(BMHC) - (CTX) - Another Look at Housing - Consensus Home Builder Review

Gregory Spear, editor of The Spear Report newsletter, explains that interest rates and corporate profits are just two legs supporting the four-legged economic table. The balance of the U.S. economy relies upon the consumer and that segment, in turn, depends directly on the state of the housing sector. Check out this expert's analysis and his review of two home builders. Afterward, discover some names from the Consensus Buy List. Detail from September 1 The market has been known to climb a Wall of Worry, but one thing that it can't ignore forever is the Federal Reserve. The market has been rallying in the last week due to the increasing likelihood that the Fed has stopped raising rates. It would be unusual for the Fed to stop a tightening cycle at 5.25%, but that now appears to be a high probability scenario. The fed funds futures are pricing in just a 10% chance of a rate increase at the September FOMC meeting and it is a coin flip by the end of the year. This past Tuesday (8/29), the release of the FOMC minutes of the August meeting only served to reinforce this dovish prognosis. The Fed is forecasting a declining economy for the next six quarters. To understand why the market is rallying on that dismal prognosis, we need to take a look at how U.S corporations have interfaced with the Fed during the recent recovery. The fact that the Fed raised rates 17 times in modest quarter-point increments since June 2004 was not a problem for Wall Street, because rates were rising from historically depressed levels. When the Fed decided to reverse course 26 months ago and start raising rates, the prime rate stood at 4%, and the federal funds rate was 1%, both 46-year lows. What had precipitated such dramatic monetary measures? The Fed faced four daunting dragons during 2000-2003: a collapsing equity bubble, a catastrophic terrorism event, major corporate corruption scandals and a war in the Middle East, the unrelenting sequence of which threatened to undermine confidence in the “system.” Drastic times required drastic measures. Once the dust had settled, the series of rate increases was medicine the market expected to take. The strength of the subsequent economic recovery, however, has been on the weak side. Gregory Spear and his team attribute that principally to gun-shy corporate CFOs who have kept the capital spending wallet on the hip, as well as rising energy and commodity costs. Instead of spending, corporations used the low interest rates to strengthen balance sheets by refinancing long-term debt, they streamlined U.S. operations and deployed capital overseas to compete in an ever more globalized market environment. This proved to be a wise move, as corporate profits have remained robust despite spotty GDP growth, cutting the P/E ratio of the S&P 500 in half over the last four years. Impressive. Management's proven ability to maintain profitability in challenging conditions is a prime reason the stock market is not shaking in its boots about the well-telegraphed economic slowdown that lies ahead. That said, interest rates and corporate profits are just two legs supporting the four-legged economic table. The balance of the U.S. economy relies upon the consumer and that segment, in turn, depends directly on the state of the housing sector. In raising rates, the Fed's goal has been to slow the economy enough to prevent an inflationary spiral without triggering a recession. If the Fed is now about to reverse course and start easing in 2007, this time it is only facing one dragon…housing, but it may turn out to be the biggest dragon of them all. Insulating Factors The good news is that although sales have declined dramatically in some areas, prices are still more or less flat year over year, not adjusted for inflation. In addition, mortgage rates have declined for the last five weeks in a row and 6% mortgages are not historically high. The pace of mortgage refinancing has actually risen in five of the past six weeks, with refi activity at its highest level since January. Curiously, the amount of cash being extracted from property has remained relatively constant in spite of higher interest rates and a softening housing market. This may mean that homeowners still have significant equity in their property to cushion the deflationary blow. Low rates of unemployment should also help. This past week, estimates for personal consumption in Q2 were revised higher, which corresponds with the fact that wages and salaries grew at an 8.5% annual pace, the highest in more than six years. Recent reports from the nation's retailers are consistent with data from the Commerce Department that personal consumption increased 0.8% in July, the largest increase in spending since January and twice the June rate. It is worth remembering that the Consensus homebuilders, which have been declining for a year, have been reporting decent quarterly profits (see discussion below). In addition, although insiders like Robert Toll are expressing shock and dismay at the magnitude of the decline in demand, the homebuilding stocks themselves are not going down on the bad news. Moreover, there were only two sales by homebuilder insiders reported to the SEC over the summer: $3.6 million by Ryland's CEO Chad Dreier, and $1 million by Lennar's vice president David McCain, both part of regular programs set up years ago. The Toll brothers themselves (Robert and Bruce) exercised options recently, but did not cash them out. In contrast, insider selling among builder executives skyrocketed a year ago, with the same two brothers liquidating $265 million worth of shares in just one month that summer. The present insider situation in the builders further differentiates the industry from the dot com debacle, when insider selling was aggressive even after stocks had fallen 50%-60%. Currently, the stock of most builders is selling for around book value. If they start to write down significant amounts of land inventory over the next year, however, book value may decline another 20% or so, and Spear's team would expect shares to follow suit. But wouldn't it be a curious paradox if in the midst of a 2007-2008 “housing crisis,” the best long-term investments turn out to be the homebuilders themselves? Consensus Home Builder Review Spear takes a look at sales and earnings numbers reported by some Consensus home builders over the past quarter, starting with the two on the Buy List. Building Materials (BMHC) is the smallest construction-related company on the Buy List. The provider of construction services and building materials to professional residential builders and contractors reported second quarter results on July 25th. Revenue increased 31% to $922 million, while net income was flat year over year, at $34 million or $1.16 per share. The company's survival strategy: diversify regionally via acquisitions to avoid being concentrated in weak markets. With over 20% of the float sold short, many are betting against this company. If they are wrong, they will need to buy shares to cover their shorts. Centex (CTX) reported earnings on July 24th. Home closings increased 1% and revenues were up 13%, but earnings per share declined 11% to $1.39 and unit backlog declined 17% as sales orders fell 21%. Centex's full year 2007 earnings guidance is $7.00 per fully diluted share. The company's survival strategy: improve the balance sheet, stop acquiring land, diversify geographically and look for acquisitions in rebounding regions. In the first fiscal quarter, Centex repurchased 3,500,000 shares, and in July the company repurchased another 1,000,000 shares. There are 10,000,000 shares remaining in the current repurchase authorization. Other Consensus Buy List stocks include: Whirlpool Corp. (WHR) manufactures and markets a full line of major appliances and related products, primarily for home use. The company's principal products are home laundry appliances, home refrigerators and freezers, home cooking appliances, home dishwashers, room air-conditioning equipment, and mixers and other small household appliances. The company also produces hermetic compressors and plastic components, primarily for the home appliance and electronics industries. Labor Ready Inc. (LRW) is a national provider of temporary workers for manual labor jobs. Their customers are primarily businesses in the freight handling, warehousing, landscaping, construction and light manufacturing industries. These businesses require workers for lifting, hauling, cleaning, assembling, digging, painting and other types of manual or unskilled work. Content Courtesy: Zacks Investment Research | Blog Home| VitalStocks Home