With NVR's weak order report Thursday kicking off the next wave of builder earnings results, Wall Street analysts' hopes for a stronger second quarter performance for the group fall, as does the likelihood that many of the public builder set will end up being profitable for the year.
In a July 20 research note, UBS analyst David Goldberg wrote:
"Any hopes builders had about a pickup late in the selling season (May and the beginning of June) have proven to be overly optimistic as the sales pace never materially accelerated. Further, although the rate of decline has slowed versus the second half of 2010, home prices remain under pressure. This, in turn, should lead to a more negative tone in EPS season--as profitability in 2011 becomes increasingly less likely--leading the home building stocks lower."
Supply continues to be a problem, as RBC Capital Markets analyst Robert C. Wetenhall pointed out in a July 20 research note: "The latest tally argues that there is about 16 months of shadow inventory on top of an estimated nine months of visible supply given the current pace of sales." But, arguably, the bigger problem is getting a handle on what housing demand will be going forward.
In some respects, it would appear that an uptick in demand could be right around the corner. The job picture is improving, home prices have largely reversed their freefall, and demographic trends are still encouraging. However, those positives continue to be offset by a number of factors ranging from shifting attitudes toward homeownership to tightness in the mortgage financing business. Without significant snapback in demand, the low-volume environment will delay both a return to profitability for many of the large public builders and a broader recovery for the housing industry.
Given this scenario, as more public builders release their second quarter earnings next week, analysts will be focused on a number of areas, including volume, costs, and capital structure. The fundamental question is how builders plan to drive sales. Community count growth may only be able to take builders so far without a meaningful growth in demand, an idea that's leading some analysts to predict that builders will have to do more discounting and incentivizing to gain the sales. A July 18 survey by Adam Rudiger at Wells Fargo of 150 sales managers at new-home communities in 20 major housing markets showed that, in June, sales managers were "increasingly reliant on marketing/promotional activity in order to generate incremental traffic and sales."
Moreover, given low expectations for top-line growth, analysts will be eager to understand how builder management teams plan to further reduce costs and increase efficiencies to preserve the bottom line. And between reinvestment in their businesses, debt maturities, and cash conservation strategies, analysts will be looking at whether the builders have ample liquidity to get them through what's shaping up to be a painfully slow recovery.
As Rudiger noted:
"We believe most builders in our coverage universe will continue to struggle to cover their costs in this low-volume environment. We prefer to focus on companies that have scale and deep market share and that have demonstrated both a willingness and an ability to generate profits, even at current depressed volume levels."