The Ryland Group's fourth quarter and year-end results, due out after the market closes on Wednesday, Jan. 23, are likely to reflect the management team's discipline in sticking to its game plan of limiting risk and staying liquid.
The strategy has been effective to date in protecting the company's stock price from some of the blows delivered to Ryland's peers. According to recent research by FTN Midwest Securities Corp., the company has retained 82% of its book value, a percentage that is significantly higher than the 51.3% average for the large-cap public builder universe.
In an interview with Big Builder in early January, CFO Gordon Milne said the team's goal for the quarter was cutting spec count and turning cash flow positive. In 3Q2007, management had reduced the company's spec home inventory by 30%, a move that limited spec counts to roughly two finished, unsold homes per community. Any further reduction in standing inventory would improve the company's free cash flow. (More from the Milne interview, plus CFOs from other big builders.)
Milne said management will also pay down more bank debt, pushing the company to a target debt-to-capital ratio of 40%. With the vast majority of the company's bank debt paid off in the quarter, Milne said the company would be left with mostly long-term, low-interest debt, with the exception of $50 million in bonds due this year.
"I think the debt problem is behind us," Milne said. "There's no point in repaying them early."
However, Milne said that management did make one amendment to a debt covenant during the quarter. This amendment comes on the heels of management's third quarter decision to amend the company's $1.1 billion credit line, reducing it to $750 million to generate an estimated $800,000 in annual savings.
Revenues are likely to slip again, as the housing market remains challenged. And judging by recent upticks in cancellation rates among some of Ryland's peers, can rates could rise from the 43% mark in 3Q2007. These factors could result in further margin compression, particularly if the company recorded additional impairment charges for the quarter.
Through 3Q2007, the company had taken roughly $437 million in land charges, a figure that represents 19% of peak book value, according to UBS Investment Bank data. UBS analysts expect Ryland's total land charges to top out at $712 million. At 31% of book value, those forecasted charges are below the 37% average in UBS's public builder universe.
While impairments have created tax implications for builders such as Hovnanian Enterprises and KB Home, Ryland management may avoid similar charges. The executive team's merchant builder strategy has led to fewer impairment charges vis a vis peers, putting management in a position to potentially avoid a three-year cumulative loss scenario. Without a cumulative loss, management will escape having to book a tax reserve charge that would deteriorate net worth.
With sales still down, management likely continued to whittle down its land inventory, letting options expire and selling off some parcels. Milne noted that while there were some land sales in the fourth quarter, little of it was residential land sold at fire-sale prices.
"You'll see us sell some pieces, but we're not desperate to sell pieces at a huge discount," he said.
Since the peak of the market, the number of lots controlled on Ryland's balance sheet was down roughly 40% to just over 45,000 lots in 3Q2007.