Another US builder feeling the pinch

Negative housing data pile up
Meritage reports ugly preliminary results, but builders up after jobs report

By John Spence, MarketWatch
Last Update: 2:34 PM ET Jul 6, 2007

BOSTON (MarketWatch) -- Meritage Homes Corp. said its preliminary home orders fell 28% and its cancellations rose in another sign that builders continue to struggle against a slumping housing market with scant relief seen in the near future.

The Scottsdale, Ariz.-based company (MTH) said Friday that its preliminary second-quarter home orders fell 28% from a year earlier to $502 million, while its cancellations rose to 37% of gross orders, up from 32% in the year-ago quarter and from 27% in the first quarter of 2007.

"Weak demand and high inventory levels have increased competition among home builders, pressuring margins despite reductions in new home starts, lot supplies and operating costs," said Chief Executive Steven Hilton, according to a Meritage statement.

Still, shares of Meritage and other builders traded higher Friday following a solid U.S. employment report. See Economic Report.

Meritage said it expects to book additional pretax charges of between $75 million and $80 million for the quarter as a result of inventory impairments and land-option write-offs. Also, it said it anticipates taking about $28 million in charges related to goodwill and other intangible assets in its challenged Florida-based operations.

The charge "belies [the] view that heavy usage of land options makes Meritage a relatively safer home builder for investors," wrote A.G. Edwards analyst Gregory Gieber in a report to clients Friday.

In early June, Meritage warned that April and May sales had been weaker than expected and backed away from its previous earnings outlook for 2007. On April 25, when the company reported first-quarter results, it had predicted full-year net income in the range of $2 to $2.50 a share, but the market has worsened since then. Analysts polled by Thomson Financial are looking for profit of $1.15 a share, on average.

The quarterly earnings season is off to an unpleasant start for the residential builders, with some of the stocks recently hitting 52-week lows.

In late June, KB Home (KBH) said it swung to a loss as deliveries dropped 36% from the previous year and prices also fell. Another large builder, Lennar Corp. (LEN), also suffered a quarterly loss, blaming impairment charges and growing inventories of homes for sale which pushed prices lower and further squeezed margins.

Many signs are pointing to a housing market that may worsen further before it improves. Economists say the market still needs to burn off excess inventory created when speculators fled the market as the mood shifted in 2005. Problems in the subprime-mortgage market and rising mortgage rates also continue to weigh.

Data paint bleak picture

On June 25, the National Association of Realtors said sales of existing homes in May were down 10.3% from a year earlier. Meanwhile, the resale inventory rose to an 8.9-month supply, the largest in roughly 15 years. The next day, the Commerce Department estimated that U.S. new-home sales fell 1.6% in May, the 18th straight month that sales fell from the previous year's levels.

Earlier this week, the NAR said pending sales, seen as a leading indicator, fell 3.5% in May. Banc of America Securities analyst Daniel Oppenheim said the data indicate inventories could rise even more. He estimated inventories of existing homes for sale could approach 10 months of supply, "likely at or above the peak in the late 1980s [and] early 1990s" -- during the previous housing-market downturn.

"We think a lower level of construction activity is necessary to work off the inventory overhang and eventually lead to price stability, since demand is not expected to improve near-term as price declines and high inventory levels depress buyer confidence," Oppenheim wrote in a report.

"We think that this correction will be equal to or, more likely, greater than that in the early 1990s," said Gieber at A.G. Edwards."It seems that home builders' efforts to remove inventory have failed to ignite the market and instead, the psychological factors of home buyers are playing a dominant role on the market," wrote Lili Zhang, an analyst at independent research firm Wall Street Strategies, in a report this week.

Buyer confidence has been further shaken by the trouble in subprime mortgages, which are designed for customers with weaker credit histories. Foreclosures are up, and the subprime mess has spilled over into hedge funds that made bets in riskier mortgage-backed securities.

"The home-building industry is in a severe recession, the subprime loans created a potentially major psychological problem for investors, and now the related hedge-fund debacle is in the news every day," wrote A.G. Edwards Chief Market Strategist Al Goldman in commentary earlier this week.

Additionally, the critical spring selling season has been a bust for builders despite "aggressive price," Wall Street Strategies' Zhang said.

"Taking all these factors into account, we feel the housing market will not bottom out until the end of 2007, or early 2008," the analyst added. "The housing market is cyclical in nature, and a housing downturn could easily last for over two years, and would not fully rebound [until] another two years later."