Large Homebuilders Running Low on Funds?

Originally published by: Wall Street JournalAugust 31, 2011

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Five years into a housing meltdown, questions are arising about how long some publicly held home builders can survive without significant improvement in the market.

Sales of newly built homes, which peaked at 1.3 million units in 2005, were running at an annual rate of just 298,000 units in July and are on pace to post the lowest count this year since record keeping began in 1963.

So far, home builders have been able to stave off disaster by sharply cutting employees and shrinking their product mix to compete with existing homes. Several Obama administration stimulus measures also helped the builders, including a tax break that allowed the builders to pocket $2.6 billion in tax refunds and a home-buyer tax credit that temporarily lifted sales last year.

But the lifelines are running out, and home sales aren't expected to pick up anytime soon.

"The market is not deep enough or big enough to support all the builders," said Alex Barron, a founder and analyst with the Housing Research Center, an independent research firm in El Paso, Texas. "There needs to be some consolidation. I don't think that means [mergers or acquisitions]. I just think that means there has to be a shakeout."

Mr. Barron declined to speculate about any specific companies. But two operators that other analysts are watching closely are Hovnanian Enterprises Inc. and Beazer Homes USA Inc. Some analysts believe both companies are running low on cash. Both companies have seen their stock prices decline nearly 60% so far this year—making them the sector's biggest decliners—and both have traded below $2 a share.

To be sure, the shares of most of the major builders have fallen so far this year. Toll Brothers Inc. shares are down about 10%, while Lennar Corp. has dropped 22%.

On Tuesday, Hovnanian shares closed at $1.75 apiece and Beazer ended at $2.19.

"Beazer and Hovnanian were the very weakest builders early into this crash. If the market stays at this low level of activity for another year or two, they are in danger," said Vicki Bryan, a debt analyst at research firm Gimme Credit.

Beazer declined to comment but expressed comfort with its financial situation.

J. Larry Sorsby, Hovnanian's chief financial officer, said in an email that the company has "taken many steps to right-size our company, strengthen our balance sheet and position ourselves for a return to profitability."

During the second quarter, Hovnanian, based in Red Bank, N.J., burned through $88.5 million, leaving it with $433.5 million in cash, though $85.3 million of that is restricted and not easily accessible.

Hovnanian, like many builders, is struggling to sell homes. Its Stetson Ranch development in Santa Clarita, Calif., is shown last December.

At that rate, Ms. Bryan said Hovnanian could run out of money in less than two years. The stronger builders have cash hoards topping $1 billion.

Mr. Sorsby believes the company's cash situation won't be a problem. "We are confident that we have sufficient capital to meet all our obligations," he said.

Hovnanian will report third-quarter results next week.

A key component in a home builder's health is its strategy for buying and developing land. Some companies have pulled back on land purchases to conserve money, while some builders have looked to new ventures to weather the downturn.

Both Lennar Corp. and Toll Brothers, for example, are working out distressed real-estate loans, a move that is being cheered by many industry analysts. Toll, long known as the builder of suburban McMansions, has expanded into urban areas building condominiums, which continue to be some of its strongest performers.

Hovnanian's strategy is to keep acquiring land lots and keep building a broad variety of homes. In the second quarter, it spent some $125 million of cash to purchase about 1,440 lots and to develop land.

"They're not changing their philosophy on land buying," said Vincent Foley, a builder analyst with Barclays Capital. "Their view is that they need to buy a healthy dose of land in order to be able to participate in any upturn."

One thing in Hovnanian's favor, he adds, is that the company doesn't have significant debt coming due in the next few years, although that changes in 2016.

Hovnanian's Mr. Sorsby said the company will refinance the debt before it matures, providing breathing room.

Still, bondholders are jittery. Some of Hovnanian's unsecured debt is trading below 50 cents on the dollar.

Some analysts are also worried about Atlanta-based Beazer. The company recently replaced longtime Chief Executive Ian McCarthy with its chief financial officer, Allan Merrill.

Mr. McCarthy oversaw the builder through numerous legal and regulatory problems, including a Securities and Exchange Commission investigation. He left several months after agreeing to repay $6.5 million and return company stock as part of a settlement with the SEC; Mr. McCarthy wasn't accused of a crime.

In 2009, the company agreed to pay as much as $55 million to the federal government and homeowners after a joint federal probe in which the company acknowledged violations of certain mortgage-lending regulations and accounting rules.

A year earlier, Beazer settled SEC civil allegations over the company's accounting practices without admitting any wrongdoing. Beazer said it understated earnings by a net total of about $28 million between fiscal years 1998 and 2006.

As of June 30, Beazer had $559 million in cash, though roughly half of it is restricted. But Beazer is also buying and developing land: It spent more than $50 million in its fiscal third quarter, and the annual total could come in around $250 million, executives said in an earnings call earlier this month.

Ms. Bryan of Gimme Credit thinks Beazer also could see cash depleted within two years.

On the earnings call, however, Beazer executives said home sales currently in backlog could help boost unrestricted cash as high as $400 million by Sept. 30. To be sure, given the recent stock-market turmoil, all of these sales may not close, they said.

Still, should Beazer meet this cash projection, the extra money "would effectively add an additional year to Beazer's survival timeline in a worst-case scenario," Josh Levin, a builder analyst with Citi, wrote in a recent client note.

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