Hovnanian Enterprises
With operations in 14 states, its primary markets include California, Texas, Arizona and the mid/south Atlantic region. The Hovnanian family still holds a controlling stake in the company.
Debt financing that seemed reasonable prior to the 2009 financial crisis became a millstone in its aftermath. The high interest payments and tight bond covenants severely limited Hovnanian’s ability to build new homes. The $2.2 billion in expensive debt in 2008 has been trimmed to $1.7 billion today, mostly through dilutive equity offerings.
A recent debt refinancing should provide considerable financial flexibility, but it involves an intentional, technical default that has rattled shareholders and threatens a potentially costly legal entanglement.
Rising labor and raw materials costs, along with fears of a housing downturn, add to investor worries that have driven the shares down 40% this year to levels not seen since the depths of the financial crisis.
We view Hovnanian as a recovering homebuilder with a poor but improving balance sheet. Its substandard profit margins will likely begin to turn up, and its new financing will allow it to increase its construction pace.
Not only will the refinancing lower Hovnanian’s interest costs but it will also push out its nearest major bond maturity to at least the end of 2021, providing the company with much-needed breathing room. While aspects of the refinancing remain controversial, a legal challenge to the transaction was rejected by the courts, and we believe the risk of other fallout against Hovnanian is low.
Largely because of its balance sheet issues, Hovnanian has not participated in the rebound enjoyed by most other homebuilders since the financial crisis, but we think the stock will now begin to catch up.
As a still quite leveraged company tied to the strength of the housing market, Hovnanian shares carry significant risks, but we think those risks are outweighed by the upside potential in the stock. Also, with its relatively small market capitalization, it could be a takeover candidate if the Hovnanian family decides to monetize its stake.
Disclosure: Accounts managed by an affiliate of the publisher of The Turnaround Letter own Hovnanian common and preferred stock.
George Putnam is editor of The Turnaround Letter.
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