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  1. Home
  2. / Investing
  3. / Real Estate

Hovnanian Is an Option Play on Management and the Housing Market

This homebuilder is a high-risk, but potentially high-reward play.
By TIM MELVIN Jun 06, 2016 | 02:00 PM EDT
Stocks quotes in this article: HOV

After leaving the beach at Saint Petersburg yesterday when the first wave of clouds and rain from the storm forming in the Gulf of Mexico appeared, I arrived home and hit the couch with the new copy of Barron's. While I know I could have read it on my phone on the beach if I so chose, I prefer to sit down with the actual paper and a beverage and navigate the pages.

Although the younger ones among us won't remember, back when I started in the 1980s we didn't have seven million web sites and TV channels devoted to the markets. We didn't even have Investor's Business Daily yet. We had the Wall Street Journal and Barron's. I have had canceled my subscription a time or two over the years, but always end up coming back to it. It's become something of a habit, it seems.

I was interested to see that Ivy Zelman had some comments on the housing markets this week. Ms. Zelman is one of the few analysts who saw the last housing crash coming and has done a solid job covering it since then. She told the paper that while she was concerned about multifamily and condo markets in cities like Miami, New York, San Francisco and Los Angeles, she likes the outlook for many of the builders.

She says we are only four years into the housing recovery and may have a ways to go. "This cycle will be elongated, and the slope of the recovery is flatter than what we thought the trajectory would look like when we called the bottom in 2012," she said in the interview. I have said all along that I think this will be a long, slow-grinding housing recovery and I am delighted to see that one of the best analysts in the business supports my view.

I also found the timing interesting, because when I was perusing the Value Line list of high potential return turnaround and long shot stocks last week, there were several home builders on the list. While they may not be for the faint of heart or impatient investor, the total return potential is huge. There will almost certainly be some big bumps along the way, so I would start small and add on the inevitable price weakness to build a position in a handful of high-return potential builders.

The longest shot of them all remains Hovnanian (HOV). The company is still struggling, and CEO Ara Hovnanian summed up its position in the last earnings release: "Since Oct. 15, 2015, we have paid off $320 million of debt. More importantly, we continue to believe that we will have the liquidity to pay off the remaining debt maturities through the end of 2017. We are certain that we are taking the correct steps that will best position our company for future success. While it is discouraging to report a loss for the first half of fiscal 2016, it is nevertheless a significantly reduced loss, and we anticipate our profitability in the second half of the year will more than offset this loss."

The company may be having a difficult go of it right now, but I can tell you that it is definitely still building. They have several projects underway fairly near my house, and they appear to be selling well. The management are taking the right steps, exiting some unproductive markets like Minneapolis and Raleigh as well as pricier markets like Tampa and San Francisco. They continue to deleverage the balance sheet and cut SG&A expenses by 420 basis points in the latest quarter.

This is not a back-up-the-truck stock by any means. It is a high-risk, high-reward special situation. You only need to own a few shares of Hovnanian, because if it all works and management succeed in deleveraging the balnce sheet and eventually growing as the housing market slowly gets better, this stock is going a lot higher. It has the risk-reward characteristics of an option on management and the housing market.

Ivy Zelman had some interesting things to say about the housing market in the interview, and it's worth your time to read it. The homebuilding sector has struggled, as investors began selling when it became clear that the recovery was not going to be an overnight event. Many of the stocks are now priced for strong long-term returns. Hovnanian is the longest shot of the bunch, but if it works -- and it appears to be right now -- it will be a moon shot.

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At the time of publication, Tim Melvin was long HOV, although positions may change at any time.

TAGS: Investing | U.S. Equity | Real Estate

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