Rising rate environment
Friedman, Billings Ramsey---Kucera, Craig---Analyst
>> shares of computer associates have fallen as much as 4.5% in extended hours trading today after the company said its profit this quarter might miss analysts’ forecasts. c.a. says that profit could miss the average 19-cent estimate but didn’t say how much. the software company reported fiscal fourth-quarter profit that topped estimates, earning $89 million in that period and excluding costs, made 18 cents a share, a penny more than expected and double the per-share profit from a year ago but the company’s revenue did not meet estimates, falling more than $12 million short. in the regular session, unchanged and down 4% in extended hours. and before the closing bell, the company said it’s reviewing the% -compensation of former chief executive, sanjay kumar. computer associates chairman says the company is seeking to settle with the u.s. justice department and the securities% -and exchange commission. computer associates is examining the pay of all officials involved in the accounting fraud which took place while kumar was the president. moving along now, we turn to today’s news with existing home sales jumping in april to the second highest level on record, pushed by home building -- pushing home building stocks higher today, and that sent the s&p home building index up more than 24 points, or 5%. craig kucera, analyst with friedman, billings ramsey, joins us now from virginia for a look at housing stocks and a preview of toll brothers earnings. let’s start with toll brothers. you’re looking for the consensus but the big story with the homebuilders, craig, is the receipt decline and concerns about interest rates. but a study or correlation between rising and falling interest rates and homebuilders over a 10-year or 20-year period of time would show that actually they do well in a rising rate environment.
>> yes, i believe that’s reasonable to say. in the current interest rate environment, we are estimating that the 10-year treasury will rise to 5.5% in the first quarter of 2005 and we believe even as interest rates rise to that level, most of the homebuilders or all of the homebuilders should be able to perform well, earning well over double-digit earnings growth in that period.
>> what if rates go higher than 5.5%? what is the pain threshold? 6% to 9%? when does it take a bite out of the top and bottom lines of these companies?
>> for one thing, i want to keep in mind that when i said 5.5%, that’s the 10-year treasury yield, implying a 7% 30-year fixed mortgage yield. we believe interest rates would have to pick up 7.5% for there to be significant impact on the organic growth opportunities for the homebuilders across the industry. overlaying that is the capacity for the homebuilders to make accretive acquisitions through the process. the homebuilders as a group maintain relatively small market share with roughly 25% of the total market share and as interest rates were to rise, if it got to the point where organic growth slowed, we believe there are many acquisition opportunities out there for the homebuilders to work through that point.
>> what sort of acquisitions, land or small builders?
>> most of the builders have been aggressive in making land acquisitions in the past several years. on average they typically have from four to eight years of land supply on their balance sheets or controlled with an option. i’m referring to acquisitions of small builders. we have roughly 20-plus public homebuilders with 20% of the market share and 70,000 to 80,000 smaller builders which seems to pose the possibility that if organic growth were to slow, that certainly those opportunities would come into being.
>> what’s with the phobia, then? i talked earlier about the inverse correlation or the correlation of rising rates and and―or falling rates and reits doing well and in rising rates they have still done well. the last time we saw the fed funds rate rising was june 1999 and june 2000 and let’s were up during that period. why is there such an unfounded fear in the market and why do these stocks continually trade at a deep discount in terms of price-to-earnings? toll brothers trading at less than nine times estimated earnings?
>> i think a lot of it has to do with the fact that we’ve been in a 12-year expansionary period of expanding growth and home building has never seen the declines it saw in the 1980’s. what i would say is the market hasn’t fully understood how the businesses have changed, how net margins for these companies are roughly twice what they were 10 years ago and how the companies now have structured their balance sheets so that leverages approaching roughly half of what it was back then. coming out of the last recession in the early 1990’s, the average debt to capital was 30% and now it’s roughly 40%.
>> volume picked up today for the first time in four days and not since last christmas had volume on the big board been so light, the last three sessions. we’ll look at why investors were keeping money on the sidelines and what changed today.
