Hovnanian has a huge mountain of debt that it is trying to outrun. Management has been diligently extending maturities on Hovnanian’s debt and raising capital through secondary offerings. My short thesis is this:
- Hovnanian is overvalued if you were to sell off all of its assets. Its market cap is $760M. Book value is -$478M (yes, that’s a negative sign).
- It’s losing money.
- They are one of the worst managed homebuilders so they will likely continue to perform poorly in the future.
The value of Hovnanian’s assets
I believe that Hovnanian’s accounting is pretty reasonable. They seem to be a little quicker than their peers are recognizing impairments on their communities. If they mothball a community, they will recognize an impairment right away (as opposed to waiting later until they have to recognize an impairment). To simplify everything, I assume that impairments do not cause distortions to Hovnanian’s GAAP accounting. In years where real estate prices move a lot, any gains/losses on the market value of Hovnanian’s land will be delayed somewhat. Since real estate prices have stayed pretty flat in the past few years, I think it is reasonable to assume that the book value of Hovnanian’s land is fairly close to its market value.
Interest capitalized is $112M according to the latest 10-Q.
The valuation allowance for Hovnanian’s deferred tax assets is $941.8 million. I will be generous and assume that Hovnanian will generate a profit and be able to use these tax assets. I will also assume that the present value of these tax assets is half of its undiscounted amount (half = $470.9M).
This gives an adjusted book value of -$478M – $112M + $470.9M = -$119.1M. Given that the market cap is $760M, I see Hovnanian as being very overvalued. This is a segment of the stock market that seems pretty frothy to me.
The company is losing money
If you factor out interest and taxes, the company has actually returned to profitability. The operating business itself is profitable and a decent business. In YE2012 (see the annual report), EBIT was $51M and the EBIT margin was 3.4% (which is pretty low). The problem is that interest expense is $152M, roughly three times EBIT. The company is unprofitable since it is burdened with so much debt.
Eventually I expect the debt to catch up with them and eventually push them near bankruptcy (or into bankruptcy). However, this may take a while. Management knows what’s coming and has been extending the maturities on debt and taking other steps to stave off bankruptcy.
Is this a good short?
Hovnanian would be a decent short if the short interest (29% of float) wasn’t so high. This is a pretty crowded trade so I am not enthusiastic about shorting it. In the past, the borrow rate was in the high single digits.
*Disclosure: No position, but patiently waiting for my limit order to fill.