Builder Stocks Bounce

Homebuilder stocks surged and short-sellers scrambled Wednesday on positive mortgage-application data and a somewhat better-than-expected report from luxury builder Toll Brothers(TOL:NYSE).

The Mortgage Bankers Association's weekly mortgage applications index rose 8.1% last week -- the largest weekly increase since January.

Elsewhere, Toll Brothers said its third-quarter revenue fell 21% from a year earlier, but its preliminary results came in higher than analyst estimates.

Housing-related stocks, which have been heavily beaten down in recent weeks, jumped to the upside on the report, as short-sellers likely booked profits.

Toll was up 5% to $24.10. Pulte Homes(PHM:NYSE) surged 9% to $22.28, while Lennar(LEN:NYSE), jumped 5.9% to $36.51. Beazer (BZH:NYSE) and WCI Communities(WCI:NYSE), two heavily shorted stocks, were up 10% and 14%, respectively.

"I still think the longer-term trajectory [for builder stocks] is down over the next six months," says Alex Barron, a housing analyst with Agency Trading, who adds that the builder stocks are very volatile and have certainly seen a lot of down days in recent weeks. "It makes sense at some point for shorts to lock in their positions and book profits," he says.

Toll's report was a mixed bag, Barron and other analysts said. The builder did not provide a profit forecast for the quarter, but its guidance for land impairment charges suggested only a small cut to book value. Thus investors may believe the company's stock is forming a bottom.

Toll said homebuilding revenue totaled $1.21 billion in the quarter, beating the $1.08 billion level that analysts polled by Thomson Financial had predicted. New orders fell 23% from a year ago.

"Excess supply exists in most markets and there is concern that additional inventory will emerge due to mortgage defaults," Bob Toll, the company's CEO, said in a statement. "Although some markets have remained strong and some appear to be stabilizing, albeit at much lower activity levels, most markets remain weak.''

The company said it expects to record $125 million to $175 million of land impairment charges for the quarter ended July 31. That amounts to a 2% to 3% reduction in book value, according to a research note from Bank of America analyst Daniel Oppenheim.

Builders have been forced to record impairment charges as values for their land holdings drop in the housing downturn. These charges cut into book value -- the stated value of shareholders' equity on the balance sheet.

Toll's stock is currently trading around 10% above its book value. Whether book value falls further will be a function of whether housing prices continue to fall over the remainder of the year.

Barron expects that builders are only about a third of the way through their impairment process, thus more hits to book value will come in the future.

Toll is in a different situation from other builders because it generally builds on older land, which takes longer to get approved for development. Thus while other builders take larger one-time large impairment charges because they're mostly building on newly purchased land that was more expensive, Toll's impairments will be smaller on a quarterly basis and spread out over time, Barron says.

One negative for Toll is that its cancellation rate rose to 24% in the quarter, from 19% in the second quarter; this suggests homeowners continue to walk away from home purchases, Oppenheim said.

"We think this will cause a surge in cancellations for Toll and other homebuilders in the coming months, resulting in even higher inventories and further pressure on home prices," Oppenheim wrote in his note.

On the plus side is the fact that Toll's liquidity remains solid, since the builder ended the quarter with $700 million of cash and Toll has one of the lowest amounts of debt in the industry, Oppenheim wrote.


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