Britannia Radio

These Businesses Are Going to Zero
By Brian Heyliger

Homebuilders are getting the squeeze.

According the benchmark home-price index (the S&P/Case-Shiller), U.S. home prices fell at an annual rate of 18% in the 12 months leading up to October.

It's the largest and fastest annual decline in the index's 21-year history... and it takes the national average for home prices down more than 25% from the 2006 peak.

My colleague Steve Sjuggerud makes a good case that the bottom is near for U.S. home prices (you can read his argument here). But even if home prices have hit bottom, it doesn't matter for many homebuilding companies. They'll still go broke. You see, most builders haven't earned a profit since 2005.

If they can't turn a profit selling homes, it presents a problem when it comes time to pay the bills. That time is approaching...

These days, most builders are unloading land assets just to keep the lights on. They're converting their real estate into cash... and they're doing it at large losses. Around this time last year, builder Lennar sold real estate assets previously valued at $1.3 billion for only $564 million... a 57% loss. Real estate prices have fallen since then. Future sales will generate even larger losses.

Builders can't keep selling themselves forever. They'll eventually run out of assets... or more likely, they'll default on a credit agreement, sending them into bankruptcy. With home prices accelerating their declines, I think it's something a few major builders will see in 2009.

Builders leveraged the hilt while the getting was good, and it worked well for them through 2005 as real estate prices rose. Now the debt is strangling them. As the value of real estate has declined, many owe much more than they can afford to repay.

Imagine trying to sell a $200,000 house you bought in 2005, only to find you have to cough up $50,000 just to close. If you can't afford the mortgage and don't have the money, you would likely be forced into bankruptcy.

That's what builders face today. And it's set to get worse as real estate prices around the country fall to new lows.

You have a couple of different ways to play this idea. You could probably throw a dart at a list of homebuilders and find one likely hit zero in 2009. But to move the odds in your favor look for the companies with the largest debt load, and the ones with that pay the most interest relative to sales. Here are a few large homebuilders I think are in trouble...

Builder
Ticker
Debt-to-Equity
Hovnanian
HOV
7.9
Brookfield
BHS
2.4
Standard Pacific
SPF
2.0
Centex
CTX
1.7
KB Homes
KBH
1.7
I've found a builder I'm certain is headed to zero in 2009. I can't tell you the name today because I just sent the recommendation to my Inside Strategist readers on Wednesday.


Is the Homebuilder Bloodbath Over?

Why Most Newsletters Are Terrible
But as I told my subscribers, there's an opportunity to make 100% as struggling homebuilders move toward zero in 2009.

Good investing,

Brian




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