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Is this homebuilder set to collapse?

Tuesday, February 27th, 2018

You may have heard Chase or I on our radio show discussing how excited we are about home builders and specifically the home builder we hold in our portfolio. The reason for this excitement is due to the housing shortage in this country which is going to take years to remedy. Home builders have experienced a 6 percent annual price increase for the past five years on the new builds which is adding nicely to the bottom line profits of most well-run home builders.

Since the financial crisis, home builders have been building less homes likely due to fear and memories of the housing crisis which is now nearly 10 years old. The slump in home building has lasted a long time and it runs rather deep. It is unfortunate that the number of new homes built over the last 20 years is well below the annual averages going back to the 1960’s. If that does not wake you up about home builders, consider this, last year less homes were built than in 1981 AND the U.S. population was a third smaller. As the population continues to grow, where are these people going to live? Many parents are through housing their adult children because they want to downsize and enjoy their retirement.

It’s important to invest in a quality builder and while we like to invest in low priced value companies one which could be too low is Hovnanian Enterprises (HOV). With a current price around two dollars and change I believe this company is more of a gamble than an investment. For the past 52 weeks, the stock has traded as high as $3.41 and as low as $1.66. Over the last 12 months, the company has a net loss of $310 million. The equity is in the minus column and declined from a negative $129 million to a minus $460 million. The assets of the company have declined over $400 million mostly due to a $200 million decline in inventory and it appears there was a write-off of some notes receivables of over $400 million. It was also disappointing to see sales down 11% for the last quarter ending October 31, 2018 when the industry was a positive 6%. The company is showing a negative net profit margin of 13.6%. On a bright note there is positive cash flow of $298 million for the last 12 months ending October 31, 2017. Looking forward, analysts are not looking for any earnings as far out as October 2019 when the mean estimate of the analysts are looking for a GAAP loss of a penny per share. It appears analysts have lost interest in this company since only two follow this $350 million market cap company.

While the company appears to have some potential, there is also a troubling lawsuit they are handling. A hedge fund named GSO Capital bought credit-default swap contracts which pay out if the builder misses a payment. The problem arose when GSO agreed to refinance the debt if Hovnanian agreed to skip a payment so GSO could collect on the swap and then GSO would benefit from holding the debt. The defense of GSO and Hovnanian is that similar deals have previously been done. I learned many years ago just because it was done in the past does not make it right and for that reason I hope the courts find both GSO and Hovnanian guilty of fraud and the company is forced into bankruptcy because deals like this gives Wall Street and stocks a bad name.

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