Shares of struggling homebuilder Hovnanian Enterprises (HOV) rallied on Friday amid press reports that Warren Buffett is eyeing the company. The news sent shares screaming 14% higher on the day. However, it is unclear whether the speculation is well-founded. In fact, it seems that bearish sentiment towards Hovnanian had quickly resurfaced by Monday.
Headquartered in Red Bank, New Jersey, Hovnanian Enterprises designs, builds and sells planned residential developments, homes, and condominiums in 17 states including California, Florida, New York, and New Jersey. The company includes two groups (homebuilding and financial services) and employs more than 6,000 workers. The company generated $6.15 billion in revenues last year.
Shares of the homebuilder have been caught in an industrywide slump. A housing slowdown caused by tightening credit conditions has resulted in rising inventories and falling real estate prices. That, in turn, has hurt the builder's profitability. Recent concerns about the subprime mortgage market have also put pressure on the housing sector. Consequently, HOV has fallen into a two-year slump—down from more than $73 a share in July 2005 to a low of $15.5 earlier this month.
The two-year 75% tumble in shares of Hovnanian was put on hold Friday, however, amid speculation that renowned value investor Warren Buffett might be taking a position in shares of the beleaguered builder. According to the Associated Press ("Hovnanian Rises Amid Talk of Buffett Bid" by Chris Newmarker) "Shares of homebuilder Hovnanian Enterprises, Inc. shot up Friday amid press reports that Warren Buffett's Berkshire Hathaway Inc. might be eying the company." Shares jumped $2.26, or 13.9%, to $18.53 amid hopes of a Buffett bid.
Figure 1: HOV Daily Chart
But skeptics abound. in an interview with the Associated Press, Andy Kilpatrick, author of Of Permanent Value, the Story of Warren Buffett, noted that "I've covered him for 20 years and I've seen these rumors, thousands of them, and very rarely are they true." Spokespeople for Berkshire and Hovnanian declined to comment, according to the Associated Press.
Indeed, the bears seemed to quickly resurface by Monday. Shares of Hovnanian edged down 69 cents, or 3.7%, to $17.84. Moreover, put volume surged. Figure 2 shows the big increase in options volume, which included more than 17,000 put options. Most of the action was in options with strike prices of 15 and 17.5. The volume in these out of the money puts seems to reflect defensive or bearish action in the homebuilder.
Figure 2: HOV Put and Call Volume
In conclusion, although shares of Hovnanian rallied on Friday, it is unclear whether or not Buffett is looking at the company. The more important issue for shareholders is the profitability question. By some metrics, the stock seems undervalued. HOV has a market value of only $1.15 billion, but generated sales of $6.15 billion. So, on a price-to-sales basis, it seems dirt cheap. However, the company also lost $30.7 million, or 49 cents a share in the quarter ended April 30. The company is expected to post another loss when it reports earnings in early September. Yet, while the company is losing money, it is also likely that the share price will probably turn around before the company begins to post actual profits. Therefore, for investors with a long range focus and a view that the housing slump will bottom later this year or in early 2008, HOV might be an interesting value or turnaround play in the months ahead.
Frederic Ruffy
Senior Writer & Index Strategist
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