|Shares Out. (in M):||0||P/E|
|Market Cap (in M):||2,900||P/FCF|
|Net Debt (in M):||0||EBIT||0||0|
|Subject||Let the Church Say, "Amen"|
|Entry||01/19/2006 11:40 AM|
I've had the same discussion with Armand over the years in the threads of a number of his previous home builder picks. I never understood the party line on economies of scale.
It is a price thing. And prices rise and stay artificially high because, in my opinion, there is collusion in the distribution channel.
|Subject||response to David101|
|Entry||01/19/2006 11:47 AM|
|I write the following with due respects. The homebuilding industry has many moving parts that make it difficult to analyze. I continually learn about the business, although I have followed it since 1986 and although I have two "friends" who were former CEOs of the larger companies, and who now have no axe to grind when they advise me, which they do. Frankly, some of your thoughts likely are not correct. For example, you state that, because some of M.D.C.'s overhaead costs have not decreased as a percentage of sales, the company has not benefited from efficiencies of scale. This is not correct because the company last year, when profits were above tend line, used the strong industry conditions to make some "investment" expenses. Also, managment's incentive compensation was unusually large in 2005. On anther matter if you spent time with the operating people of a large homeubilders, I think you would find that they have many ways to reduce costs as they grow -- through savings on labor as well as materials (they can use subs more efficiently -- the subs are not, in most cases, the "moms and pops" they use to compete with), through best practices, through using scale to reuduce unit marking costs, etc. You also point to some selective discounts on Centex homes -- yes, in the current weaker market, Centex and others started increasing incentives in selective markets, sometimes when the company made an error in opening a community in a less than desirable location or in a slowing market. These selective incentives have always been part of the busines -- and in spite of the incentives offered by Centex recently, including the ones in Atlanta that mede the press, I think you will see that Centex's margins in the current March quarter will be fine. Again, one can always select a negative or a possitive, but to understand the industry one needs to balance the positives and negatives with knowledge and perspective.|
|Subject||response to blue 320|
|Entry||01/19/2006 01:31 PM|
|I will cite some of the sources of efficiency of scale: national purchases of materials, appliances, etc. at a reduced price; importance of large builders and ability to keep the subs busy because of large volumes leads to better quality subs and lower costs; many communities in a metro area means lower advertising costs per community; the more houses that are build, the more tricks are learned to reduce costs that can be spread through company via best practices (optimium design can lead to lower use of material such as wallboard, wire, pipe, etc); high volume leads to ability to build sub-assemblies (trusses, panels, etc) off-site at reduced costs; increased size leads to some efficiences over such relatively fixed costs as corporate managment, costs of listing on NYSE and producing 10Ks etc, accounting costs, etc.|
|Subject||question re competitor|
|Entry||01/19/2006 01:39 PM|
I agree with much of your logic regarding the advantages of a small land base in a decelerating environment. Valuation issues aside, why not own NVR -- which has higher returns on invested capital than MDC -- based on your logic? Seems that all your reasons to go long MDC would aptly apply to NVR as well.
I enjoyed the write-up, and agreed with much of it.
|Subject||reply to Jaxson905|
|Entry||01/19/2006 01:48 PM|
|Thank you for your comments. I do not know NVR well. I was able to get some insigt on M.D.C. over the years. We are very conservative investors who believe that there is protection in a company's book value (if properly stated and other things being equal) and were impressed that M.D.C. today is selling at about what its book should be two years from now -- thus reducing risk. NVR is selling at a large multiple of book, which likely would preclude our studying it -- altough we very well might be missing an excellent opportunity.|
|Subject||Insider Selling & Margins|
|Entry||01/19/2006 02:36 PM|
I like the secular story in the home builders. There is demand for new housing as the population increases, wants a vacation home or is part of the supersize-me generation (after all, what is a SUV or mini-van, other than a super-sized station wagon?). There will be be peaks and valleys but the overall demand trend is positive.
I agree that this sector has a lot of moving parts. It is very much a part of larger macro trends, whether it is boomers retiring to FL or AZ, or low employment, or forign central bankers buying boat loads of 10-year Treasuries that keep mortgage rates artificially low.
But it still comes back to the margins. In 1995, MDC's pre-tax margin was 3.1%. That represents one end of the extreme, caused by the S&L crisis, particularly Silverado and Lincoln for the Denver area, and a recession. As I look at 2005's pre-tax margin of 16.6%, I have to say that is an extreme, too, caused by excessive liquidity and a thirst for 10-year Treasuries by foreigners.
