Property Boom
How Big U.S. Home Builders
Plan to Ride Out a Downturn
D.R. Horton Keeps Costs Low
As It Takes On Small Rivals
In 'Pickup-Truck' Markets
Skepticism on Wall Street
By JAMES R. HAGERTY and KEMBA J. DUNHAM
Staff Reporters of THE WALL STREET JOURNAL
November 30, 2005; Page A1
FORT WORTH, Texas -- As a young man, Donald J. Tomnitz watched the arrival of Wal-Mart Stores Inc. doom his aunt's local drugstore in Mexico, Mo. Today, as chief executive of one of America's biggest home builders, D.R. Horton Inc., Mr. Tomnitz likes to compare his company to the steamroller that put his aunt out of business.
Both Wal-Mart and Horton were founded by folksy entrepreneurs rooted in Arkansas. Both cater mainly to moderate-income customers and have relied on high volume and rigorous cost controls to crush less-efficient competitors. Both have stellar long-term records: Horton, which sells more new homes than any other company in the U.S., says it has recorded a rise in earnings for every single quarter since it was founded in 1978.
But while Wal-Mart has long inspired awe on Wall Street, Horton and its biggest rivals are struggling to win respect from investors, who tend to view the industry as prone to boom and bust cycles. Fifteen years ago, when housing markets in parts of the country slumped, some large home builders ended up in bankruptcy court.
Now, as interest rates rise, the boom that has more than doubled house prices in many U.S. cities over the past five years appears to be nearing an end. Investors have driven down home-builder stocks by nearly 18% since their July 20 peak, as measured by a Banc of America Securities index of the industry. Though the Commerce Department estimated yesterday that sales of new homes in October surged to a seasonally adjusted annual rate of 1.4 million, up 13% from September's pace, the median price of those homes was up just 0.9% from a year earlier and most analysts say the market will slow in the next few months. (See related article.)
Horton and other big home builders insist they can keep increasing sales and profits rapidly even if the housing market slumps. They believe any downturn will be short-lived. And as the market consolidates into fewer hands, the big companies say they can squeeze suppliers for lower costs, grab the best land available and take market share from smaller rivals.
"We can earn our way through any economic cycle, except one like the Great Depression," says Mr. Tomnitz, a former banker and Army captain who has served as D.R. Horton's CEO since 1998, six years after the company went public.
Horton, which dubs itself "America's Builder," says it will sell 100,000 newly built homes in 2010, nearly double the 51,172 it sold during its latest fiscal year that ended Sept. 30. The company also projects that earnings will grow 15% to 20% annually over the next five years.
Pulte Homes Inc., the No. 2 builder behind Horton in terms of unit sales, forecasts that it will deliver over 10% more homes in 2006 than it will this year. KB Home, the fifth-largest builder, projects annual earnings growth of 20% to 25% for each of the next three years.
Many investors and analysts are skeptical about these goals. "These are still cyclical companies in a cyclical industry," says Ivy Zelman, a Cleveland-based analyst at Credit Suisse First Boston. Others are more worried. When the current house-price boom ends, says Peter D. Schiff, president of Euro Pacific Capital Inc., a stockbrokerage firm in Darien, Conn., home-builder stocks "are going to collapse."
The U.S. home-building industry still includes some 80,000 companies, most of them tiny local outfits, but it is changing dramatically. Five years ago, the top 10 home builders controlled only about 10% of the U.S. market. Now their share is about 25%, and the big builders predict it will top 50% within a decade. The top 10 had combined revenue of about $73 billion in 2004, up from $13 billion a decade earlier, according to Builder magazine, a trade publication. Five home builders are now in the S&P 500-stock index, including D.R. Horton.
Bulking Up
As their companies bulk up and Americans obsess over the value of their homes, chief executives of the biggest builders have become regular guests on business TV channels. They also pay themselves like investment bankers. Bruce Karatz, chief executive of KB Home, earned $23.9 million last year, including base salary, bonus, restricted stock awards and long-term incentive pay. Total CEO compensation for the other top five builders last year ranged from about $8.7 million at Horton to $19 million at Centex Corp. That compares with a median of $6 million for CEOs of all S&P 500 companies, according to Corporate Library, a corporate governance advisory firm in Portland, Maine.
Home building is turning into one of the nation's "core" industries, as auto manufacturing did in the early part of the last century, KB's Mr. Karatz says. Americans spent around $417 billion on newly built homes in 2004, estimates Michael Carliner, an economist at the National Association of Home Builders. That compared with $687 billion of new car sales in the same year.
One big difference from the auto makers: Builders have relatively small work forces. Horton employs about 8,900 people, compared with 325,000 at General Motors Corp. That's because home builders subcontract virtually all of the construction to specialist firms in such trades as framing, electrical wiring and plumbing. "I view this business as a form of retailing," says Gregory E. Gieber, an analyst who tracks home building at A.G. Edwards & Sons Inc. in St. Louis. "Their job is to design, market and sell something which they don't actually manufacture." That means the home builders don't have to pay severance costs if their demand for construction labor suddenly drops.
Horton already builds homes in 74 metropolitan areas in 25 states. It expects to branch out further, hopscotching its way from sprawling cities to growing towns nearby. By using the existing staff in the big cities to manage the new areas, it avoids adding new layers of administrative costs. In these smaller "satellite" markets, where few big housing companies venture, Horton believes it can grab business from what Mr. Tomnitz calls "pickup-truck builders."
One new market where Horton recently acquired lots for new homes is Baton Rouge, La., which is booming as refugees from Hurricane Katrina seek housing there. Horton plans to use existing management teams in Texas to help oversee the Baton Rouge expansion.
