Why There May Still Be Time For This Homebuilder's Turnaround

Hovnanian Enterprises' (NYS: HOV) lower fourth-quarter losses seem to be in line with the general industry trend of great numbers from most homebuilders. But a deeper analysis tells me things might not be as good for this company. The housing sector seems to be picking up, but not Hovnanian. Read more to find out why.

First, the good news
Hovnanian's contract-cancellation rate improved, falling to 21% from 24% a year ago. This is indeed a positive sign, especially when we consider how high the rate is for some of its peers. For instance, Beazer Homes' (NYS: BZH) cancellation rate was 34.2%, while D.R. Horton's (NYS: DHI) cancellation rate stood at 29% in their respective fourth quarters.

Hovnanian's net contracts also rose marginally, by 3% to 1,175 homes. But what stands out is the rise in Hovnanian's backlogs -- an important indicator of future revenues -- to $552.4 million, up an impressive 26% from last year. Note how this contrasts with peer Pulte Group's (NYS: PHM) 4% fall in its last-quarter backlogs.

Now, the bad news
First is the fall in Hovnanian's revenue to $341.6 million from $353.0 million for the year-ago quarter. It's sad to see Hovnanian's top line languishing when most homebuilders have enjoyed higher revenue recently.

Even Beazer, which had a dismal third quarter, beat Street estimates with a 25% jump in its fourth-quarter revenue as home closings and orders rose. Hovnanian's lower deliveries (which came in at 1,245 homes as compared to 1,287 homes last year) was in contrast to what most of its peers have reported recently. Sadly, higher backlogs may not mean much unless Hovnanian starts actually delivering more homes.

In spite of lower revenue, Hovnanian saw its fourth-quarter losses narrow to $98.3 million from $132.1 million a year ago. If you are wondering how this happened, it was lower land-related charges and some gains from repurchasing debt that lifted Hovnanian's bottom line.

Will this strategy pay off?
At a time when most homebuilders are turning to strategies like customized and energy-efficient homes, Hovnanian is lapping up land at low prices.

It isn't the only one eyeing land purchases, though. NVR surprised many by shunning its 'land-less' policy some time back by purchasing a big land portfolio in Washington. Standard Pacific (NYS: SPF) is also adding land lots to its portfolio, but it lowered its purchases to $98.5 million in its third quarter from $55 million in the second quarter.

Hovnanian spent around $95 million of cash in the last quarter on lot purchases and land development. While the company is all upbeat about its strategy, unfortunately, I am not. Hovnanian's emptying-pockets-on-land strategy doesn't make a lot of sense to me when its revenue continues to remain weak, its bottom line is still in the red, and worse, its debt is humongous when compared to its cash balances.

Hovnanian's balance sheet leaves us with no reasons to cheer at all. The homebuilder's long-term debt stands at $1.67 billion. Compare this with no profits and meager cash equivalents of $244.4 million, and you'll know what makes Hovnanian's financials anything but impressive. Accumulating losses have resulted in negative equity, and the company looks almost entirely capitalized on debt (total debt-to-capital ratio is at an astounding 140.6%). It can't get any worse.

Signs of life?
Hovnanian may not have come up with impressive numbers, but the housing market is showing signs of recovery. Higher orders and healthier backlogs are the first signs that suggest the return of home buyers to the market.

Recent housing data has been positive too. The National Association of Realtors reported a surprising rise in the sale of previously-owned homes in the U.S. in October. New-home sales also rose 1.3% and 5.7% in October and September sequentially. On top of that, Freddie Mac's U.S. Economic and Housing Market Outlook for October highlighted a gradual pick-up in both new construction as well as rentals this year.

The National Association of Home Builders/Wells Fargo Housing Market Index has continued to add to the optimism. After posting its highest one-month gain in more than a year this past October (which sent homebuilder stocks in a tizzy), the Association has reported another rise in the index for November, touching its highest level since May 2010. This is a clear indicator of improving consumer confidence in the housing market.

It looks like home buyers are finally getting lured by the rock-bottom mortgage rates and unbelievably low house prices. But the question here is: When might Hovnanian attract more buyers?

The Foolish bottom line
The housing sector may be bathing in optimism, but Hovnanian still has a long to go to turn its red into black and get a grip on its huge debt.

Fools might as well look around for other homebuilders who seem better prepared for a recovery. You nevertheless would not want to miss the bus once things start looking juicier at Hovnanian. To be the first to know when this happens, add Beazer or any of the other housing stocks to your stock Watchlist, our free and personalized stock-tracking service that keeps you updated on all your favorite companies

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At the time thisarticle was published Neha Chamaria does not own shares of any of the companies mentioned in this article.Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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