Summary
1. Unsold Inventory will increase in 2008. 2. Gross margins will seem to be inflated but this should be analyzed closely as this could be skewed by previous impairments. 3. Well-managed companies will survive this bear market and shine in the long run.
Analysis
It is common knowledge that gross margins tend to get skewed due to previous impairments. A number of companies, big and small are writing off standing homes so that they will convert to revenues. This is a quirk in the way we account for impairment accounting in a way that this results in reducing the basis of a home. This in turn increases the gross margin on the home when sold. the original impairment charge included a discount factor associated with the asset holding period that reduces the basis in the home.
The above is very important when analyzing the gross margins. Many a times, we are ignorant or deliberately avoid considering the impairment accounting principle that leads to an artificially higher gross margins. This leads to an incorrect picture of home sales and eventually leads to investors making wrong decisions.
Home sales will continue to see a decline in 2008 albeit not as large as last year. We will see bottom sometime towards the second half of the year. A lot of homeowners are now realizing they are in a buyer’s market and slowly adapting to the changes. Home prices are dropping fast, due to increasing competition from other sellers and homebuilders.
Bottom line, we have not seen the end of the homebuilding industry crisis and 2008 will not be much different than last year. A number of homebuilder companies will face a severe crunch and extreme pressure and one may see some consolidation. I would not say that this is a beginning of a long bear market for homebuilding companies and a few of the well-managed companies will survive and begin to shine.
