Description

 

Key points:

 

Valuation

 

On a price to tangible book basis, CTX is trading at a 46% premium to PHM and DHI is trading at a 48% premium.

 

Leverage

PHM and DHI have the same Net Debt/Cap ratios at 40% while CTX is at 46%

 

Liquidity

PHM looks great from a liquidity standpoint. Only $25 million was drawn on the revolver as of Q3’07, they should have over $1 billion in cash at the end of Q4’07, and none of their debt will mature until 2009.

 

Geographic Exposure

Their geographic exposure is similar to CTX and DHI. In regards to the high risk markets, they have a little more exposure to Phoenix and Las Vegas and a little less exposure to Florida and California.

 

Write-offs

They have already written off a higher percentage of their inventory than either CTX or DHI so far. I think when all is said and done, they should be average or better than average in terms of write-offs since they bought a little less land than many peers in the peak years.

 

-------------------------------------------------------------------

Valuation

 

Given the issues right now for the industry, investors are primarily focused on valuing these names off of book value.  Lower relative multiple reflect more liquidity risk or more impairment risk. I will address those issues below, but I don’t think either explain the substantial discount that PHM is trading at vs. CTX and DHI right now.

 

	P/TBV
PHM	0.54
DHI	0.79
CTX	0.78

 

Off of peak earnings, the valuations look like this;

 

	‘05 P/E
PHM	2.0x
DHI	2.8x
CTX	2.8x

 

Another way I like to think of the relative valuation is that while PHM has $400 million less equity than DHI, they have $500 million less Debt and $1.6 billion less market capitalization.

 

 

Leverage

PHM currently has the same Net Debt/Cap as DHI at 40% and is below CTX at 46%. Builders tend to generate the majority of their cash flow in the last fiscal quarter. DHI has already reported their Q4 and their balance sheet reflects the benefit of the cash generation. PHM will catch up and have lower leverage after they report their Q4 (CTX doesn’t close their year end until March and they will still have higher leverage afterwards).

 

Liquidity

 

The tables below shows near term debt maturities:

 

 

	% of Debt Due within next 2 Years
PHM	11.9%
DHI	24.1%
CTX	18.4%

 

 

	Revolver	2007	2008	2009	2010	2011	After	Total
PHM	25	0	0	400	0	700	2450	3575
DHI	150	215	0	585	400	450	2150	3950
CTX	0	0	450	225	300	400	2300	3675

 

PHM should end the year with over $1 billion on its balance sheet and be in a much better liquidity situation than most of the industry. They will have the cash on hand to retire all of their debt due through 2011 if they chose.

 

They have already negotiated the removal of the interest coverage covenant from their debt and they have gotten relief on their tangible net worth requirements as well.

 

 

Geographic Exposure

I attached a table below to highlight their geographic exposures based on units. This is not that precise and the builders don’t give great detail on this issue. Looking at it on a unit basis also ignores sales price and profitability, but that is less of an issue now that most markets are struggling.

 

I would say the key point for all three of these companies is that they are extremely diverse and don’t have the significant regional exposure like some of the more distressed names.

 

			CTX	DHI	PHM
California			13%	17%	11%
Texas			22%	25%	13%
	Florida		14%	9%	16%
	Georgia		2%	3%	5%
	North Carolina		6%	2%	3%
	South Carolina		6%	2%
Southeast			28%	16%	24%
	Arizona		4%	14%	14%
	Colorado		2%	9%	2%
	Nevada		3%	6%	8%
Southwest			9%	29%	24%
	Virginia		1%	3%	3%
	Maryland		3%	2%	2%
Midatlantic			4%	5%	5%
	Michigan		2%		4%
	Ohio		4%		1%
	Illinois		2%	4%	5%
	Indiana		2%		1%
	Tennessee		1%		1%
	Minnesota		3%	2%	3%
	Missouri
Midwest			14%	6%	15%
	Washington		1%	1%
	Massachusetts
	New Jersey		3%		1%
	Pennsylvania		0%		1%
	New York
Northeast			3%	0%	2%
	Oregon		1%	1%	1%
	Other		6%	1%	4%
		AZ and NV	7%	20%	22%
		AZ, NV, and FL	21%	29%	38%
		AZ, NV, FL, and CA	34%	46%	49%
	Total		100%	100%	99%

 

 

Write-offs

They have already written off a higher percentage of their inventory than either CTX or DHI so far. I think when all is said and done, they should be average or better than average in terms of write-offs since they bought a little less land than many peers in the peak years. I have attached a table comparing their charges to peak inventory/equity.

 

	CTX	DHI	PHM
Q1 '06 Equity	5,012	5,944	6,183
Q1'06 Inventory	9,662	10,852	10,105
Q4'07
Q3'07	$         990	$         319	$         842
Q2'07	$         193	$         824	$         749
Q1'07	$         202	$           81	$         132
Q4'06	$         435	$           78	$         370
Q3'06	$         131	$         199	$           88
Q2'06	$           36	$           57	$           62
Q1'06	$           28	$           10	$             5
Total	$      2,015	$      1,568	$      2,249
% of Equity	40.2%	26.4%	36.4%
% of Inventory	20.9%	14.4%	22.3%

 

Risks (from a paired perspective):

 

Management

 

One explanation for the PHM discount is a less experienced and lower quality management team. This point is hard to argue, but at this point, everyone is doing the same thing. There is not a debate about the industry’s problems and everyone is trying to liquidate bad inventory and generate cash. I would say that PHM was slower than some to recognize the severity of the slowdown, but they clearly get it now and addressing the problems like everyone else.

