For Hovnanian Enterprises CEO Ara Hovnanian, the company's path back to profitability from its fiscal 1Q2011 loss of $64.1 million, or ($0.82) per share, begins and ends with its community counts. Like many of its peers, the company must transition out of its legacy communities, shifting toward a greater mix of newly acquired, more profitable communities, while growing its overall community count.
During the quarter, the company opened 20 new communities and sold out of 23 existing communities, ending the quarter with 201 actively selling communities versus 189 a year ago. Roughly 30% of the deliveries for the quarter came from new communities, and management indicated that percentage would likely grow to 40% by the end of 2011. In addition, the company spent $75 million to acquire just shy of 1,300 lots--550 lots coming from newly identified land parcels and roughly 700 coming from takedowns on existing options.
However, management will have to significantly accelerate both its acquisition of lots in new communities and its closeout of legacy communities if it aims to reach financial breakeven in 2011. Based on some simple, back-of-the-envelope calculations that assume (1) the company's fixed costs remain relatively flat at around $375 million, (2) its average sales price ticks up a bit to $300,000, (3) its margin remains stable at around 17%, and (4) annual deliveries per community hold steady at roughly 23 homes per community, the company would need to grow community count nearly 60% to break even.
While management cautioned participants on its related earnings call that such calculations offer an overly simplistic look at the company's financial situation, management sounded an optimistic note when it came to evaluating the company's ability to deliver, pointing out that as new communities make up a greater portion of its community mix, per community sales pace is likely to pick up while margins improve, decreasing the number of deliveries and communities the company would need to get back into the black.
"We think these metrics are reasonable and achievable in the not too distant future," Hovnanian told analysts.
Further buoying management's outlook were some encouraging traffic and sales trends through February, as the spring selling season moved toward full swing. After a slow period in November and December, the company experienced a sequential increase in net contracts per actively selling community to 1.8 and 1.9 contracts per community in January and February, respectively. Although this level of activity was down slightly from the prior year, when the company averaged 2.1 and 2.2 contracts per community for January and February, Hovnanian said he viewed the information as mostly positive considering that last year's sales were aided by the federal home buyer tax credit.
"We'd always like to see more sales, but we're feeling good," he said about the spring selling season.
He added, "We saw pricing pressures in November and December, during the slow period of selling season. More recently things feel a little more stable."
However, he noted that, in terms of sales incentives, many home builders were shifting toward offering option and upgrades rather than straight-up price reductions.
Hovnanian also provided some regional color, pointing to the Washington, D.C., market, parts of the San Francisco Bay Area, Houston, and Chicago, despite its macroeconomic issues, as areas of sales strength. Alternatively, he noted that slower locations included nearly every market in Florida, parts of the greater Sacramento area, and Minneapolis, to some extent.
When asked if management expected any near-term crimp in buyers' abilities to purchase homes from the company, given impending changes in the secondary mortgage market, tighter underwriting standards, and rising interest rates, executives said they believed the effect would likely be minimal, assuming any changes in the financing markets happened incrementally over a longer period of time.
"A rapid rise [in interest rates] over 6% would be a psychological hurdle," said Hovnanian. "But that's very unscientific; it's just more of a gut feeling."
In addition, CFO Larry Sorsby said, "We are confident that the government will take cautious and appropriate steps to ensure there is a valid mortgage market that can be accessed by individuals who want to purchase a home ... Needless to say, this is something we will be keeping an eye on."
Moreover, he added, "Although loan approval standards have not materially changed in the last three to six months, it is true that the file for loan applications is much thicker than it has been in the past. Mortgages, however, remain available for creditworthy applicants."
Learn more about markets featured in this article: San Francisco, CA.