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MDC Holdings Inc. Message Board

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  • oldschoolbuilder oldschoolbuilder Apr 24, 2006 9:51 PM Flag

    Value of MDC's assets

    <<I already understood you're view of the accounting principles, you outlined them already, but thanks for chiming in. although, I'm not clear at all in your answer regarding standards for writing down impaired inventory.>>

    Standards for writing down impaired assets--check out MDC's disclosure on the topic in the company's 10-K.


    <<It would seem to me, some of the incentives are already bordering on impairment status. I believe we are less than 6 months away from the first large HBs taking inventory write-downs.>>

    Even with the incentives, the builders are making lots of money. Margins are lower but still VERY positive. As I illustrated in my previous post, MDC's average lot cost is $70K while its average selling price is $350K. We have a long way to go before we hit the need for impairment. Also, MDC has a very short land supply relative to other builders (and lower leverage too), which is bad for NT margins but provides a lot of flexibility for capital deployment (and lowers the risk of any asset writedowns).


    <<Regarding your call for a bear case:
    Speaking in broad generalities, companies often trade below cash value when they are in burn mode, and most HB shorts expect negative earnings within 12-18 months.>>

    Lower earnings are possible, but negative earnings or a "burn mode" any time soon are highly unlikely--I can't get there unless some Armageddon scenario is assumed.


    <<Similiarly, as a broad characterization, cyclicals always look extremely cheap at the top of a cycle when it is time to sell, and extremely expensive at the bottom of the cycle when there are no/negative earnings. How many housing cycles have you seen in your lifetime?>>

    True, cyclicals have low P/Es at the top of a cycle, but the P/Es for the builders on even a 50% haircut to earnings are still very low. Moreover, MDC looks very cheap on book value (and liquidation value) as I illustrated in my prior post.


    <<Finally, nearly all the HBs balance sheets have shown negative cashflow as they leveraged for growth and future sales.>>

    Not so. Lennar, KB Home, NVR, Ryland and Toll Brothers in particular are cash flow positive (or darn close). If any builder decides not to grow land inventory in any given year, cash flow will be very positive. Negative cash flow is a function of investment in land inventory for future growth. Pull back on growth and free cash flow becomes abundant.


    <<In a down market, they will have to show positive cash flow, as the equity gates close.>>

    It just may happen--check out DR Horton's comments on the recent conference call. Equity gates closing limits the amount of NEW competitive capital into the business too.


    <<In your analysis, you failed to factor in the carry-costs for those assets...land is taxed, and empty houses still are expensive to maintain.>>

    Carry costs are capitalized and expensed--so they are part of the equation to some degree. They are nowhere near as high as one may think though given the build-to-order model of the large public builders and the increased use of land options.


    <<you argue that a down market is an opportunity to gain market share, but market share itself is a profit drain if the houses can't be sold above cost>>

    True--but c'mon now, that's a pretty dire scenario being painted.


    <<but you agree its a down trend we're now in>>

    Yes, we are in an inventory-driven downtrend or correction. That does not mean it will last forever--or even more than 1-2 years. Down earnings are OK as long as they are still high on an absolute basis. The market seems to assume a precipitous collapse. I just can't get there--and I have tried factoring in some doozy scenarios.


    <<I think the only difference between bulls and bears are the v

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    • Parsing each statement line by line...My, you have much time to kill. Again, if I wanted the company spiel, I know where to find it. I'm more interested in historical context. When previous RE cycles turned, at what stage did publicly traded HBs have to re-price their inventory.

      I agree margins on houses that went under contract 6 months ago and closed this quarter were still profitable. But, I'm routinely seeing 60-100K incentive offerings now -- easily into the 20% profit margin the industry had been delivering, plus they're now paying realtor fees.

      Negative earnings have happened in every other RE down cycle -- why not this one?

      What type of Armageddon scenario do you need:

      Try this one:

      30 year rates increase to 7%.

      Housing sales drop from record pace to 70% of current levels -- a mere 30% drop.

      New construction drops by 20% from current levels, and maintains this for 3 years to wash out excees inventory built for speculators.

      Housing prices that have increased 30% annually for 5 years, retract 20% annually for 2 years -- and then stay flat for an extended period of time.

      By my calcs:
      Profit margin of 20% is totally eliminated in first 12 months. Subsequent sales for the indefinite future are then a break-even proposition. HBs are saddeled with an extra 18 month inventory they can't unload without a loss, and high fixed costs going forward (due to all those wonderful land deals).


      Want Armageddon?

 
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