The average pre-tax margin for MDC from 1995 to 2005 appears to be around 9.5%. I do believe there are some efficiencies of scale, and would think 11% would be normal. You believe 11% was normal and that they have now achieved 200 bps of margin efficiency. Based on what? The flaw with that arguement is that the top two cost inputs are land and labor, and margin improvements in those cateegories can be arbbed away.
Related to the margin improvement is their land strategy, which many home builders have adapted. The majors are controlling more land via options, which is bought in as the land nears development. Kind of like the real estate version of just-in-time inventory, where you only keep 1-2 years of owned land. The whole idea behind this strategy was to avoid the problems of the early 90's and having too much land on hand in a down cycle (oh yeah - this IS a cyclical industry). In a rising land market, this is like rocket fuel. Leasing lots seems to run about 7.5% of cost. If land appreciates more than 7.5%, the cost of leasing is "free." When land appreciates less than 7.5%, leasing starts becoming a bigger expense, either through letting unprofitable leases expire or extending existing ones) and margins shrink.
We can debate until the cows come home whether normal pre-tax margins are 11% or 13%, and neither of us will be able to provide any hard data to support our numbers. The only ones who know are insiders, which brings me back to: I'll buy when insiders buy.
I am all talked out about margins. Ready to talk cash flow?
|Entry||01/19/2006 02:54 PM|
|Why are they not willing to commit to a buyback the way others have been recently? Clearly the market has been rewarding RYL for this and BZH and CTX more recently. I assume part of the reason is their land supply. Since they have not made the large investment in land inventory, they need the cash more going forward. Which I guess begs the question if their Net Debt/Cap can be compared to peers due to the difference in business models. If they were to increase their land to the level of peers, they would probably have to take their leverage up to the levels more inline with the group.|
|Subject||there was another write-up 2 w|
|Entry||01/19/2006 03:14 PM|
|i can't find it anymore. did you see it?|
|Entry||01/19/2006 06:28 PM|
You have to deconstruct the numbers a bit to see what is going on, but your example will help illustrate some of the dynamics of the process.
You believe that they can do $6 bb in revs in 2006, which is a 23% increase over 2005. My question is how do you get there? Revenues increased about 20% between 2004 and 2005. If you look at their year-end figures in the 8-K, the number of homes sold increased 10.3% and the average home price increased 10.7%. Roughly speaking, half of the revenue increase came from increased prices and half from selling more units.
You said backlog is up 27% yoy. That is based on the estimated sales values. In terms of units, the backlog increased 3.6%, so a large part of the backlog increase is from price. You can see that in the average backlog home price at the end of 2004 was $295K and it is $374K at the end of 2005. The grey area is that homes are not homogenous, i.e. the retiree rancher in FL would be cheaper than the MD McMansion, so product mix is a variable. But there are some clues from past. At the end of 2003, the avg backlog price was $286K. The avg home price settled in 2004 was $254K. The $295K at the end of 2004 compares to avg price settled of $283K. So backlog price is the ideal. There are cancellations that factor into the mix. Plus, the current backlog of 6,532 units represents about 5 months of sales based on the 15,307 units sold in 2005.
Related to the mix issue is that CA, MD and VA have the highest avg prices - around $500K. In 2005, homes sold in those three states accounted for 23% of units sales but 36% of revenues. The combined backlog in those three states went from 3,261 at 12/31/04 to 3,222 at 12/31/05.
There has also been concern because MDC's 4th Qtr 2005 orders of 2,405 was almost 10% below 4th Qtr 2004 orders of 2,662.
The biggest question is what will normalized sales be? The whole idea of margins reverting to normal is based on demand returning to normal, but that means demand has to decrease. If we had hyper-inflation or explosive population growth or a surge in employment, demand could contract without MDC having to cut price or sell fewer units. But we don't have those conditions, so the likely case is that prices flatten with the possibility of a decrease in units sold.
Let's assume for a moment that MDC does $5 bb in revs for 2006 at 11% pre-tax margins. Assume 37.5% for taxes and 46 mm shares and you get $7.50ish EPS. That would put MDC at a 8.7 P/E. Historically, it has traded at a 7.0 P/E. The margins won't shrink all the way to 11% in 2005. Let's assume the same $5 bb in rev, to be conservative, and plug in 14% pre-tax margins. That generates a $9.50ish EPS or about a 7.0 P/E at current prices.
Thus, I could say MDC is fairly priced, and maybe slightly cheap if I think they can do $5.5 bb in revs.
