WCI and DHOM / Let's do the Math

Bizjournals is reporting Dominion Homes loses $3.9M in 1Q, predicts loss for year.

Dominion Homes Inc. lost $3.9 million in the first quarter as the homebuilder's sales and building activity continued to slow.

It blamed the loss on finishing fewer homes than expected and a 5.5 percent drop in profit margins because of "competitive pricing pressure" from the slowdown in new home sales in Central Ohio and Kentucky. It said that was especially true in the Columbus area, as several competing homebuilders have been offering steep discounts. Dominion also builds in the Lexington and Louisville, Ky., areas.

The loss would have been worse, but the company recorded a $1.8 million gain from its new Centennial Home Mortgage LLC mortgage-banking joint venture with Des Moines, Iowa-based Wells Fargo Home Mortgage Inc. The joint venture takes over Dominion's mortgage-origination business from Dominion Homes Financial Services Ltd., which has come under regulatory scrutiny for a high level of defaults by Dominion home buyers.

Dominion's revenue in the first quarter dropped by a third to $61.8 million, from $92.6 million a year ago, as the number of homes it completed fell to 315, from 478 last year.

The company's backlog of homes under contract for construction stood at 590, with a sales value of $118.2 million, versus a backlog of 780 homes worth $157.8 million at the end of the first quarter 2005.

Dominion's sales were also down in the quarter. The company signed 475 new contracts, down 24 percent from 626 contracts a year ago. The average sale price fell as well to $188,000, from $193,000 last year.

That doesn't bode well for the remainder of the year. Dominion CEO Douglas G. Borror said in the earnings release that he expects to finish 2006 in the red.

"Based on the level of sales we are currently experiencing, we do not expect that 2006 will be a profitable year," he said.

That doesn't bode well for the remainder of the year. Dominion CEO Douglas G. Borror said in the earnings release that he expects to finish 2006 in the red.

Why should it bode well for anyone in the second half of the year?
Nonetheless that did not stop WCI from putting out a nonsensical story starting with this headline:

WCI Reports First Quarter 2006 Earnings Up 142%.

"Because we are experiencing lower overall demand for our Florida active adult communities, tower residences and our higher-priced Mid-Atlantic homes, we are lowering our EPS guidance for the year to $4.50 to $5.00, which represents a 12% to 25% increase over 2005 reported EPS. Upside to this estimate may be possible if demand improves or incremental land sales are closed."

Current Guidance

For 2006, the company currently projects the following:

• Total revenues of $2.8 to $3.0 billion
• EPS of $4.50 to $5.00, which includes approximately $0.15 of impact from the expensing of stock-based compensation
• EPS for the second quarter of 2006 to range between $0.75 to $0.85
• EPS for the third quarter of 2006 to range between $0.85 to $0.95
• Traditional Homebuilding Division gross margins between 22% and 23%
• Tower Homebuilding Division gross margins between 25% and 28%
• New orders approximately equal to 2005

Let's see if I have this straight.
First quarter EPS was $0.89 - up 154.3%
EPS for the second quarter of 2006 to range between $0.75 to $0.85
EPS for the third quarter of 2006 to range between $0.85 to $0.95
First quarter new orders were $334.8 million - down 46.7%

Now, let's do the math giving WCI the benefit of the doubt on the high end.
.89 + .85 + .95 = $2.69.
Hmmm WCI is projecting $4.50 to $5.00 earnings for the year?
Once again giving WCI the benefit of the doubt, this time on the low end my math says WCI is projecting $4.50 - $2.69 or $1.81 in earnings for the 4th quarter(doubling any other projected quarter) in spite of the fact that new orders are down 47%.

I am now being flooded with telepathic questions.
"What the hell are they smoking?"
There is absolutely no way in hell WCI can make those numbers in spite of the fact I gave them every benefit of the doubt on all of their range forecasts.

Also note that During the quarter, WCI repurchased one million shares of the company's common stock at an average price of $25.48 per share. In October 2005, the company's Board of Directors approved the repurchase of an additional five million shares of WCI's common stock, from time to time, based on certain parameters. After this quarter's purchases, WCI is authorized to repurchase an additional four million shares based on the current Board approval.

What a waste of money. Unless of course you are an insider with lots of stock options bailing your personal shares as the company buys them back from you.

PBernhardt on Yahoo message boards had these notes on the conference call.

• Will sell amenities to free up cash. Some may be profitable sales, some not. No clear answer.
• Reducing budget for land acquisition by half.
• Going to use options more than they have in the past to acquire land.
• Instead will use cash to buy back stock. Bought back 1M last Q at $25 and change.
• Balance sheet is weakening.
• Currently cash flow negative.
• Currently trading at close to book value (as are many HBs right now). Suggest that book value may be even higher, but restricted by accounting regulations. Note that half their capitalization is tied to land values. They would not break out what % is recently purchased.
• No planned land write-offs, but definitely left door open.
• Ratio of debt ratio to net cap climbed to 58% -- not good.
• Cancellations returning to historic norm (have been historically low for HBs in last 2 years).
• Admit they are going into preservation mode.
• Margins declining.
• Incentives up to 4% from 1% in past.
• Reduced guidance still depends on very optimistic projections.
• Even though they reported increase in EPS, shareholder's equity rose a tiny fraction (this will turn south unless the market turns around for this company).