Horton bought 17 companies between 1994 and 2002, a period in which acquisitions accounted for about half of the company's growth. Its most recent major acquisition was the $653 million purchase of Schuler Homes Inc. in 2002, which helped vault Horton into the industry's No. 1 spot in terms of unit sales that year. While he doesn't rule out further acquisitions, Mr. Tomnitz says he is focused on growing the company without them.
Horton and other large builders say they now have enough financial strength to give them a big edge over small and midsize competitors in negotiating with suppliers and in bidding for choice plots of land, which can sell for more than $100 million. Horton estimates that it saves $3,500 per home by negotiating national contracts with suppliers of such things as appliances and roofing tiles. The big builders also can afford to fight long legal battles over zoning or spend years persuading local politicians to back their development plans.
Horton also expects to grow by constructing more townhouses and condominium buildings in states like California and New Jersey, where prices of houses with their own yards have soared beyond the reach of many buyers. Until 1996, the company built only detached single-family homes with their own plot of land. In the 12 months to Sept. 30, condo buildings, duplexes, townhouses and other so-called attached homes made up about 17% of Horton's sales and the company expects that figure to grow. By squeezing more families into smaller spaces, Horton executives say they can keep prices affordable and attract buyers who otherwise would have to rent.
America's big home builders say they have learned lessons from the past, when the companies often found themselves carrying too much debt and owning too much land during market slumps. Today, big builders increasingly negotiate options to buy land rather than immediately purchasing it outright, a technique that gives them an escape route if their land needs prove smaller than expected. They have stronger balance sheets than before. The median debt load for major builders is 43% of their capital, down from 57% in 1990, according to Ms. Zelman, the CSFB analyst.
Even so, Ms. Zelman argues that the home builders haven't insulated themselves from downturns. She thinks housing demand in recent years has been artificially inflated by the lowest interest rates in four decades, an influx of investors speculating on higher home prices and lenient loan terms -- factors likely to diminish as the market cools. Investors and buyers of second homes accounted for 18% of sales of new and previously owned homes in this year's first half. "What happens if 15% of demand goes away?" asks Ms. Zelman.
Ms. Zelman doesn't expect the big home builders to implode. But she does think that profit margins will shrink in the next few years as the market cools. If home prices are flat or fall, she doesn't believe Horton will be able to meet its target of recording double-digit profit growth every year.
Horton executives reject any suggestion that they are vulnerable to a weakening market. "We're a double-digit company," Mr. Tomnitz said on a recent conference call with analysts. Horton and other builders are counting on population growth and immigration to underpin the market in the long term. They also note that land is in chronically short supply near the coasts where rapid job growth fuels demand for housing. That scarcity of space helps support prices.
Horton's brash goals reflect the personality of its chairman and founder, Donald Ray Horton. Mr. Horton, the son of a sheriff who later became a real-estate broker, was born in a rural home near Marshall, Ark., with no indoor plumbing. At age 21, he quit college to run the real-estate agency started by his father. A few years later, the younger Mr. Horton moved to Fort Worth, where he found a job selling new homes.
After selling homes for less than a year, Mr. Horton concluded that it would be more lucrative to build them as well. "It looked pretty simple to me," he says. Starting with savings of $3,000, he persuaded a bank to lend him $30,000 to launch the company in 1978. While his first house was still under construction, Mr. Horton sold it for $43,560, giving him the funds to start immediately on two more homes.
By the late 1980s, Horton was one of the biggest home builders in the Dallas-Fort Worth area. Mr. Horton then began expanding in other cities -- starting with Phoenix, Orlando, Fla., and Atlanta. The company has concentrated mainly on the Sunbelt because "that's where the job growth is," Mr. Horton says. But the company also has spread north to such states as Oregon, Illinois and New Jersey.
Mr. Horton puts part of the company's success down to low costs. In 2004, Horton's sales, general and administrative costs came to about 9.2% of revenue, compared with a range of about 10% to 14% for the four other builders that make up the industry's Big Five, according to an analysis by Banc of America Securities.
Legends of Penny-Pinching
Horton executives cherish the company's legends of penny-pinching. Mr. Tomnitz boasts that his office furniture was bought second-hand, as were the company's boardroom table and chairs. Another senior executive says that when he first joined the company in the 1980s he noticed that a clerk was re-rolling adding-machine tape so she could use both sides.
The company's local chiefs get a lot of independence, but Horton watches their spending and results closely. Gordon D. Jones, a chief operating officer responsible for nine central states, says he compares the costs of each local division he supervises "to make sure we're not getting hosed" by suppliers. Mr. Jones says Mr. Horton also scours over the fine details of divisional spending. "He knows how much you're spending on Dumpsters," Mr. Jones says.
Still, Mr. Horton cautions managers against complacency. According to one of the company's maxims, known as Hortonisms, "It's a quick trip from the penthouse to the doghouse."
Despite soaring sales, D.R. Horton regularly ranks dismally in customer-satisfaction surveys done by J.D. Power & Associates, a Westlake Village, Calif., consulting firm best known for its rankings of automotive quality. In the latest report from Power, released in September, Horton rated average or below in each of the 25 cities where its customers were surveyed. The surveys cover the quality of workmanship and materials, price and value, and home design. Rivals Pulte and Centex do far better on the surveys -- and trumpet the results.
Mr. Horton says the company, in which his family still owns a 13% stake, couldn't sell so many homes if it wasn't pleasing customers. Now 55 years old, he also says he spends most of his time thinking about how to make his company better in the long run, not how to impress Wall Street or outside consultants. One recent thought is that Horton eventually might provide in-home services that would allow old people to keep living in their own single-family houses rather than moving into group homes. |
