Hovnanian’s Mid-Week Roller Coaster Ride

Residential construction firm Hovnanian Enterprisies (HOV) reported earnings after the close on Wednesday and reported a worse than expected loss. Earlier in the day, Hovnanian rose more than 11% in Thursday trading in reaction to slightly better than expected housing starts data this morning. Housing starts rose 8.9% to an annual rate of 574,000 homes, as the government extended and expanded the home buyers’ tax credit in the month. However, the NAHB/Wells Fargo index of homebuilder confidence unexpectedly dropped from 17 to 16 in the month of November, which seems to fly in the face of the somewhat encouraging housing starts data. Any reading under 50 on the index suggests pessimism on the part of builders, and of the 50 economists surveyed by Bloomberg, not a single one was predicting a decline in November.

Unfortunately for Hovnanian, they also had to report earnings on the day following this major advance in the stock and as a result the market was expecting to see improvement at 12 straight quarterly losses. In fact, the results were far worse than analysts had expected, and HOV fell like a stone after hours. Analysts set the bar relatively low, expecting revenue to fall 37% from a year ago contributing to a loss of $1.40 per share. Actual results showed revenue slumped nearly 40% for a net loss of $250.8 million or $3.21 per share. This setback confirms our fears that a recovery will not be as rapid for homebuilders as some would hope.

Management was quick to point out that the quarter showed some improving trends as net contracts improved from a year ago by 60%. Furthermore, they believe they have purchased some attractive land at depressed prices. The cancellation rate was 24% in the quarter, which is still high but improved from 42% a year ago.

However, in the here and now, we cannot see anything to be encouraged by in the results as of the close of fiscal 2009. Fundamentals have been crushed with revenue dropping by more than half and the company taking massive losses due primarily to impairment charges. Ockham’s current stance on HOV is Fairly Valued largely due to the low price, and HOV is among our best rated in the residential construction industry as you can see from the chart to the right. We continue to believe there is no reason in the fundamentals of these homebuilders that should encourage value investors to dive in. From our view, these are mostly tools for speculators looking to play a rebound in the housing market.

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Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

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