Thursday, October 11, 2007 0 comments ++[ CLICK TO COMMENT ]++

Moody's Cuts Homebuilder Bonds to Junk; Sam Zell On Housing

Moody's just cut some homebuilder bonds to junk.

Moody's Investors Service on Thursday cut its ratings on home builders Centex Corp (CTX.N: Quote, Profile, Research) Lennar Corp (LEN.N: Quote, Profile, Research) and Pulte Homes (PHM.N: Quote, Profile, Research) to junk status, saying it expects bleak housing industry conditions to linger at least until 2009.

Moody's lowered...Pulte's senior unsecured rating by one notch to "Ba1" from "Baa3"... The outlook on all three companies is negative, meaning another rating cut is likely over the next 12 to 18 months.

This was something I was expecting and PHA is down around 4% today. I was expecting a bigger drop in PHA's price but I guess the market already priced in a lot of negativity (this may be true given that CDS on the bonds are trading at values that imply even worse ratings). It is also surprising to see PHA, as well as the stocks of homebuilders, rallying in the last few weeks.

Pulte's earnings call is on October 24th and it remains to be seen what comes of that. Consensus expectation is for -0.26 EPS this quarter and I suspect it may be worse than that.

Sam Zell recently said that he expects residential housing to stabilize in 2008, with the economy hitting a recession in 2009. The 2009 call is far later than what I expect (I'm still not in the recession camp; slowdown is what I expect right now). If he is right in saying that housing should stabilize next year then the best opportunity to buy this sector (assuming the sector is going to do well) may be in the next 6 months.

One thing that may make it far worse for the homebuilders than the past is the fact that inventory is massive. Depending on what the builders have done in the last few months (earnings call should shed some light on that), we have about 6 months to 1 year worth of unsold inventory. Given that houses are very expensive and Americans don't have high savings, getting rid of that inventory will be tough. Discounting likely doesn't move inventory as easily as in other industries (say semiconductors or clothing). Similar to what happened to the mortgage lenders, I think some builders will have to go bankrupt (or bought out) for the industry to return to healthy levels. The name of the game, then, is to pick the ones that won't go bankrupt to be sold out at distressed levels. This thinking is one reason I'm looking at the bond instead of the stock.

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