Home Builders' Stocks Lose
Curb Appeal with Investors

Major home builders are expected to report yet another quarter of stellar earnings this week. But those figures are unlikely to revive the builders' slumping share prices. That is because a number of analysts and investors have concluded that the house party is ending.

Few expect a widespread drop in home prices. Even so, the boom of the past decade is running up against some big obstacles. They include rising interest rates, regulatory concerns about loose mortgage-lending standards, swelling inventories of unsold homes and growing skittishness among consumers.

As a result, a Banc of America Securities index of major home-building stocks has declined about 25% since July 20, and Daniel Oppenheim, the bank's housing analyst, issued a report last week predicting that investors' sentiment toward housing will "get worse before it gets better." Already, home-builder stocks are about as popular as lime-green kitchen countertops. They are trading at about 6.3 times projected earnings for the next four quarters, compared with 14 for all stocks in the Standard & Poor's 500-stock index, according to David Dropsey of Thomson Financial.

Executives at big home builders, who argue that their companies can keep growing quickly even if interest rates move higher, are increasingly frustrated. Ryland Group Inc., a Calabasas, Calif., home builder, last week reported a 42% increase in profit for the third quarter ended Sept. 30. But the company's stock, which closed Friday at $69.22, is down from a high of $83.13 set July 20.

"It would be like I offered you Cindy Crawford and you said she had a mole," R. Chad Dreier, Ryland's chief executive, groused in a conference call with analysts and investors. "You know, nothing is ever good enough." He accused Wall Street of suffering from a "disconnect with the real world," where housing demand remains strong.

There has been some positive news about housing during the past week. Denver-based home builder MDC Holdings Inc. last week exceeded analysts' expectations with third-quarter profit growth of 15%. In addition, an index of home-builder confidence released by the National Association of Home Builders and Wells Fargo & Co. improved this month after hitting the lowest level so far this year in September, although it remains below the mid-year high. And the home-builders association expects a record 1.275 million sales of new single-family homes this year, a rise of 6% over 2004.

Analysts expect big builders such as Centex Corp., Pulte Homes Inc., Standard Pacific Corp. and Meritage Homes Corp. to post profit increases of at least 14% from a year earlier when they announce their financial results this week.

Still, amid one of the most closely watched earnings seasons the industry has had in years, investors seem to be focusing mainly on the negatives. On Tuesday, NVR Inc., Reston, Va., reported a 28% increase in third-quarter net income and projected that its profit will grow 30% for all of 2005. But the company's stock tumbled 10% as investors fretted about a 19% drop in orders in the Washington, D.C., area, one of the builder's main markets and until recently one of the hottest spots in housing.

Another worrisome sign is that mortgage costs are rising. Freddie Mac reported that its latest survey showed that the average interest on 30-year fixed-rate mortgages was 6.10% in the week ended Oct. 20, the highest since July 2004.

Ivy Zelman, an analyst at Credit Suisse First Boston, says investors also are fretting about an increase of home-contract cancellation rates in some markets, more incentives being offered to home buyers and a regulatory crackdown on "exotic mortgages" that give borrowers low initial payments but leave them facing steeper costs later on. "Even if things are good right now, things are beginning to cool and consumers haven't even been faced with this winter's heating bills yet," she says. "There are just a lot of 'what if' questions; no one knows what is going to happen, so investors are thinking, 'Why take the risk?' "

Mr. Oppenheim of Banc of America Securities last week lowered his ratings on home builders Hovnanian Enterprises Inc., Ryland and Toll Brothers Inc. to "neutral" from "buy," on MDC to "sell" from neutral, and on NVR to sell from buy. He is keeping a buy rating on D.R. Horton Inc. because he believes its earnings will be less volatile and likes the Fort Worth, Texas, company's focus on lower-cost homes. Mr. Oppenheim says he is being more cautious about home builders in general because his latest monthly survey of real-estate agents showed fewer home shoppers and slower price gains.

Some analysts remain bullish. Stephen Kim, an analyst at Citigroup Inc., doesn't believe that the sluggishness in the Washington market or other recent developments point to a significant slowdown. He says home-builder stocks have slumped several times during the past few years, only to rebound once fears were dispelled. "I would tell people that it isn't going to be any different in that regard this time," Mr. Kim says. "You've got a lot of negative sentiment and a lot of concern, but not a lot of real hard evidence of weakness."

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