FUNDAMENTAL FEATURE - Hovnanian (HOV)

Hovnanian Reports 8th Consecutive Loss Since April 2006

On Wednesday, September 3 after-hours, Hovnanian Enterprises (HOV) reported a Q3 ’08 loss of $2.67 per share or $202.5 million on $716.5 million in revenue vs. a loss of $1.27 per share or $80.5 million on $1.1 billion in revenue a year ago. Excluding pre-tax land charges of $11.7 million, the loss would amount to $87.7 million. Analysts were expecting a loss of $1.57 per share on $703 million in revenue. Shares were down $0.65 or 8.4% to $7.10 in after-hours trading and should gap down today.

Home deliveries declined 31% to 2,185 homes vs. 3,179 a year ago. The number of net contracts declined 38% to 1,584 homes. The cancellation rate declined to 32% vs. 35% a year ago. Contract backlogs ended at with a sales value of $1 billion totaled to 2,976. At the end of July 31, HOV operated in 354 communities. At the end of April 20, HOV operated in 379 communities, and in fiscal 2007, 431 communities in 47 markets in 19 states.

HOV generated cash flow of $192.2 million and CEO Ari Hovnanian expects to end the fiscal year with $800 million in cash. HOV also received a federal tax refund of $94.7 million in July. As of July 31, homebuilding cash was at $677.2 million.

Management cited that the law that President Bush signed on July 30 providing up to a $7,500 income tax credit to first-time home buyers should help increase demand. Buyers must close on their purchase before July 1, 2009. The Senate Finance Committee estimated that 1.6 million people will use the credit for qualified individuals who earn less than $75,000 and couples who earn up to $150,000.

The problem that I see is, compared to housing tax credits in the past, this one must be repaid. The tax credit passed by Congress in 1975 of $2,000 did not have to be repaid. The loan must be paid back within two years, at no more than $500 for 15 years. The homebuyers using the credit are expected to save the money, rather than spend it as a down payment for a new Mercedes-Benz.

The outlook for the major homebuilders is neutral to negative. The outlook is dependent on the demand for new and luxury homes and economic data on mortgage rate increases, further deterioration in credit, a further increase in foreclosures, higher unemployment. Since 2006, the top 13 homebuilders wrote off more than $25.2 billion in land, options, goodwill and JV investments. During the 2009 calendar year, I expect to see the homebuilders stabilize their businesses as cancellations and write-offs decline.

However, the homebuilding industry has been consolidating since 2006 and many smaller builders have left the marketplace, bankrupt. Looking forward, the major homebuilders are and will continue to be in the best position over their smaller and non-public competitors.

Currently, 10 firms publish recommendations on HOV with 6 “Hold” ratings and 4 “Sell” ratings. Current revised or reiterated ratings have not been issued by the 10 firms as of this writing, so expect them to come in the next few days.

Shares have declined ever since HOV hit its high on 7/20/2005 at $73.40. Shares now sit at 2002 levels when the housing market began to pick up. For the long-term, HOV is a buy for investors who wish to hold for at least two years. HOV appears to have stabilized and is forming a multi-month/year rounded-out bottom. For the short and intermediate-term, HOV will most likely trade in a neutral-range for many months to come.