Thursday, June 26, 2008

Cracks Widening in Homebuilder Hovnanian Enterprises' Foundation

While Hovnanian Enterprises’ (HOV-$6.14) balance sheet is improving, the operating environment in general for the industry remains bleak in an ongoing recession-like environment.

The US housing industry has been hit hard in the past two years, a decline which will take longer than usual to correct (as depicted in the image below)-- exacerbated by rising unemployment and food & energy prices.

Although the homebuilder’s cancellation rate is improving, from38 percent to 29 percent, backlog is down 54 percent-- or $1.2 billion—and its last quarter metrics remains abysmal, alongside its comparable rating amongst BZH (Ba1), TOL (Baa3), DHI (Ba1) and CTX with a Caa1.

As if the inflationary environment is not enough, HOV has a real possibility of going insolvent because the money it raised from stock and debt issuance ($126 and 600 mn, respectively) went towards working capital needs and paying back revolver drawings. In addition, the company has limited access to its revolving credit facility. Latest EPS loss was almost 2x as high as Street expectations, coming in at -$5.29 vs. -$2.65 a share.

Cash on hand has been rising at most homebuilders (sales of subsidiaries, stock and debt issuances—TOL recorded $1.23 bn, CTX $775 mn, BZH $277.3 mn and DHI $519 mn). HOV management expects to be cash flow positive by year- end. , The Company has $500 mn in cash and expects to have $800 mn by year- end.

However, given the continued declines in housing starts (dropped 3.3% in May, the lowest level since '91 with single and multi-family homes declining 1% and 8%, respectively) and NAHM sentiment index dropping to 18 in June from 19 in May, there is no telling how bad it's going to keep getting –continuing increase in foreclosures and bankruptcies (i.e. LandSource, a significant joint-venture of LEN filing for bankruptcy).

Contributor Yaser Anwar does not hold a financial position in any stocks mentioned in this article. The 10Q Detective has a Full Disclosure policy.

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