Too Much Debt is a Bad Addition for Home Builders
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While home builder stocks have rebounded strongly for 2012, the levels of debt for many should be of grave concern for long term investors. Compounding the high level of debt for these firms is a negative profit margin for many, which is a lethal combination. Others have declining earnings, which are also threatening to the future prospects of these companies. As much of the home builder rally has been liquidity induced with strong support for buyers from government actions, the long term demand might not be there to allow these companies to recover fully, particularly with such heavy debt loads.
Beazer Homes (NYSE: BZH) is one such home builder. Over the last 52 weeks of market action, Beazer Homes is higher by 48.22%. But Beazer Homes is losing money with a negative profit margin of 12.13%. For the last ten quarters, Beazer Homes has had negative cash from operations. Compounding this is the net of cash debt of $1.5 billion, much of it at very high interest rates.
This results in a great deal of debt for Beazer Homes. The debt-to-equity ratio for Beazer is 8.05. That means it required more than eight dollars in borrowing to create every dollar in shareholder equity. While a short float of 5% is considered to be troubling for a stock, there is one of 16.03% for Beazer Homes.
The recent share price rise is also following a seasonal pattern for Beazer Homes that has transpired over the course of The Great Recession. It rises in the spring and summer, which is the peak home buying season. Realtors tout the strong sales, the press runs the stories, and the stock rallies. Then it drops in the fall and winter as sales decline seasonally. Last year, Beazer Homes was trading around $5 in the spring. By October, it was under $1.50 a share.
For 2012, PulteGroup (NYSE: PHM) has soared by 110.46%. This has taken place even though PulteGroup has a negative profit margin of 1.95% and a debt-to-equity ratio of 1.85. While borrowing can be used to juice up the return-on-equity (ROE), this does not appear to have happened with PulteGroup as its ROE is a negative 4.21%. A ROE of 15% is considered to be average. There is a short float of 9.03% for PulteGroup. Those short last year were rewarded as PulteGroup was over $8 a share in May. By October, it fallen more than half in value to around $4.
KB Homes (NYSE: KBH) has a short float of 47.51%, which is truly stunning. The company is also losing money with a very high debt load. It too has a negative ROE at minus 16.16%. KB Homes also plunged more than 50% in 2011 in price levels from the spring to the fall.
Over the last year of market action, Lennar Group (NYSE: LEN) has more than doubled. It has a very high level of debt. This debt-to-equity ratio of 4.85 will be difficult to service with earnings-per-share growth falling by 4.97% this year. For the next year, earnings-per-share growth for Lennar Group is projected to plunge by another 48.53%. There is a very negative trend for a company with such a huge debt load.
Standard Pacific Corp. is another home builder with a high level of debt and declining earnings-per-share growth. The debt-to-equity ratio for Standard Pacific Corp. is 2.08. Earnings-per-share growth is down more than 3% this year. Another bearish sign for its future is a price-to-earnings growth (PEG) ratio of 7.22. According to investing legend Peter Lynch this is one of the most vital financial indicators with a PEG of 1 being adequate; and the lower the better. There is a short float of 16.10% for Standard Pacific Corp. From the spring to the fall of 2011, Standard Pacific Corp fell from over $3.90 a share to under $2.50.
While a high level of debt, high short float and other bearish financial indicators may plague these home builders, it is not the industry norm. DR Horton (NYSE: DHI) has a profit margin of 21.67% and a very bullish PEG of just 0.75. The ROE for DR Horton is 29.34%. NVR Inc is debt free with a very modest short float. As the chart below reveals, NVR Inc and DR Horton have much more favorable capital structures than others in the home building sector.
The housing sector in the United States will rebound soundly when the economy recovers strongly. This is clearly not happening as economic growth is falling in the United States with unemployment rising. About the recent good news in housing, Robert Shiller, economic professor at Yale University and co-creator of the Case-Shiller Index cautioned that, "We seem to have upward momentum...but there are a lot of clouds on the horizon too."
On the macro-level, these "clouds" are the approaching "Fiscal Cliff" in the United States which could force the country back into a recession, the European debt crisis, weak economic growth in emerging market nations such as China, and the continuing need for American government entities at all levels to assist home buyers. That the Federal Reserve is considering additional quantitative easing measures is further proof of the anemic recovery in the United States from The Great Recession.
This tepid recovery is still taking place in the home building sector. Share levels are up so sharply as a result of the steep price declines suffered during The Great Recession. All share prices are well below the pre-Great Recession peaks. The high levels of debt, negative profit margins, woeful ROEs and bearish PEGs are testament to how weak many home builder stocks are despite huge price increases this year. The high short floats reveal that many do not expect these gains to last. With the seasonal share price patterns for home builders, those gains might be eroding very soon.
Fool blogger Jonathan Yates does not own any of the stocks mentioned in this article. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.