The Tycoon Report

Breaking Down the Case-Shiller Index

"Home prices down a staggering 16%!" and "Property values plummet!" are what the headlines read after the Case Shiller report was posted on Tuesday, July 29. Perhaps, it is the media's obsession with de-moralizing investors, or maybe it is our custom of judging all of our economic reports on a year over year basis, but we urge investors to take the headlines with a grain of salt (they are just trying to get your attention). Homebuilder stocks climbed 7% on average on Tuesday during trading following the report because, believe it or not, it was good news.

The May Case Shiller index, which measures average home prices taken from a sampling of 20 U.S. cities, was down 15.8% from last May, but was only down 0.9% from April. The last time the index saw such a small month to month decline was in September 2007. In today's housing market, falling prices are completely expected, and the fact that the decline decelerated in May is a slightly positive step towards a correction.

A key part of the report is that seven out of the twenty cities sampled showed month to month price increases. Denver, Atlanta, Boston, Minneapolis, Charlotte, Portland, and Dallas showed modest improvements. These results show a regional nature of our nation's housing crisis. It is the areas such as Las Vegas, Miami, and Los Angeles, which were, and continue to be, the hardest hit regions, that drag down the rest of the country and steal the headlines. Take Charlotte for instance, home prices in the growing North Carolina city are flat on a year over year basis and in Dallas, prices have risen more than 1% in each of the last three months. The movement in some of the healthier areas of the country suggests that the buying interest is returning, and prices are back on an uptrend. On the other hand, in areas such as Florida and California where prices became especially inflated during the housing boom, foreclosures continue to pile up and these regions may continue to experience worsening environments for months to come.

Clearly, the May Case-Schiller report is nothing to pop the champagne over, but it shows the market's capacity to change. The rate of month to month decline in home prices has decelerated in the last three months reported. It began with a 2.7% decline in February (the peak month-to-month drop in prices to date), slowing to declines of 2.1%, 1.3%, and 0.9% in March, April and May, respectively. Two regions showed month to month increases in March, growing to seven regions in May. With the rate of decline dropping lower by the month, if this trend continues, home prices will start to rise within the next few months. It would certainly be too optimistic to say that this is actually the beginning of a bottom, but it is sure starting to look like one.

We are going remain on the conservative side and project that we are not going to hit a bottom within 2008. Certain homebuilders with exposure to the better performing regions of the country have a chance to become more profitable as the year goes on, even if the fundamentals of the housing market continue to decline.

Pulte Homes Inc. (PHM) and Centex Corp. (CTX) are two companies that have already sold off large portions of inventory in problem regions, and are mitigating massive impairment charges that have been plaguing the homebuilders' balance sheets. In both cases, at the end of the fourth quarter of calendar 2007, these homebuilders wrote off as much inventory as possible (think kitchen sink) in a proactive manner to lessen the need for further write down in future quarters. This affords these homebuilders the opportunity to earn benefits from prior impairments. Having sold off large portions of less valuable land in problem regions such as California, these businesses may experience improving gross margins with a better regional mix of products. Both companies have strong footprints in areas such as Texas and parts of the Northeast where, as demonstrated above, prices are more favorable. Finally, cost cutting initiatives are materially reducing overhead expenses. We believe that the calendar fourth quarter was the worst it will get for the aforementioned homebuilders, and as such, will be shielded enough to weather the rest of the storm and possibly even improve profits until the eventual turnaround, at which point the stocks will appreciate nicely.

Click here for a copy of our latest comprehensive report on Pulte Homes.

http://www.wstreet.com/members/pulte_research_report.asp

Written by David Urani a Research Analyst for Wall Street Strategies (www.wstreet.com) specializing in the homebuilding, staffing, medical devices, and logistical services industries.