Since I have neither the insight nor a time machine to predict what actual sales volume and price will be in 2006, I'll wait on the sidelines. I'll know MDC is cheap when I see insiders buying with two fists.
|Entry||01/19/2006 08:28 PM|
|sorry if I inferred that bv had anything to do with cash generation -- did not mean to|
|Subject||reply to David101|
|Entry||01/19/2006 08:37 PM|
|Agree with most of what you write. The question of margins will be proved by experience. I base my estimates on what others have led me to over the years -- the others are former CEO's of large homebuilers who I have gotten to know -- one since 1986. This is either a good business where the large bulders have advantages that are reflected in higher margins vs. higher cost, less well positioned mom and pop builders , or it is not -- and therefore where the large builder's margins will shrink under the weight of competition. I believe in the former -- and time will tell. In the meanwhile, we are protected by a book value and by a stock that would be selling at a much lower PE than the stock market even if 11% or 10% is the correct margin -- so either way I believe M.D.C. is attractive -- which is the beauty of the investment -- I can be wrong by quiet a bit and, over the longer run, have little risk and still make some money.|
|Subject||reply to allen688|
|Entry||01/19/2006 08:43 PM|
|You raise a good point. My reading is that Larry Mizel believes that there is a good chance that land values will decline (maybe quite sharply) and that M.D.C. should have considerable dry powder to take advantage of such a situation - and that purchases of inexpensive,well located land can then drive the company forward. The Lennars did this in the early 1990s and greatly benefited from this in the late 1990s and into the new century.|
|Entry||01/19/2006 08:44 PM|
|No, I did not -- what happened to it?|
|Subject||to many of those who wrote que|
|Entry||01/19/2006 09:39 PM|
|Many of you have raised good questions - questions that got me thinking. I have the following thoughts. The 2001-3 period, when M.D.C.'s margins averaged just above 11%, should have been a difficult peiod to be a homebuilder. 2001 was a recession year. Just after 9/11, Larry Hirsch (then the Chair and CEO of Centex) told be that the homebuilding business was a disaster -- traffic had collapsed and the view was that it would be a long time before orders returned to a normal level. Weak order in late 2001 and into 2002 dampenend revenues and profits in most of 2002. Orders improved some in late 2002, but the economy was still weak -- and the unemployment rate still high. Homebuilding orders did not turn strong until mid-2003 -- and those orders were not closed until early 2004 (with few exceptions). Thus, 2001-3 should not have been pretty years for the homebuiders -- and yet in that environment M.D.C.'s margins were 11+%. I firmly believe that large homebuilders are becoming more efficient with size and time (learnings to be more professinal, instituting best practices, etc.) and this all give me confidence that 13% or so are not unreasonable margins for a normal environment -- and that, if anything, the 13% could prove conservaitve. |
Again, the attractiveness of M.D.C. seems to come down to whether you believe that the homebuilding industry will continue to consolidate -- which is my belief. If it does continue to consolidate, than one can purchase a rapidly growing company (over a cycle), (1) with a strong management that owns 25% of the outstanding shares, (2)with a strong balance sheet, and (3)with a book value that in two years should equal the current price of the stock -- at a very low multiple of earning in a normal year. Give the above characteristics of M.D.C., I could make a strong case that it deserves to sell at least at a market multiple -- which means that the shares would more than double. Furthermore, all the negativism about the homebuilders adds to my confidence about M.D.C. as an exciting invesment -- becuause the present price likely already reflects the negativism. I beleive that the real debate should be about whether the industry will continue to consolidate -- and not about the homebuilding cycle.
|Entry||01/20/2006 04:47 AM|
|I liked your writeup and the ensuing discussion but I wanted to comment on your statement that "the 2001-3 period, when M.D.C.'s margins averaged just above |
11%, should have been a difficult peiod to be a homebuilder."
From January 2001 to June 2003 the Fed reduced rates by 550 bps. Mortgages rates began a long, steady fall to all-time lows in 2004. The census bureau publishes annual housing completions going back to 1968 (http://www.census.gov/const/compann.pdf). If you look, you'll see 2001-03 was pretty decent, about 50% higher than the trough in 1991. This doesn't mean that MDC's normalized margins are or aren't 11% but I just wanted to note that those years weren't exactly the great famine for builders.
Do you have any examples of smaller homebuilding companies that have gone bankrupt or experienced a decline in orders as a result of losing share to the larger builders in the last few years? Thanks.
|Entry||01/20/2006 10:14 AM|
|Why have new homebuyers seen no part of the scale economies you trumpet in the form of reduced or even level home prices? |
I made an off the cuff comment about the collusion in distribution channels, but others are looking in this direction. See:
DOJ Competition & Antitrust Workshop on Real Estate Industry
I think collusion in restraint of trade, supported by a licensing system, explains a portion of the issue. In any event I'm still steaming over the commissions I paid on two real estate transactions this past year.
On another front, I recognize that the shift from outright buying of land to option purchases and JV arrangements has impacted reported gross margins. Should analysts consolidate the JV's and look at margins on that basis? Is there enough information out there to do this for most companies?
