on 6/07 and SG& of 20%!!!!!!!!!!!!!!!!!!!!!!!!!!!!!  the good?  they recently said orders were only down 2% YOY

Stocks I would buy after a large sell off and we don't go in recession

#5 KBH - $645 million in cash (if your not impressed add up all the cash of the above builders... and its pretty close to $645 million)... they have been unloading land like crazy down to a 4 year supply, 2nd lowest in the industry.  They can borrow up to 79% on their revolver and their public debt is trading at 89% of par.

#4 MDC - $731 million in cash...  they can borrow up to 97% on their revolver and their public debt is trading at 90% to par... they only control 3.6 years of land!!!!  So these guys can take advantage of the downturn...

#3 RYL - Why Ryland?  I think they are first to be bought out in consoldiation.. don't want to any further there....  Ryland is known in the industry as being conservative... and they are... they use higher hurdle rates to feasy deals and they will hold gross margins rather than fire sale... there cash is only $81 million... however there debt is only 983 million which is low... debt to capital of 40% is also very low...  nothing pops out as to why RYL should be #3, however, I feel I understand the industry pretty well and I think Ryland is going to pay out

#2 TOL - A lot of people either hate or love TOL...  I like that they had 23% gross margins prior to impairment and SG&A at 11%. both close to best in industry right now..  TOL buys premium positions (except for their crappy acquisition of landstar homes) and Bob Toll reviews all acquisition deals....  they have an 8.1 month backlog, biggest in the industry right now.  Their cancellation rate was only 24% best in the industry right now....  they have $771 million in cash... best in the industry... their debt to capital is 39%, top 4 in the industry....

#1 NVR - 22% gross margin before impairments 2nd to TOL.  4% SG&A.. not a misprint... next closest is 10%.... can rate 27% 2nd only to TOL...  Net Orders YOY increased 12%, 2nd to SPF... $314 million in cash plus 97% of their revolver is available... their cash and revolver availability can pay off their debt 5.69 times... the next closest is MDC at 1.89 times...  debt to capital ratio of 16% best in industry... they own zero lots and control 84,600 lots...  NVR has huge market expansion abilities, because they are so much smaller geographically... the finished lot strategy works... just go back to my blog where I showed NVR as being up 2,000 percent in 5 years, 3rd best in the industry... MTH was #1 and they also do a hybrid off the MTH strategy

Well fools from time to time I will throw out a graba$$ blog post, but the information series is done... it will mainly be some very relevant quick information on the industry...

good luck to all...  sorry if you wanted me to post that all the builders were going under, but again I am not in the recession prediction business and a few key builders are getting it

For those of you who go to dog shows, they have the term best in show for the best dog overall... since all builder stocks are dogs, my lowest rating is worst in show and I award it to more than one dog... because i'm nice

Losing the worst in show rating is very very hard......  it means you suck so bad I question your viability... perma red thumb

thoughts on macro bankruptcy count

The editor of big builder magazine appears to agree with the consensus that 1 of every 3 large builders (both private and public) is going to go under... unofficially we are at 4 of the top 200 so we have another 46 to go...

In a previous blog dated 9/25 I had stated that 8 publics of the 21 I track would be going bankrupt, delisted or bought by bondholders at a lower price than they were trading at....  I don't track AVTR (and they are a top 50 homebuilder), but my percentage was 36% if you include AVTR....  Going forward I will track their numbers too...

Beazer downgrade to worst in show

One of the homebuilders I had as a potential bankruptcy was BZH.  However, on my 20 of 20 blog post I had BZH as a special situation crap pick.  In other words, this stock is a piece of crap, but because of the lack of visibility it is hard to tell how bad their situation is...

----- EXTENDED BODY:

Well accidently, I missed some of their numbers on their 8k dated Oct 5...  in reading an analyst report this morning I grabbed these missing numbers and put them in my spreadsheet....  wow!!!!  they are bad!!!!!  after the 8k was issued the stock started trending down to the 8s, but shot up huge on the short covering rally...

Here are the numbers that concern me

68% cancellation rate (worst among the publics)  remember, a cancellation a lot of times can result in a future unsold spec depending upon the stage the house was in when cancelled... both a cash drain and will have to be sold at a deep discount to move..

YOY orders drop 52%... again the worst among the publics for the most recent quarter!!!!!  remember there are 21 I track and you are number 21 in these 2 important categories

Monthly sales absorption per community.. because I dont have an updated community count I used Junes... they are averaging 0.7 net sales per community... guess... that is right #21 of 21 builders...  my god I can't even believe this number.... 

There is a lack of visibility in backlog, but my estimate is 2.3 months.... worst in the industry...  remember how long it takes to build a home... call it 4 months... so if you drain your backlog where is the cash coming from during that 4 month period of cash out flow with few sales from backlog?

Now they did increase their cash position to 400 million, however, they had as of last quarter a debt to capital ratio of 58%....  not worst in the industry but in the bottom 1/3

Thus, I have no choice but to downgrade BZH from special situation crap to worst in show....  this thing will probably tank when they (if they ever) provide us financials

also, they spent 18 million towards the bondholders to get them to amend the bonds so that they didn't have to report their financials within the time period allocated... another total waste of 18 million