After reporting Q3 results last night, Hovnanian Enterprises (NYSE:HOV) isn't getting much love from analyst community:
- Credit Suisse is downgrading HOV to Underperform from Neutral
Lowering to Underperform – improving orders, but write-downs and operating losses erode equity value. We see Hovnanian’s 9% decline in orders in 3Q as an improvement, but with 3.5% gross margins and SG&A representing 14.3% of revenue, these orders don’t create value for equity holders, especially when combined with the $106 mln of impairments in 3Q. To work out of its $1.8 bln of debt (book value is now -$3.07 per common share), Hovnanian must generate significant returns from existing assets, but we think this will be challenging given the likelihood of continued operating losses and impairments. We are maintaining our $2 target price.
$546 mln of cash provides liquidity and some time, but balance sheet restructuring still needed. We recognize that the $546 of cash provides Hovnanian with breathing room until the nearly $700 mln of debt maturities in 2013, but think that it will need to restructure its balance sheet given the lack of equity, absent a sharp rebound in home prices. In addition, we think that change-in-control provisions on Hovnanian’s debt would discourage most potential acquirers.
Future quarters likely to bring margin challenges and impairments. We anticipate further erosion of book value based on our expectation for continued operating losses and at least $100 mln of future impairments.
- JMP Securities notes that after another rough quarter, they are maintaining their Market Underperform rating and $0.50 price target (based on little to no common equity value left in the company).
Quite a run for the stock on not-very-strong fundamentals. Since closing at $0.60 in early March, shares of HOV have been on a tear: up over 600% since that time and nearly doubling YTD (against 78% and 22%, respectively, for the Homebuilder index XHB). We fail to see a positive catalyst that has either been responsible for the run-up or that could propel the stock further; it is, in our view, a combination of the success of the group as a whole combined with possible short-covering that has propelled the stock, and we feel the shares are ripe for a more severe correction than what we expect for the rest of the group. While some companies, in our opinion, are poised for a return to profitability in 2010, we feel that a positive bottom line is still at least a couple years out for Hovnanian.
The problem for HOV remains the balance-sheet-versus-margins conundrum. As of the end of the third quarter, the company now has a very high net-debt-to-cap ratio of 74% (up from 60% ast quarter) and negative common equity (though a small amount of equity still remains in the form of preferred shares). While we are not overly concerned with liquidity issues—the company continues to pay down pending maturities, including $119 million in July of notes due 2010-2017, and cash-on-hand is roughly $550 million currently—the high debt levels, equity troubles, and covenant restrictions on the company’s ability to pay down further debt are all prohibiting it from taking impairments at the necessary level. This has put serious pressure on margins, which have been some of the lowest in the industry; while decreasing pricing pressure should help, we doubt that pricing will recover quickly enough to seriously help Hovnanian over the coming couple of years. HOV’s balance sheet woes will, in our view, also limit its participation in the land-buying game for the foreseeable future, a severe competitive disadvantage against its better-capitalized rivals coming out of the present downturn.
- UBS says that focus on liquidity, over profitability, leaves them cautious. Despite the outperformance this Q, cash flow was a disappointing ($49mn), ex $180mn of outflows associated with its tender offer and revolver. Further, although the company reduced debt by ~$119mn, the lower cash balance resulted in the net debt-to-cap (adj for FAS 109) +235bps seq to 64%. In turn, we expect mgmt to remain focused on driving FCF over profitability, resulting in higher impairments and lower margins relative to its more liquid peers.
Action: Cannot feel too good shorting a $4 stock with 27% short interest, but I think the stock is due for a serious correction here.
Even if the worst is behind and we are at the beginning of next upcycle, HOV is not very well positioned to take advantage. Their focus is rather on survival and keeping the balance sheet from getting worse while competitors in better shape can take steps for future profits. And when HOV can finally start investing for future, they are a few years behind the competition and must pay up, leaving them in serious disadvantage.
Oh, and this is a best case scenario. If there is no quick improvement in real estate, HOV will keep struggling and equity holders don't have much to hope for.
I believe these results give some of the longs a reason to step out, sending the stock lower. Current $4.25 lever of pre-mkt should be good for a short as I expect the stock to fall below $4 today.