Sunday, November 19, 2006

DR Horton Inc Analysis

D.R. Horton, Inc. is the largest homebuilding company in the United States, based on our domestic homes closed during the twelve months ended September 30, 2005. DR Horton constructs and sells high quality single-family homes through its operating divisions in 25 states and 74 metropolitan markets of the United States, primarily under the name of D.R. Horton, America’s Builder. D.R. Horton, Inc. is a Fortune 500 company, and its common stock is included in the S&P 500 Index and listed on the New York Stock Exchange under the ticker symbol “DHI.”

The home builders have taken a beating in the second half of this year and are trading for low P/E ratios. The main reason for the low price is the decline in the U.S housing market. One interesting phenomenon is that the recent bad news on housing starts didnt depress the home builders and the wall board manufacturers. We will look into the home builders - especially DHI to see if they have hit a bottom and if the stock is a buy at the current prices.

DHI primarily has two businesses. The first one is the one that specializes in building single family homes. The second part of the business specializes in doing mortgages and financial services. The home building business accounts for 98% of the revenue whereas the financial services account for 2% of DHI's revenue. The majority of DHI's revenue comes from the six states of California, Arizona, Colarado, Texas, Florida and Nevada. One should also note that the housing bubble has been the strongest in California, Florida and Nevada.

The housing market is the strongest in spring and summer months - consequently, the sales and revenues from homes is also the strongest in those months.

Let us move forward to the latest quarterly report. The cash and cash equivalents have declined from 1.1 billion to about 100 million. The inventory of finished homes and land under development has increased sharply from the year ago period. Although the company says it is monitoring the housing industry carefully, the increased inventory in a down market is definitely going to erode the profit margins.

The analysts are expecting the EPS to improve in 2008 for DHI while expecting steep slow down in the March quarter and fiscal year 2007.

The book value of the stock is in the finished houses and the land it has under its name. Since the company uses debt to finance its operations, the decline in housing prices or new homes will erode the book value. So a book value of $21/share is not what is made out to be.

Looking at DHI's balance sheet, cash from operations and free cash flow have both been negative for the past ten years except 2003. Cash from financing has been positive primarily because of the issuance of a lot of debt. The company does sport good return on equity and return on asset numbers. Since the company doesnt have a positive free cash flow and has a heavy growth in inventory, it may be prudent to stay away from the stock till early next year. It may also be prudent to stay away till the time the inventory/accounts receivable situation improves on the balance sheet compared to the existing housing market conditions.

No comments: