Hovnanian Enterprises' fiscal third quarter results beat analyst estimates, showing management's progress in improving operations for the financially strapped company. The company's quarterly loss narrowed by roughly 30% from last year to $50.9 million while the company's sales increased by a third. A small increase in community counts (4%), as well as the calendar-driven benefit of an additional weekend in August to sell homes, helped drive the 33% jump in new orders. (Click here for full quarterly results.)
"Our performance is at an inflection point," said Hovnanian president and CEO Ara Hovnanian.
However, company executives said some of that extra sales benefit was eroded by a number of macro market events that came to a head in August. Whereas last August, sales started to recover following the post-tax credit plunge, this August, sales, as measured on a per community basis, were only on par with last year's pace. This was at odds with sales per community trends during May, June, and July, which were significantly above last year's levels.
Hovnanian said, "This August, home buyer confidence was clearly shaken by extreme stock market volatility and the federal debt ceiling battle. Compounding the problem was Hurricane Irene, which impacted many of our markets."
"Our New Jersey office didn't regain power for five days," he added.
Given the August sales shortfall vis-a-vis expectations, management was pushing out its timeline for a housing recovery until the tail end of 2013. Consequently, it lowered its performance guidance for deliveries, revenues, and gross margins for its fourth quarter.
"With all the economic turmoil--both domestic and international--there's not much pointing to an improving housing market at any point in the near future," Hovnanian said.
Without much hope for any pickup in new-home sales volume and assuming home prices remain stable, Hovnanian executives' plan to move the company out of the red and into the black once again focuses on growing community count, benefiting revenue, allowing the company to better leverage its overhead, and improving gross margins. The sooner the company returns to sustained profitability, the sooner it will be able take advantage of a significant amount of deferred tax assets that will be critical to servicing a massive debt load starting in 2015.
At quarter end, the company had 202 actively selling communities, and management indicated that it expected to have an even greater number of communities actively selling by the end of its fiscal year. It's expected that at the end of the company's fiscal year, roughly 40% of deliveries will be from so-called "newly identified" communities, or those purchased after Jan. 31, 2009. This compares with 12% of deliveries coming from new communities in 2010. That percentage should continue to grow through 2012, positively affecting margins, executives said.
Consequently, company strategy was shifting to reflect the adage, "You have to spend money to make money." Management said it was committed to using more of its $273 million in unrestricted cash to purchase land positions in new communities, targeting quarterly cash totals of between $170 million and $245 million. During the quarter, management spent roughly $105 million in cash on roughly 1,200 lots. Executives said based on current sales pace and excluding the roughly 7,678 lots currently mothballed, the company has 2.9 years worth of land; including the mothballed lots, that lot pipeline stretches to 4.8 years.
Despite the market uncertainty, Hovnanian said investing in land was the best use of the company's cash assets at this point in the housing cycle for several reasons. First, management was focused on buying short-term lot positions that would allow the company to turn them and convert them to cash once again quickly. Second, a larger lot inventory would help the company balance its fixed interest costs and leverage its overheads.
"We are better off investing in land even if it returns less than our 25% IRR. It is still better than earning a few basis points of yield on Treasurys," he said.
However, one of the vulnerabilities of the management team's plan is its reliance on pricing stability, something that is being threatened by the government loan resets on Oct. 1. While the loan limit resets are expected to negatively affect just 5% of the company's communities, executives said they feared the move would exacerbate the market's current pricing pressures.
"We expect it will adversely impact all home prices, but it's too early to know what the full extent will be," Hovnanian said.