Hedge-fund manager David Einhorn has a prediction about publicly traded homebuilders: “Slowing orders, reduced prices, reduced margins, slowing backlogs – it’s all going to come.”
And he’s one of the bulls. “I don’t think that’s what the bet in the stocks is all about,” said Einhorn, who runs the Greenlight Capital fund.
Could it simultaneously be true that there is a housing bubble and that homebuilders are undervalued?
Housing-price gains have been huge and mortgage-lending practices lax. The washout was bound to come, and it looks as if it may have started. Investors are beginning to panic.
Toll Brothers, once the most admired homebuilder, warned in recent weeks that sales would disappoint. The stock is down almost 50 percent from its peak. KB Home has warned about cancellations and falling orders. That stock is off 25 percent from its top.
More warnings are sure to come. And the next stage could be big price cuts to move homes. Credit Suisse analyst Ivy Zelman, a longtime bear who is finally achieving a measure of vindication, says Centex is already running sales in select markets.
“Depending on where the builder builds … a great tailwind now becomes a major headwind. It was a great ride up, but it could be an ugly ride down,” he says.
Even while their earnings and shares were soaring, publicly traded homebuilders didn’t win investor respect.
Homebuilders have had years of double-digit earnings growth, through several interest-rate cycles and a mild recession. They have been taking market share from private developers and are up to around 30 percent from 8 percent in 1990, according to Zelman. What’s more, they have great returns: Industry leaders’ return on capital tops 20 percent.
Despite that, investors refuse to pay anywhere near what they pay for the average stock in the major indexes, based on earnings.
Homebuilders’ shares as a group are trading at six times projected per-share earnings. That means only one thing: The market doesn’t believe the earnings. And at the heart of it, they fear builder bankruptcies, as happened in the early 1990s.
“If you talk to a hedge-fund manager, (the homebuilders) are going from 50 percent growth to 20 percent to down 50 percent. It’s totally manic-depressive behavior,” says Margaret Whelan, an analyst for UBS who has a far less gloomy view herself.
That’s why the bulls need this housing slowdown. They are expecting that the companies will be able to have some earnings growth, grab more market share and throw off enough cash to buy back stock to shore up their share prices.
