Biggest housing write-downs yet to come

Look at almost any major homebuilder's balance sheet these days, and it practically screams at you: "Don't believe Mr Market. Trust me!''

Either homebuilders as a class are grossly undervalued, or their assets are worth much less than their financial statements say. Odds are it's the latter.

Home prices still show no sign of bottoming. And next month may bring lots of new confessions, when most of the companies report year-end earnings.

Take Pulte Homes, for instance. The Bloomfield Hills, Michigan, company showed $8.1 billion of inventory on September 30, namely land and houses. The company's book value, or assets minus liabilities, was $5.2 billion. Yet Pulte's stock-market value is only $2.7 billion, after a 68 per cent drop in its shares this year.

That raises the question: Is Pulte's inventory, by itself, really worth three times more than the company as a whole? Probably not.

Pulte spokesman Calvin Boyd says the company tests its asset values quarterly, though he declined to comment on whether it might write them down more this year. Pulte reported a $787.9 million net loss last quarter, including $1.2 billion of pre-tax write-downs, about half of which were for inventory.

Eight of the nine US homebuilders with market values of at least $1 billion now trade for less than their book values. Some like Pulte already have taken large write-downs on everything from real estate and joint ventures to goodwill. Yet their plunging stock prices indicate bigger charges to earnings may be needed.

Big gap
While the stock market isn't the final word, a large gap between a company's book and market value is a strong indicator that write-downs are needed.

Under the accounting rules, companies mainly use internal estimates of future cash flows to test whether assets such as real estate may be impaired. If the values aren't supportable, companies must write down the assets to their so-called fair values, though these may be only loose guesses.

Pulte is one of five companies in the Standard & Poor's 500 Homebuilding Index; the others are Centex Corp., D.R. Horton Inc., KB Home, and Lennar Corp.

While the five companies have a combined book value of $22.7 billion, the stock market says they're worth just $15.2 billion. Put another way, the market is signaling that their net asset values are inflated by more than $7 billion, mostly because of frothy inventory values.

Oddly, Wall Street analysts covering the stocks appear to be rejecting the market's hints. Pulte, for instance, is expected to post a $153.2 million fourth-quarter net loss, according to a Bloomberg survey of seven analysts.

That suggests no one is counting on major writedowns. The loss would be much larger if Pulte were to mark its assets in line with what its stock price implies.

At $317.2 million, only Miami-based Lennar is expected to post a bigger fourth-quarter net loss, according to a Bloomberg survey of six analysts. Lennar showed $6.7 billion of inventory at Aug. 31 and a $5.1 billion book value; its market value is $2.8 billion. Lennar spokesman Marshall Ames declined to comment.

Toll Brothers Inc., based in Horsham, Pennsylvania, reported an $81.8 million net loss for the quarter ended Oct. 31, driven by $314.9 million of pretax writedowns. Among major homebuilders, the gap between its book and market value is one of the smallest. Toll's inventory was $5.6 billion, and its book value was $3.5 billion, compared with its $3.3 billion stock-market value.

"If I thought I had something that required an impairment, I would have already taken it,'' says Joel Rassman, Toll's chief financial officer. "If I didn't take it, it's because, based on Wednesday's market and our estimate of future market conditions, it doesn't require it. But if the markets continue to decline, it may change the calculation.''

Keeping mum
Fort Worth, Texas-based D.R. Horton showed $9.3 billion of inventory and a $5.6 billion book value at Sept. 30. Its market value is $4.4 billion, down about half this year. D.R. Horton spokeswoman Jessica Hansen didn't return phone calls.

Dallas-based Centex showed $7.8 billion of inventory and a $4.2 billion book value at Sept. 30. Its market value is $3.2 billion. Centex spokesman Eric Bruner declined to comment.

KB Home, based in Los Angeles, showed $4.4 billion of inventory and a $2.7 billion book value at Aug. 31, compared with its $2.1 billion market value. KB Home spokeswoman Heather Reeves declined to comment.

Hovnanian Enterprises Inc. last week reported a $466.6 million net loss for its fiscal fourth quarter ended Oct. 31, including $382.7 million of pretax writedowns. The Red Bank, New Jersey-based company said it had $3.5 billion of inventory at Oct. 31 and a $1.3 billion book value. Its market value is just $448 million. Hovnanian spokesman Jeff O'Keefe declined to comment. The company's stock is down 79 per cent this year.

You gotta believe
So, to believe Hovnanian's balance sheet, Hovnanian's inventory is worth almost eight times more than the stock- market value for the entire company.

One investor on Hovnanian's Dec. 19 earnings call asked: "Can you believe the book value?'' Hovnanian's chief financial officer, Larry Sorsby, replied: "We are just not in a position that we are going to make a projection.''

If Sorsby really believed the book value, my guess is he would have said so.