J.P. Morgan home-building analyst Michael Rehaut on Thursday downgraded the stock of Hovnanian Enterprises (NYSE:HOV) to "underweight" from "neutral"and that of KB Home (NYSE:KBH) to "neutral" from "overweight." At the same time, Rehaut upgraded Standard Pacific (NYSE:SPF) to "neutral" from "underweight."
The changes were made in concert with the release of J.P. Morgan's home building sector update. Rehaut reiterated the "overweight" rating of his top pick, Lennar (NYSE:LEN), as well as that of Toll Brothers (NYSE:TOL) and NVR (NYSE:NVR). He also maintained ratings on the rest of his coverage universe, with D.R. Horton (NYSE:DHI), PulteGroup (NYSE:PHM, Meritage Homes (NYSE:MTH) and Ryland at "neutral" and Beazer Homes (NYSE:BZH) and M.D.C. Holdings(NYSE:MDC) at "underweight."
In downgrading Hovnanian, Rehaut cited the company's eroding equity position. In a research alert, he wrote, "Our lowered rating reflects our increased concern regarding our outlook for a continued material decline in book value, which we believe will exacerbate the company¹s need for equity over the next 12 months. Moreover, given our outlook for continued material losses at least through 2012, we believe that an equity raise during this period would be difficult, and would also not likely materially improve the financial position of the company."
Regarding KB, he wrote, "We believe recent heightened investor concerns regarding liquidity will not abate over at least the next two quarters.Additionally, we lower our 2012E to a negative EPS position, which we believe will further delay visibility for the reversal of its DTA to book value. Finally, we believe our outlook for gross margins in 3Q to remain below the industry average will result in an additional investor concern."
He said of the Standard Pacific upgrade, "Fundamentally, we note that while the company continues to have an above average net debt-to-cap of 57% vs.the group¹s 47% (ex-NVR), we point to several positive attributes, including our outlook for positive EPS in 2012, a more stable capital structure and liquidity position, as well as above average margins. Lastly, we expect SPF to demonstrate above average order growth in 2H11."
His take on the rest of the sector was modestly positive. "We continue to view supply as manageable, as it remains below peak levels and foreclosures should continue to liquidate at a moderate pace, which, combined with our outlook for a still slight improvement in demand, drives our view that home prices should be flat to down only 3% in 2011, as well as remain stable in 2012," Rehaut wrote. "Importantly, we note our outlook remains materially more optimistic than our view of the buyside consensus for at least a decline of 5-10% in home prices over the next 6-12 months. In addition, we believe liquidity positions across the industry are largely stable, in contrast to what we believe are concerns reflected by current valuations."