As we at WCI go about the business of creating luxurious lifestyle communities, marketing and selling homes in those communities, and providing an unmatched lifestyle environment for our customers, we are frequently reminding ourselves of our obligations to our shareholders.
I want to discuss a topic in which I am personally involved. I believe it is critical to the home building industry and to WCI's continued prosperity as a home building company.
The subject I would like to address is one that I am quite passionate about: home building industry valuations.
Let me begin this discussion by pointing out a few important facts. The average P/E for the public home builder group today is approximately 8.4 times projected 2003 earnings. As recently as early 2002, the industry's P/E was about one-fifth the S&P 500 average despite the fact that our industry's return outpaced the S&P's by more than three times last year. In fact, home builders have posted one of the best earnings growth performances of any sector of the market for the past decade.
I am also puzzled about how our industry's P/E can lag those businesses that serve our sector. The home furnishings sector rates a P/E of 12.6 while the P/E for the building products sector is 11.9. With a price to book (value ratio) of 1.9, home building has not gotten the respect it deserves from Wall Street and as an industry. We need to get our message out and dispel the myths that perpetuate in our industry.
Bigs Getting Bigger
The first myth that is working against our industry is the perception that home building companies are small, local businesses and that our industry is highly fragmented. That may have been the case 30 years ago, but it is not factually supported today.
Large national builders are exerting more and more dominance within our industry. In fact, the 100 largest builders in America deliver more than 30 percent of the new homes sold annually, up from 20 percent less than a decade ago.
There are a lot of small builders who deliver less than 100 homes each year, but the biggest builders in America today measure their sales volumes in the tens-of-thousands of units and their revenues in the billions of dollars. These are the builders who produce the overwhelming majority of economic value associated with our modern home building industry.
And if you haven't noticed, the big builders are getting bigger. Today, we have the capacity to grow through mergers and acquisitions. Whether it's a big builder adding to its market share in an existing market or entering new markets through acquisitions, it's happening all around us. Big builders are buying smaller builders and on occasion, big builders are buying other big builders ... the Pulte acquisition of Del Webb in 2001 comes to mind.
I don't know if big builders will account for nearly 75 percent of all sales as some people have suggested, but make no mistake, the bigs are getting bigger. And, there are significant benefits to size.
Changing Cowboys
Another myth that seems to dominate our industry -- in spite of evidence to the contrary -- is that home builders are run by cowboys who know more about deals than running multi-billion dollar enterprises.
It's been a long time since I ran into any cowboys in this business.
Speaking about the financial aptitude that this industry requires brings me to the third myth -- a belief that home builders are highly leveraged and rely on huge debt burdens to finance large inventories of new homes built largely on spec.
The truth is that for the past three decades, the large, publicly held home builders have had access to debt and equity markets that provide a stable, long-term source of financing.
Today, home builders must maintain reasonable, pre-negotiated debt-to-capital ratios. Those ratios on builders' balance sheets have declined substantially from the 60 percent range at the beginning of the 1990s to the current 40 percent to 50 percent range.
Investors need to judge the public home builders not by the volume of homes that we build but by the return we generate on our equity. That return has risen from about 10 percent in the mid-1990s to more than 20 percent in each of the past four years. In case you haven't noticed, the S&P 500 has produced opposite results during this period.
Seeing Success
Myth number four is probably the one we are working the hardest to dismiss.
This is the belief that home builders are uniquely cyclical, dependent on low interest rates for year-to-year survival. Since the early 1990s, we have successfully powered our way through at least two pullbacks in market demand.
Throughout this period, we have continued to expand our market dominance and increase our earnings. Public builders' earnings per share have increased at compounded rates in excess of 20 percent for the past one, three, five, seven, and 10 years. In fact, earnings growth has averaged 25 percent annually during the past decade, declining only once in 1995. As an industry, our earnings per share gains increased 35 percent in 2001 and a healthy 20 percent in 2002. I ask you: How many other industries can make that claim?
This success has been driven by size, which affords better access to lower priced capital and gives us first crack at the best land opportunities and subcontractors. The economies of scale have provided the largest builders with better control over purchasing and production management resulting in reduced costs.
And let's be sure we don't overlook the changing complexion of our nation's demographic profile. The Joint Center for Housing Studies at Harvard University has stated that our industry will need to produce 1.7 million new housing units every year for the next 20 years to meet projected demand. That's impressive. During the past 45 years, housing starts have exceeded two million units annually only four times.And let's be sure we don't overlook the changing complexion of our nation's demographic profile. The Joint Center for Housing Studies at Harvard University has stated that our industry will need to produce 1.7 million new housing units every year for the next 20 years to meet projected demand. That's impressive. During the past 45 years, housing starts have exceeded two million units annually only four times.
We are on the threshold of unprecedented demand in our industry thanks to the aging of America, a wave of immigrant population growth, and the huge market of echo boomers -- children of America's 78 million baby boomers. These are the demographic realities that will support our industry for decades to come.
No Bubble Here
The last myth that I want to dispel is one that always seems to get the attention of the media -- the anticipation of a housing bubble that's unique to our industry. A bubble that is ready to burst.
According to data compiled by Standard & Poor, prices for new and resale homes -- relative to household disposable incomes -- are lower today than they were in the 1980s and 1990s. In 1980, the average home cost $64,600. That was 3.1 times the average household's annual disposable income. Today, the average price of a new single-family home is $182,300, and that number is 2.6 times the average household's income.
At BIG BUILDER magazine, we invite home building industry executives to share opinions and concerns about managing in today's increasingly challenging business environment. If you're interested in sharing your opinions, contact Wyatt Kash, Editor, at [email protected]. |
Additionally, the idea that a rise in mortgage rates will somehow inflict a fatal blow to housing is nonsense. With the advent of innovative mortgage products, I think it's doubtful anyone will ever again pay 10 percent for a mortgage. Monthly principal and interest for a median-priced home today equals 16 percent of household income. In 1990, that figure was 20 percent, and in 1980, it was 23 percent. A conventional 30-year loan would need to rise to well over 9 percent before we reached that 23 percent figure again, and frankly, that's not something we're likely to see for a long, long time.
I'm sorry, but there's no bubble here in home building.
It is only a matter of time before investors recognize the fundamentals of this industry and the value it represents. When investors do come to their senses, our P/E multiples and stock prices have nowhere to go but up.