Armand, you've had an amazing run with the builders and I commend you on it. I just have always felt that the success folks experienced here was misattributed. Afterall, negative real rates of interest, laddering, and collusion throughout the distribution channel (appraisers, brokers/agents) offered an assist as well.
|Subject||Pair Trade etc.|
|Entry||01/21/2006 01:22 AM|
|Kudos to Armand and David for an interesting writeup and subsequent discussion of MDC. I appreciate all the well reasoned arguments on both sides though I suspect that David may be right that the timing might be early here. I have a copy of questions and would love to hear your thoughts:|
1.) Possibility of a Pair Trade
Are there any companies that might be good to pair with MDC. If we accept the thesis that MDC is better than the pack, which companies would be good candidates to short against an MDC long? Ideally, based on either poor management, high land inventories or unattractive valuation.
2.) Reasons for valuation
As was pointed out, over long periods of time, the homebuilders (even good ones) seem to trade at mid to high single digit PEs. If this is such a good business, why is the market putting such low multiples on "normalized" earnings? One possibility: recent earnings are supra normal and will mean revert to significantly lower level. But perhaps you have other thoughts or more details to add. I've noticed that (to generalize) the proportion of the pain can be comparable to the proportion of the excess. Since 2001 - thanks to Greenspan & Co - helicopter liquidity and interest rate stimulus, housing has exploded to the upside out of proportion with fundamental demand and long-term trends (as was noted). When this corrects, dont you think the correction could over shoot in the other direction? In that case, isnt a 1991/1992 scenario more likely to represent the downside case - i.e. more competion from excess of secondary market homes, perhaps higher rates from a macro shock - leading to significantly lower volumes and lower prices? In this type of scenario, could not sales drop 30 to 50% from current levels? (say units and prices both drop by 20% each in the next 2 to 3 years) - If you think this is rediculous or impossible, I'd appreciate your reasons. It is in part, because of the possibility of this scenario that I am wondering if there isn't a way to hedge out some or a good part of the macro scenario through a pair trade. Any thoughts?
3.) Other investors
Finally, I heard David Einhorn present this at several conferences last year. Any idea whether he still holds the company and whether they have been buying? Who are the other large holders?
Thanks again to everyone for a lot of thoughtful analysis
|Entry||01/21/2006 05:48 PM|
|Time to talk about consolidation/growth. I forget who mentioned it, maybe it was Cramer, but the top 10 builders in the US control only 30% of the market, so they have lots of room to expand. |
It's a half truth. If new homes were widgets that sold for the same price everywhere, home builders could continue growing for a long time. But what is interesting is that the top builders have tended to expand into the same markets: California, Phoenix, Las Vegas, Mid-Texas, Florida, the Atlantic coast line. This week, Toll announced it was buying a piece of Chrysler's testing ground in Phoenix. There are a number of builders already in Phoenix. Why do I mention this?
Builders are not dumb and they know it is all about location, location, location. Build where the demand is because that means good pricing and units sell fast - key elements to making money in home building. Soft pricing and slow inventory turn - very, very bad.
Now relative to MDC, their current orders have an average price of $374K per unit. The question is how many more areas in the US are there that MDC can sell homes for $350K or more?
Why is price important?
Simple, higher priced homes have higher margins and higher profits. You can see it in the margins of the home builders. TOL has the highest historical operating margin of the top 12 builders at 16.0%. At the low-end, you have BZH with op. margins of 7.0% historically and RYL at 8.4% historically. Think of it this way: A new 2,800 sq home in the Metro DC area will cost $450K while the same home in Metro Ft. Wayne, Indiana will cost $250K. Materials and labor will be roughly the same. There is a big difference in land prices but not $200K worth. Thus, the $450K home is more profitable and higher margin.
Even if margins were the same on lower priced homes, they have to sell more homes to maintain the same revenue and profits.
But there is another issue and that is home size. Builders have benefited from selling larger homes. The bigger the home, the higher the margins. There are fixed costs in building a house so there is "building leverage" in increasing home size. A 3,000 sq home does not cost 50% more than a 2,000 sq home to build, especially if it is on the same lot size.
This is all to put the perspective on the type of customer that MDC sells to. A good portion of MDC's sales are to upper middle class buyers. There is nothing wrong with serving that segment, but it is limited and once you move up market, it is much harder to move down-market without compressing margins sharply. It is much easier to move up-market and that has been happening with the big entry-level builders pushing up market. All the builders want to operate in this market, and there have been more than enough buyers filling the category that there has been little competition. But what happens if demand simply reverts back to normal?
