If you want to play the housing recovery theme, first read the post that's just before this one.
If stocks are your favoured instrument, one place to start is to examine the major homebuilders in the USA and examine which among them is best managed and positioned to ride this potential recovery.
If stocks are your favoured instrument, one place to start is to examine the major homebuilders in the USA and examine which among them is best managed and positioned to ride this potential recovery.
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| Image: Dr Horton |
The biggest among them is worth investigating - DR Horton (NYSE: DHI). With its operations spanning the entire continental USA, its use of land parcel options to hedge its purchases for its land portfolio, and its decent financials, DHI is well positioned to benefit from an upturn. The land options are real options, i.e. they are not financial derivatives but ones that involve the receipt of actual plots of land and can be viewed as call options.
However, if the housing market double-dips or crashes, DHI would naturally follow the industry's downturn. So first decide if housing is going to make a comeback (which it has not yet failed to do before since we actually all need housing and not "eyeballs" or tulips), or not.
Disclosure: I have direct holdings in DHI.
I use the term direct holdings because for some companies, I might have indirect holdings for example in an indexed ETF. I do not use derivatives, though I might in future. A direct holding is a very specific investment or "bet" and stockpicking is not for those not versed in financial analysis.
A widely diversified ETF or mutual fund might be a better instrument for those wanting to ride with the market, or even to play specific sector themes. In this case, housing sector ETFs are available, but as with all investments, you should conduct your own research to determine its suitability for your portfolio.
DR Horton (NYSE: DHI)
7 Dec 10
P=11.33
DHI FY10 ends 30 Sep 10.
Since the collapse in revenue in 2008, whereby losses begun in 2007, a recovery in revenues can be seen in 2010 data. Their darkest hour was in 2008 where they lost 2.6b. but since then, the NI has been improving and has returned to positive in 2010.
Some care has to be taken because a lot of the data have a certain degree of management discretion which while suitable in most situations is especially suspect in a distressed asset.
The investment case here is that homebuilders have fallen a long way and once a recovery in the housing market is underway, the swing back for them will be tremendous. However, the investment method here would be to examine its performance assuming NO swingback but not deepening of the housing fallout, and evaluate it on that basis. Any topside would then be a fortunate but non-contingent thing.
EPS_10=0.77
PER_10=14.7x
Div_10=0.15
Divyield_10=1.32%
Stock repurchase authourisation left=100m
Num shares outstanding=318.6m
They have $4.03 of cash and cash equivalents unencumbered.
On a PB basis, they are not that cheap. However, their current assets can cover all liabilities, suggesting that their financial position is strong.
PB=1.38x
PTBVPS=1.42x
FCF: The FCF analysis indicates a FV=37.59 or upside of 232%. Yes, that was the case I was looking for, which indicates that the upside should be tremendous once the housing market stabilises on a fundamental basis. And this is based on zero growth, ie g=0. For it to be at its current P, CFO needs to fall 3.5x, to 200 from 709.4m. This implies that the market is pricing it for a long term decline of 9%. However, even a 5% decline still gives FV=18.
But it must be noted that CFO was from reducing inventory (6% decrease from 2009), which means less available land going forward. Hence CFO might be impaired in future. But the generation of liquidity from the raising of cash would give DHI a strong position to benefit from upswing. The problem is, upswing is not imminent or foreseeable in the near future. DHI becomes a strong buy once the unemployment figures improve. It is currently standing at 9.8% though 9.6% has been the figure for some time.
From a historical relative valuation point of view, DHI had low PERs even before unprofitability set in. From 2001-2006, the average PER=7.75. This implies that even the current price is way too high, it should be half of it.
Debt: It is noteworthy that DHI’s credit rating is junk, BB- on S&P. However, their capacity for their debt is high, since they have recently repaid loans expiring, and have a strong balance sheet. So this figures low on concerns in comparison to macro growth factors. They have reduced their debt to 16.1% from 32.5%. But their 3-5year debt is about 1b that they would require financing. Especially in 2014 where they have to repay 794.5m due to their recent issuance of notes. This issuance is at their highest interest rate, 8.2% despite the benign wider interest rate environment. This indicates that their debt is considered of higher risk as viewed by the investment bankers advising them then. If the housing market has by then not picked up, which is a low-medium risk scenario, they are in danger of insolvency, depending on their current asset position then.
While DHI is diversified over the US, it is not internationally diversified and hence is completely dependent on the fortunes of the US housing market. This is a negative point for the company, which will not enjoy the rising demand arising from emerging markets etc.
Its net profit margin is real low. In 2010, it is 1.8% and it was a loss for 2009. Inventory was impaired only 1.8% in 2010 while it was 11.1% in 2009. They managed their land inventories also by securing options for parcels of land. The writeoff here is more severe, 31.5% in 2010 and 440% in 2009. This actually reflects the soundness of the options policy.
Of all the homes in inventory, 12.6% are model homes. 54.7% are unsold (speculative), more than the 50% in 2009. 33.7% of the inventory are completed homes and 25% of completed homes have been unsold for more than 6 months. This is more than 18.9% in 2009 but the 6month ratio had improved, it was 36.4% in 2009.
Conclusion: It would seem a good tactical position is to buy in when it appreciates and tests new highs. The idea here would be to capture the market reading of an improvement in the position of the housing market. Or when the statistics indicate that employment has stabilized and improved. This requires a very careful reading of the market. A review should be initiated once a substantial upmove is detected, since the stock has been treading in the 9.50 to 11.5 range. A review should be initiated at 11.5, or 4.5% above current price.
20Dec10: Initiated buy at P=11.67. Next buy to be done after new year in Jan. TP=37.59. Initial cutloss=0.9*11.67=10.50.
13Jan11: Second buy at P=12.95. Average price is now P=12.277, cutloss=11.05.
24Jan11: I checked through the FCF again, and revised to account for M&A and increased MRP to 6.5%. The revised FV=31.1.
27Jan11: DHI reported 1q, and it had a EPS_1Q11=-0.06, a loss of 6cents. DHI faces headwinds from the poor housing market. If CFO is half of last year’s, DHI is still valued about $15. If however, 1Q CFO is reflective of all remaining quarters, FV=8.75. But that would be crazily pessimistic. The swing down today of about 4% is more than normal, but the volatility had been high, with DHI swinging up 3%, down 3%, regularly. This is not unusual given the state of the industry. The projection for a reversion once US employment data improves is intact, I retain previous recommendations.
22Feb11: I raised RFR to 4.7 inline with 30yr USG bond. This lower FV based on 2010 to 27.96. I revise TP=27.96.
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