Shorting TOL and its confreres:
Under the Radar: Deconstructing the Homebuilders
By Christopher Edmonds
Special to TheStreet.com
11/16/2001 02:50 PM EST
While the homebuilding sector remains the darling of many analysts, one short-seller
continues to pound nails into its coffin.
This column profiled the homebuilders as a short opportunity back in August, and the play
was quite successful. While many of the sector's names have rebounded lately, one hedge
fund manager continues to like the short side.
"These stocks are trading on hope," says the fund manager, who wished not to be identified.
"We like the shorts more than ever. Employment trends are still negative; the stocks are
trading at a premium to book value where they were three or four months ago when people
didn't think we were in a recession."
Plus, the fundamentals of the homebuilding business are weakening: Backlog is stagnant if
not falling; inventory is edging higher; and cancellation rates are high, about 20% in
September, and creeping higher. In good times, cancellation rates run about 5% to 6%.
Homebuilding bulls point to the record level of mortgage business, something the fund
manager calls a false signal. "Mortgage originations have been strong, but 85%-plus are
from refinancing," he says. "With rates so low recently, everyone who wants a home has
purchased in the last year or two. The biggest risk is that everyone who wants a home has
one."
He notes that real estate agents are already reporting a significant slowdown in high-end
home sales -- generally, houses costing more than $600,000 -- which will eventually hurt
high-end builders like Toll Brothers (TOL:NYSE - news - commentary - research - analysis),
which he is short.
"What's happening with the economy is currently affecting high-end home prices, but that
will eventually filter down to midlevel builders as well," he says. Fed Chairman Alan
"Greenspan has done everything he can to support the homebuilders, but fundamentals
continue to weaken and there isn't much more he can do."
The manager is also short Ryland (RYL:NYSE - news - commentary - research - analysis) and
is eyeing as possible shorts both D.R. Horton (DHI:NYSE - news - commentary - research -
analysis), trading at more than two times book value, and NVR (NVR:Amex - news - commentary
- research - analysis), which trades at nearly five times book value.
However, he'd leave Centex (CTX:NYSE - news - commentary - research - analysis) alone, as
its diversified income stream provides some protection. If you want to be long the sector,
he says he'd focus on Clayton Homes (CMH:NYSE - news - commentary - research - analysis), a
manufactured-home developer. |