That is today's lesson: know the locations and markets that the home builder serves.
|Entry||01/21/2006 11:41 PM|
Indeed, MDC enjoys one of the best ROIC's among home builders and has one of the lowest P/B ratios. But ratios are only a starting point for looking at a company. What do you make that ROIC peaked in 2000-2001? Or that its current P/B of around 1.65X is 26% above its historical levels? They are just numbers that give us a starting point in projecting what they will earn in the future.
Given that MDc's capital structure has not changed dramatically, other than a gradual deleveraging as debt to capital has gone from 50% to the low 30's in the past 10 years, there is a correlation between margins and ROIC, i.e., I cannot see ROIC expanding when margins are shrinking.
You had asked why it trades so cheaply. Same reason that steel companies tend to. ROIC's tend to be low (let's face it, MDC's normal ROIC is probably around 15% and according to magicformulainvesting.com, there are a lot of companies with much higher ROIC's out there). Home building is a capital intensive business where you have to acquire land inventory and then build the house before collecting much of the sale price. You can see it in their cash flow statements - they look horrible because of the inventory build.
The other reason for single digit P/E's is the cyclical nature of the business. Home building is impacted by interest rates and by the economy, and they can change very quickly. Home building tends to be characterized by booms and busts; rarely is the new home market in a smooth transition.
|Subject||mortgage ops, title biz,k deri|
|Entry||01/22/2006 07:05 PM|
thanks for the write-up. what is your response to dave's comments about the mortgage ops, title biz. also how comfortable are you with derivatives mentioned in the footnotes?
|Subject||reply to Charlie479|
|Entry||01/24/2006 07:31 PM|
|Thank you for your thoughful questions. The easiest one first -- the largest 10 homebuilders have increaed their market shares from abut 9% in 1996 to about 24% currently. Many smaller builders, and in past years we spoke to some, simply came to the conclusion that given the cost and dificulty of financing, the difficulty of getting attractive permited land, and the aggressive marketing, etc. strategies of the large builders, that they simply would develop out their remaining land holdings and then leave the business --- this is what happened as opposed to many bankruptcies. Regarding another question, most observers -- including Harvard's Joint Studies on Housing group, believe that a normal number of single family starts in the U.S. (which takes into consideration the basic demand for homes due to family formation, the tearing down of old obsolete homes, etc) is 1.4-1.5 million. Single family starts in the 2001-2003 period were near or below that level. The decline in short term rates (and long term rates and mortgage rates did not decline that quickly) is a positive -- but major negatives in the 2001-2003 period were the recession (and hence lack of confidence) and 9 /11. You made an important point, starts in 2001-2003 were much above 1991. Let us look at what happened. Until the last 15 or so years, most homes were financed by mortgages obtained at banks, especially S&L's. When the S&L crises came, financing for developers and eventual homeowners dried up -- and this caused an unusually low level of housing starts-- way below basic demand. The drying up of financing to small mom and pop builders was the trigger that caused the small builders to withdraw from the business and created the vacuum grabed by the big builders that had access to public financing. I spoke to several small builders that said that they withdrew from the homebuilding business because banks made they personally guarantee new loans -- they were unwilling to put their entire net worth on the line for a new buuilding community. Best Armand\440|
|Entry||01/24/2006 07:35 PM|
|Hi - we have disagreed for several years. During those years I have depended on the knowledge of a few friends who are in the business -- and they have largely been right (they are particulary knowledgeable, bright, and successful). Best, Armand440|
|Subject||reply to Abrams705|
|Entry||01/24/2006 07:40 PM|
|Tnank you -- my best guess is that, partially because of the problems during the S&L crises and partially because manamgnet has already become so successful financially, that, if anything, the company will be on unusually good behavior re accounting, etc.|
|Entry||01/24/2006 07:50 PM|
|I am confused by your questions -- please be more specific. Armand440|
|Entry||01/24/2006 11:46 PM|
|i was referring to dave's comments, particularly :|
"Another issue to discuss is the in-house mortgage financing
business. No one seems to notice that many of the homes sold by builders had financing
arranged by the builders. It is often referred to as the capture rate and MDC had a
capture rate of 54% in 2004, which I'll admit is lower than other builders. Almost all
these loans are flipped and are not kept on the books. There is a two-fold concern
here. One is underwriting quality, as evidenced by KBH's settlement with HUD last
summer and the sale of its mortgage ops to Countrywide. Second is that they are dependent
upon a liquid wholesale market for the loans. I am not suggesting anything
nefarious is going on with MDC, just pointing out an area that bears watching, especially as
Value Line noted that 32% of MDC's 3rd qtr sales used interest-only mortgages. It
is easy to overlook the mortgage ops because revenues and profits are minor compared
to home building but they are integral to making sales happen.