PBerhardt offered these comments:

The only thing in my view that is keeping this stock from dropping on today's report is the fact that it is trading at book. They were asked if this didn't make them an attractive take over candidate. They said they would do what is best for the shareholders (of course), but does anyone believe a company this highly leveraged is a good acquisition candidate? I don't.

I expect the company will not only sell amenities, but also land to try to make up for lost home sales in an attempt to meet their numbers going forward.

Based on those Conference Call notes I have two questions:

1. Since when does "Survival Mode" mean wasting money buying back shares?
2. Is it really in share holder's interest to waste money that way?

What would a homebuilder post be without a few comments from Mike Morgan at MorganFlorida? Here goes, from Mike:

Of all the builders in Florida, WCI is facing the most problems. They are concentrated in the most overvalued markets that are seeing 75%+ drops in sales. I’ve made some notes below in red along side excerpts from this morning’s release.

With traffic levels off approximately 50% in Florida, we also have delayed the release of several towers from the first and second quarters to later in the year, and have reduced the number of towers that we expect to introduce to the market this year to 11 to 13 compared with our initial expectations of 15 to 17.

The 50% drop in traffic levels is what I have been reporting on for quite some time now. This is not something unique to WCI, but WCI will suffer far more than other builders. WCI concentrates on towers. This is where we have seen the most speculation and the largest number of speculators. Moreover, the rise in prices for this product has been unrealistically driven up by investors. Who are the investors going to flip to if sales are off 50%? And who does WCI think they are going to sell new towers to if previous buyers (flippers) have thousands of units they will need to sell . . . at any price to avoid foreclosure.? You can’t rent these things for anywhere near carrying costs. Let’s not forget the 70,000 units being built in Miami with just a 2,500 a year absorption rate. If you’ve forgotten you high school supply and demand lessons, this would be a great time to rethink that stuff. Naples numbers are even worse.

Note the comment that they are canceling projects in response to the weak market. I can assure you that they are going to have major problems with projects they have already started and cannot sell out. They can’t stop building. They must complete these units and pay the carrying costs on towers with 50-75% vacancies. I say 50-75, because they will see huge numbers of flippers walk away from contracts as the closing date approaches. Most astute investors will cut their losses, even if that means walking away from a $100,000 deposit or face a $250,000 loss if they close. I have clients walking away form $50,000 deposits on $500,000 homes. They don’t even bat an eye. It is far worse in the condo market since inventory is far more overwhelming.

By the way, WCI is the major player in the Naples area, and this is the most overvalued market in the US.

Even with first quarter incentives during our peak selling season, orders fell off the face of the earth with a 51.5% decline. The incentives from other builders are increasing. Moreover, the inventory buildup in the hands of flippers is staggering. This will be the biggest problem facing builders moving forward. There is no way to compete with desperate amateurs. They do not have the luxury of carrying these homes until the market corrects. They must sell or be foreclosed. Irrational exuberance will become irrational sales prices on the downside.

As condos go so will home sales. Cancellations do not occur until closing is demanded by the builders. My clients don’t walk from deposits until the last minute. WCI will see huge cancellation rates. First, why would a flipper close and lose more money holding a unit they can’t sell? Second, even if these units are primary residences, why close when you can buy an identical unit for less? Primary buyers can actually walk from a deposit and buy another unit on the secondary market that will make up for the lost deposit and save them a pocket full of money. As Horton said on their conference call, when buyers decide to cancel, the first thing Horton does is to true to drop the price and do whatever it takes to close the deal. The boss said they will “not be blown out of the water.” True. They will be torpedoed in the water and sink with inventory.

Add to the problems, the death of three workers buried alive in concrete this past week in Miami. OSHA has shut down construction on this project, which is WCI’s largest. You can bet the owner of the unit where the men died will cancel. And with disclosure of this to the other buyers, I imagine you will see huge cancellation. How many people want to live in a building where three men were buried alive in concrete.

The home building industry has faced a huge labor problem and even bigger problem with incompetent labor. The three men killed were all immigrants. One man had two dollar bills in his pockets. Illegal immigrants are common on construction sites here. And immigrants willing to work for low wages are the norm. In order to squeeze margins, the builders are looking the other way when subcontractors hire incompetent labor and build inferior product.

We have the biggest story to hit the Street involving one of the top 5 home builders. They are building homes that are riddled with serious code violations. One home we inspected came back with a 33 page report. The second home 36 pages. We are in the initial stages of litigation that could open up the biggest can of worms that this industry has seen. I expect this builder, as others, to cave in . . . settle . . . and demand signed confidentiality agreements from the parties and their agents. If not, you’ll be seeing it on 60 Minutes or Dateline in the next few months.

One builder just ripped the roof off a home that they insisted was fine. Well, the roof was defective, as are dozens of other things in these homes. This is just one home. They have hundreds built the same way in just this one development. The roof was installed improperly to save a couple of rows of tile. Multiply that by several hundred homes, and that can represent the squeezed profits for the sub. It is still the builder’s responsibility to sign affidavits swearing that the product meets code. I hate to use the “F” word, but these construction defects are either gross negligence or intentional fraud. There is no in between here.

Mike

I offer a tip of the hat once again to Mike Morgan and also to Yahoo poster PBernhardt.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/