Interesting Hovnanian Enterprises Earnings Call

Putting the chips on the table

Hovnanian is a builder I have been watching for a while. Homebuilders are an interesting sector with a scenario analysis that is especially binary these days. Either things will go swimmingly or things could go very badly. The market seems to have voted in the negative lately, pricing the builders as if a deep downturn is likely. Current market values seem to not only forecast a reversal of above-average margins, but a decline to revenues well below current levels.

I, as you know, am more bullish on the sector because I think (1) the lack of supply is underappreciated (even as it has become more appreciated), and (2) the lack of entry level buyer demand was from a regulatory impulse, not a natural impulse. On point #2, the negative effect of mortgage suppression on prices meant that rent inflation had to be excessive for a decade to accumulate to where we are now. Even if the federal government won’t let the tenants buy their homes, the rents are now high enough that investors are willing to pay enough to induce the homebuilders to build entry level homes again at scale.

So, for the sake of a speculative position, I would prefer to see the homebuilders buying up these cheap shares, taking out debt, and investing for a continuation of recent construction levels. Since the market is pessimistic, homebuilders won’t do that. Many are buying up shares with free cash flow, but the pessimistic market would likely punish a homebuilder who leveraged up to do that.

So, the only way to get a leveraged homebuilder is to invest in one that isn’t leveraged by choice. Hovnanian, as far as I know, is an outlier in this regard. Many of the homebuilder stocks have declined enough this year to offer good speculative opportunities, but Hovnanian still carries enough financial leverage from the Great Recession to multiply the potential upside of positive scenarios.

In some ways, this leads them to be somewhat conservative. For instance, they are plowing their ample cash flow into buying down debt.

On the other hand, they recently have taken an aggressive position operationally, and I think the way they are thinking about it is very smart.

More discussion below the paywall.