As for the derivatives, i notice they use derivatives and was wondering if you have more detail than what's disclosed in the footnotes.
thanks in advance.
|Subject||reply to scrooge83|
|Entry||01/25/2006 06:07 AM|
|Thanks. Do not know anything more about derivitives. Am not too concerned about mortgages. Had reviewed FICA scores, etc. with them and believe that mortgage quality is a modest problem in our whole nation, but not particularly with M.D.C. Best Armand440|
|Subject||to david and armand|
|Entry||01/25/2006 12:55 PM|
|Thanks for the responses.|
|Subject||sustainable competitive advant|
|Entry||02/06/2006 12:38 PM|
|Back in 2003 I looked at several homebuilders and recall HOV saying they acquire one or many small builders, one market at a time, acquiring control of more than half of the market in question. This would let them build a competitive advantage from the start and counter some margin compression over the long run. (I'm talking about competition vs. other big builders, not smaller ones). How does MDC compare to other big builders in that respect? |
Do you happen to know if HOV still has such advantages or if the quality of their (and other builders') acquisitions has deteriorated over the past 2 years? How about the price of the acquisitions?
|Subject||what made you bearish?|
|Entry||02/08/2006 04:23 PM|
|Armand, I've gone through all your homebuilder message threads. Together they're a nice platform for further researching this industry. Your strategy of buying a relatively land-light builder @ close to book certainly sounds conservative to me but now I've got a few tough questions, quoting things you've said in various threads: |
1) you said WEB bought CTX. Was it your impression he was "dipping his toes" & planning on buying more or buying an entire builder, or had he established a full position?
2) HOV's CEO/CFO told Blue320 that costs are local and the whole scale thing is very exaggerated. You've provided an interesting rebuttal, but can you state outright that HOV's CEO/CFO was wrong? (assuming he really said exactly that)
Look again at what you say there: "So when interest rates rose…" & "not the cost of money, has changed". You are contradicting yourself. Interest rates rising is equivalent to cost of money rising. Availability & cost of funds are connected. If you really want to lend to people who really want to borrow from you, then you'll find depositors who really want to deposit. Now you might rebut: "But We had an S&L crisis", which brings me to your next sentence:
Yes, things have changed. Today our mortgages are financed by hedge funds who think about 2&20 on December 31st and MBS investors overseas whose names we can’t even read.
But what if we get even more inflation during the slowdown? The things that caused the housing boom/bust in the first place also happen to be inflation-generators. This correlation affect could cause what is popularly known as "stagflation".
In prior threads you stated multiple times being aware of the macro problems. You said you'd hold the shares… the market is a weighing machine in the long run.. you don't care about interest rates, etc. But now you've apparently been shocked into selling. I would infer that it took a whole lot of headwind to shock you since your holdings and bullishness were sizable. Can you therefore share with us what you foresee in the macro environment that scared you so much? (or is it simply that the shares were very overvalued?)
Your sell-off of land-heavy builders seems to indicate fear that they'll have a liquidity crisis. After all, if they're undervalued long-term cash generators, why do you even care about book value?...especially as an ardent homebuilder bull!
So my question is this: since history suggests liquidity crises usually hit an entire peer group, won't MDC suffer the same nasty treatment from capital markets as all the others?
Don't get me wrong, your purchase of MDC sounds relatively conservative, I'm just surprised you didn't suggest a pair trade given your newly bearish medium-term stance.
|Subject||The family’s all here…|
|Entry||02/08/2006 07:43 PM|
|The family’s all here…|
On Monday, homebuilder MDC Holdings filed their preliminary proxy which was chock-full of interesting things. Among them were the enormous bonuses given to both Chairman Larry Mizel and COO David Mandarich, the second year in a row that both men’s bonuses were over $20 million. Indeed, both men saw their bonuses increase modestly in 2005 (if the word modest could be applied to a $20 million cash bonus), despite the fact that the company’s stock declined and also underperformed MDC’s self-described peer group.
Equally interesting was the long list of related party transactions, including the new disclosure that Mandarich’s son, Christopher took home nearly $800K last year between salary, bonus, and restricted stock, as the company’s regional president for So. Cal and Nevada. David’s sister, Carol, also is a new addition to the filing, and drew a salary of $80K and another $30K in bonuses. It’s not clear from the filings how long both have been on MDC’s payroll or how their salaries compare to prior years. The proxy does note, however that Larry Mizel’s wife, Carol, who I highlighted in this post last year, had her decorating fee cut to $120K a year, down from $240K. There was also the fact that in addition to paying longtime director Gilbert Goldstein $252K in consulting fees in 2005, it also provided $17K worth of office space. Goldstein’s contract is set to expire at the end of this month.