 

And while many investors seem to give DHI more credit from a management standpoint, I am not sure this is justified. They clearly have seen many real estate cycles in the past, but they missed this bubble as badly as anyone. Their CEO was singing the “this time is different tune” at the top of the market and their main goal was clearly to be the biggest builder (and they bought the land to prove it).

 

Sentiment:

 

Most of the various builders out there have their cheerleaders. PHM seems to be the only one with much/any sell-side support. They have many of the risks that investors are looking for from a short perspective and the liquidity to trade. Valuation seems to take a backseat to a lot of this analysis and it PHM could continue to underperform despite the discount.

 

Shareholder base:

 

There are some differences in the shareholder bases of these companies which may be contributed to the underperformance of PHM.

 

Harris Associates (Oakmark Funds) is the 3^rd largest holder of PHM. While they are great contrarian, value investors, they made it clear in their Q3 letter that they would be harvesting tax losses in some of their names. They specifically highlighted PHM as one of those names. It appears to me that a lot of the recent underperformance has been attributed to this and I would not be surprised if they were buying CTX with some of the proceeds since they seem committed to their thesis.

 

DHI	Holder Name		Position			% Port	% O/S
1	Fidelity Management & Research		42,003,687	119,573	577,970,733	0.08	13.34
2	T. Rowe Price Associates, Inc.		22,480,175	6,125,700	309,327,208	0.12	7.14
3	Capital Research & Management Co.		14,742,767	9,680,000	202,860,474	0.02	4.68
4	Wellington Management Co. LLP		12,103,352	6,214,822	166,542,124	0.05	3.84
5	MFS Investment Management		10,571,947	5,635,115	145,469,991	0.12	3.36
6	Vanguard Group, Inc.		10,304,101	251,797	141,784,430	0.02	3.27
7	Oppenheimer Capital		10,239,395	8,191,421	140,894,075	0.91	3.25
8	Barclays Global Investors NA (CA)		9,535,565	-882,865	131,209,374	0.01	3.03
9	Lazard Asset Management LLC		8,994,533	8,994,533	123,764,774	0.23	2.86
10	Goldman Sachs & Co.		7,996,758	7,469,119	110,035,390	0.12	2.54
CTX	Holder Name		Position			% Port	% O/S
1	Hotchkis & Wiley Capital Management LLC		20,054,500	1,218,900	533,650,245	1.9	16.5
2	Legg Mason Capital Management, Inc.		16,427,954	-677,910	437,147,856	0.68	13.51
3	Fidelity Management & Research		10,729,000	8,487,300	285,498,690	0.04	8.83
4	Oppenheimer Capital		8,579,241	2,867,681	228,293,603	1.48	7.06
5	OppenheimerFunds, Inc.		5,322,039	2,024,139	141,619,458	0.1	4.38
6	U.S. Trust Co. of New York		4,703,989	179,357	125,173,147	0.28	3.87
7	AllianceBernstein LP		4,623,711	2,492,086	123,036,950	0.03	3.8
8	Vanguard Group, Inc.		4,524,107	197,019	120,386,487	0.02	3.72
9	Barclays Global Investors NA (CA)		4,522,170	506,097	120,334,944	0.01	3.72
10	Tontine Partners		4,460,879	-1,419,388	118,703,990	1.03	3.67
PHM	Holder Name		Position			% Port	% O/S
1	Legg Mason Capital Management, Inc.		29,846,109	-1,038,570	317,264,139	0.5	11.66
2	Hotchkis & Wiley Capital Management LLC		21,247,400	3,668,900	225,859,862	0.8	8.3
3	Harris Associates LP		17,285,843	3,769,827	183,748,511	0.27	6.75
4	Baillie Gifford & Co Ltd.		12,880,191	-201,482	136,916,430	0.24	5.03
5	TCW Asset Management Co.		11,208,753	-6,592,147	119,149,044	0.24	4.38
6	AllianceBernstein LP		8,985,125	-138,441	95,511,879	0.02	3.51
7	Vanguard Group, Inc.		7,955,246	193,091	84,564,265	0.01	3.11
8	Barclays Global Investors NA (CA)		7,080,563	-87,415	75,266,385	0.01	2.77
9	State Street Global Advisors		6,624,987	-102,565	70,423,612	0.01	2.59
10	Janus Capital Management LLC		5,554,697	1,477,875	59,046,429	0.06	2.17

 

 

 

Catalysts:

 

-         I believe that part of the undeperformance will be corrected as we move into the new year and the tax loss selling by Harris and others subsides.

-         Some of the sell-side has been noticing the underperformance and are likely to adjust some ratings to account for the valuation differences.

-         The biggest catalyst might come after PHM reports their year end and the market recognizes the strength of their balance sheet

 

 

Catalyst

- I believe that part of the undeperformance will be corrected as we move into the new year and the tax loss selling by Harris and others subsides.

- Some of the sell-side has been noticing the underperformance and are likely to adjust some ratings to account for the valuation differences.

- The biggest catalyst might come after PHM reports their year end and the market recognizes the strength of their balance sheet