AMERICA'S PUBLIC HOME builders cruised familiar and exotic waters to the same idyllic place in 2004, delivering boatloads of profitable growth in their operating results and on Wall Street, but leaving essential questions unanswered about how to navigate a course in the more hostile climate ahead.

Earnings for the group grew some 40 percent on average last year, according to Ivy Zelman, housing market analyst for Credit Suisse First Boston, and builder stock prices “were in line with their earnings growth, up an average 39 percent,” she adds.

“In terms of their operating performance, 2004 was probably one of the golden years for home builders,” says Greg Gieber, vice president of A.G. Edwards in St. Louis.

As a reward for performance, five public home builders' debt was upgraded by one or more of the rating services in another active year for builder bond issues. Strong earnings growth, longer land positions, and a favorable interest rate environment all combined to make 2004 “pretty robust in general and a fairly active year of issuances,” explains John Forrey, managing director of credit research at Merrill Lynch.

MANNING THE DECK: General William Lyon of William Lyon Homes (top), John Peshkin of Taylor Woodrow Homes (middle), and Peter Rummell of St. Joe Co. Illustration by Travis Foster Reflective of a rising tide's effect on all ships, builder after builder blew through prior year operating records by the time Dec. 31 came around. Meritage Homes reported its 17th consecutive year of record revenue and net earnings. 2004 was D.R. Horton's 27th consecutive year of growth and increased profitability. M/I Homes posted its ninth record year in a row. Many others reported similar results. Public home builders as a group achieved a median 37 percent earnings growth and only Dominion Homes reported an EPS decline (some 37 percent).

That the industry would perform this well wasn't obvious as 2003 drew to a close. Economists forecast a decline in housing starts and rising interest rates. “There were naysayers at the beginning of the year [2004] who said it can't go on for another year,” recalls Eric Elder, senior vice president of marketing and communications at The Ryland Group. “I think everybody breathed a collective sigh of relief at the end of the year that the industry did it again.” See chart of Top Public Builders

According to Larry Sorsby, executive vice president and CFO of Hovnanian Enterprises, “We did much better than we expected at the beginning of the year. All of us wondered whether in the heavily regulated markets we could continue to see double-digit home price appreciation. Most of us suspected that we could not and we were wrong,” he adds, “just as we would have doubted it at the beginning of 2003, and would have been wrong two years in a row.”

But the year was no walk in the park. On Wall Street, interest rate worries resulted in “pretty tepid performance by the group” until the third quarter, when the stocks “continued the dramatic out-performance of the market they've had since 2000,” explains Stephen Kim, managing director at Smith Barney. For the year, builder stock appreciation beat the S&P 500 index 39 percent to 9 percent. Likewise, builder bonds “hit a pretty big bump last spring when rates spiked and negatively impacted the spreads, but they bounced back,” Forrey explains.

Rain, Rain On the operations side, torrential rains in California and Florida hurricanes impacted the operations of many public builders. In Florida, the impact fell primarily in the fourth quarter “when shingles and building inspectors were in short supply and you couldn't get power to your sites all the time,” explains Phil Creek, executive vice president and CFO of M/I Homes. As a result, some homes slated to close in the for fourth quarter won't close until the current quarter of 2005, Creek adds. “That was a pretty significant impact, and again all [the builders] felt it.”

Storms further pressured material supplies already squeezed in a vice grip of increased demand, says Roger Cregg, executive vice president and CFO of Pulte Homes. “With the constraints of a lot of materials going to China, there were shortages of roofing materials and cement mix. Those things play on the industry much more so than they ever have in the past,” he says, largely because the large public builders have greater needs than ever before.

Source: Credit Suisse First Boston