A few other interesting tidbits had to do with Mizel pre-paying for his personal use of the corporate jet (a good thing that may one day rub-off on other CEOs) and that the MDC/Richmond American Homes Foundation has a net worth of $26 million and has paid out $2.24 million since its inception in 1999.
|Entry||02/13/2006 02:58 PM|
|Great thread on the homebuilders. I have a quick question regarding the implications of a severe correction in the homebuilders. If prices and units do decline by 15-20% each and revenue falls off a cliff, what is the read-across for the economy given the well documented lack of savings in the country and the use of "equity" in an individuals home as a sort of piggybank?|
I dont own a homebuilder but it seems the multiples account for a dire outcome yet companies most directly impacted trade at far more robust valuations. For example, what would happen to Home Depot's outlook (I am not close to HD - just throwing it out there) if new construction, remodels and improvments slow?
|Subject||armand - a picture is worth...|
|Entry||03/15/2006 06:15 PM|
|In one of your threads you mentioned that big homebuilders would not directly compete with one another until 10 years from now, when they will have captured most of the market share from smaller bankrupt builders. I had given the benefit of the doubt to that argument until today, when I saw the following picture:|
Note the D.R.Horton sign says "NYSE listed"... reminds me of the good 'ol days
|Entry||03/15/2006 07:15 PM|
|Amusing picture. There are still many smaller builders in the U.S. (thousands of them). In the current and expected down market, these small builders will have a much more difficult time than the large builders, because their cost structure. We feel that they will continually and gradually leave the business, creating a vacuum that the larger builders will fill for many years. If the small builders face very serious problems, the exodus could take less than ten years, but this would be a high quality problem. I do feel that the lowest fruit aleady has been picked by the largest builders, so their gains in market share will be less than during the past ten years.|
|Entry||04/20/2006 10:05 PM|
|We expected a downturn, but frankly Q1 orders were moderately weaker than we expected (because cancellations were 30%). Our thesis remains that most of MDC's competitors purchased land too aggressively in 2005 and that MDC will be advantaged both in the downturn and then at the bottom, when they can take advantage of opportunites at a time when many competitors will be out of the land buying business, or looking to reduce their land holdings. Larry Mizel alluded to this on the call -- and I think he is right to build dry powder and not to repurchase shares. The company's book value will end the year at about $54 and very likely will be comfortably over $60 at the end of 2007. We would be surprised if MDC sold below book, especially given its strong balance sheet. One reason orders were relatively weak in Q1 is that the company is in the land constrained areas that were paticularly strong last year. Coming out of the downturn, I would want a company that is heavily dependent on land constrained areas because that is were the best long-term opportunites are. In short, while I was dissapointed in Q1 orders, nothing has changed re our longer term thinking.|
|Entry||05/30/2006 02:54 PM|
Do you have any opinion about the character of Larry Mizel? A couple of people have told me that they decided not to do business with him after the Silverado affair, and I wondered what you thought of this.
|Subject||Any update Armand?|
|Entry||07/20/2006 05:01 PM|
|This sector sure is a hard one to figure out right now.|
|Subject||More on Collusion Claim|
|Entry||07/22/2006 08:16 AM|
|New Headache For Homeowners:Inflated Appraisals|
As the housing market cools, Americans are confronting a problem that was easy to ignore during the boom: inflated appraisals of home values.
Critics inside and outside the appraisal business have long warned that many appraisals are unrealistically high. That's partly because generous appraisals help loan officers and mortgage brokers, who often choose the appraiser, complete more deals. If a home is appraised at less than the buyer offered, the deal is likely to fall through.
Inflated appraisals didn't matter much when home prices were rising at double-digit rates, since market values would quickly catch up. Now, however, prices are leveling off in many places and falling in some. Some homeowners are finding that the market value is below what past appraisals led them to believe.
The appraisal system has a built-in conflict of interest. Appraisers often are hired by loan officers or mortgage brokers, whose compensation depends on how many loans go through. Appraisers, dependent on loan officers for their livelihoods, say they often feel pressure to come up with a number that will allow a home purchase or refinancing to proceed.
Eric Randle, an appraiser in the Los Angeles area, says he frequently receives faxes from loan officers asking whether he could appraise a specified home at a certain level. The implication is that an assignment will be forthcoming only if he's willing to hit the desired number. Mr. Randle says he declines to work on those terms.
One of Mr. Randle's appraiser friends recently received a fax from Eric J. Roberts, a mortgage loan officer in Bakersfield, Calif., for Pinnacle Financial Corp. The scrawled fax message listed an address in Los Angeles and said, "I need 2 get to 750K for this Appraisal. If not please provide a value range or call me."
Mr. Roberts declined to comment. Doug Long, chief executive officer of Orlando, Fla.-based Pinnacle, said he didn't think Mr. Roberts did anything wrong but added, "The wording could have been better."
Consumers often play along with dubious appraisals. Danny Wiley, an appraiser in Nashville who is a member of the national Appraisal Standards Board, in May was asked by a lender to appraise a condo in Spring Hill, Tenn. The buyer had offered to pay $139,000, but the contract required the seller to pay $10,000 toward the buyer's closing costs. In effect, Mr. Wiley says, the price had been inflated by $10,000 to allow the seller to provide money to help the buyer cover closing costs.
Mr. Wiley estimated the value at $129,000, the same price at which numerous identical units in the same complex had recently been sold. That should have killed the deal. But Mr. Wiley says the sale later went through, apparently after the lender found another appraiser willing to value the condo at $139,000. Mr. Wiley declines to identify the parties involved in the transaction, citing client confidentiality.
Federal law governing appraisals dates to 1989, when Congress passed legislation aimed at preventing a recurrence of the savings-and-loan crisis. That law leaves licensing and regulation mainly to the states, but many of them don't provide much funding for oversight.
T.J. McCarthy, chairman of the Illinois Real Estate Appraisal Licensing Board, says the state's appraisal regulatory agency is "severely understaffed." As a result, he says, the backlog of unresolved complaints is so large that rogue appraisers sometimes can retain their licenses for years while awaiting regulatory action. The Texas agency responsible for monitoring appraisers has just three investigators, all part-time, and is so stretched that staff members answer the phone only in the afternoon. As part of a broader push to improve legislation of mortgage lending, Congress is discussing provisions that would tighten regulation of appraisers.
Some lenders use appraisal-management companies to create a Chinese wall between the appraiser and the loan officers. But appraisers say these companies often choose the cheapest and fastest appraiser rather than the most qualified. "You get someone who is not intimately familiar with the local marketplace because they are willing to do it for less," says Jeffrey Jackson, chairman of the appraisal firm Mitchell, Maxwell & Jackson in New York.
|Entry||07/24/2006 04:51 PM|
I very much appreciate the time that you have spent to educate us about homebuilders. This thread and others are a great primer on the industry.
Three questions that I do not think have been asked:
1. On a recent DHI call, Don Tomnitz said that the share held by big homebuilders was 25% nationally, but 40-50% in the larger markets (he was not precise about defining "larger"). Do you agree with him? Does this worry you as you think about the big builders eventually competing away the profits wrung from the small guys?
2. If you were a builder CEO, would you rather have high local market shares (like Centex wanting to be top 5 in every market they compete in), or would you prefer to move between markets opportunistically, like MDC has done in places like Texas?
3. What is more important for scale advantages - high local market shares or high national market share?
Thanks for any help.
|Subject||why not NVR?|
|Entry||07/25/2006 02:38 PM|
Your arguments for MDC might also argue for owning NVR
Do you agree with that?
|Subject||Party Line Squiggles|
|Entry||08/26/2006 10:37 AM|
|"There has been little consolidation among the publicly traded builders in the past decade, but Robert Toll thinks the downturn could prompt some deals. He says there is some benefit to greater size because bigger home builders can take on larger projects." |
Toll says that the benefit of larger size is that companies can take on larger projects. I guess it's a variant of the standard party line (broad economies of scale in homebuilding) but the squiggle that I think he's introducing is also a tautology that, for me, really doesn't explain much.
I suppose bigger home builders (more assets and revenues) can take on bigger projects because they have more to borrow against and can therefore can invest more in the marginal project. But do scale economies come from the liability side of the balance sheet or from assets? Aren't liabilities enablers and stuff like productive scale the drivers of value?
And doesn't project scale (more financing, larger land ownership, bigger projects) introduce risks that require consideration?
The concept of economies of scale in the context of project based work just doesn't work well, particularly when those projects are scattered across a broad geography, are executed at different times, and share little across project in terms of productive effort.
|Entry||09/19/2006 04:52 PM|
|Just started looking at some of these...do you know why MDC's reported cancellation rates are so different from, say TOL's? In FY95 it was 25% vs. TOL's 4%. I assume it's definitional |
|Subject||reply to ad88|
|Entry||09/26/2006 02:22 PM|
|Toll's cancellation rates are low becasue they sell very high price, luxury homes that they demand and receive a large deposit for. Buyers who cancel can lose a very large amount of money. MDC's cancellation rates are high because they are heavily concentrated in "land constrained" areas of the country that have seen particulary large appreciation in prices. Buyers will cancel if they find an alternative home that is being discount to the extent that it is worth losing the doposit, which tends to be small on MDC's less expensive homes.|