Impairments Spark a Sell-Off, But Position BZH for an Earnings Rebound

Beazer Homes (BZH) reported a fiscal 2019 second quarter loss of $3.28 per share, compared with earnings of $0.36 per share in the comparable prior year quarter.  The loss included a large impairment charge and a much smaller gain on debt extinguishment totaling roughly $3.08 per share.  Excluding those items, fiscal second quarter earnings would have been about $0.20 per share.

The impairment charge was taken against assets in California.  In response to a change in market conditions, the company reduced its assumptions for future sales prices of homes in certain active communities that previously had high carrying costs.  In addition, Beazer decided to take a similar charge on certain inactive projects that also had high carrying costs which are being marketed for sale. Fourteen of the fifteen impaired communities have been on the books since before the 2008 financial crisis.  The write-downs will accelerate the conversion of these assets into cash and allow the company to redeploy the capital more quickly into newer projects with better potential returns or perhaps to reduce debt or buy back stock.

Excluding these net charges, earnings were still below the prior year.  Homebuilding revenue declined 4.6% to $420.9 million, as a 10.4% decline in unit closings (to 1,134) was partially offset by a 6.5% increase in the average selling price to $370,700.  Excluding the impairment charges and amortized interest, Beazer’s gross margin declined 150 basis points to 19.8%, which the company attributed to changes in product mix, pricing strategies at individual communities, efforts to improve cycle times and purchase accounting adjustments related to a recent acquisition.

Land sales during the quarter were only $0.3 million, down from $14.0 million last year.  Excluding land impairment charges of $38.6 million, gross profit on land sales was just about breakeven, compared with $0.7 million last year. Despite the decline in revenues, Beazer’s SG&A expense ratio (including commissions), eased by about 10 bp to 10.7%.

Taken together, BZH’s operating income (excluding impairment charges) declined 37.4% to $8.7 million and its operating margin dropped by about 100 bp to 2.0%.

Despite the decline in profits and profitability, CEO Allen Merrill said this was a strong quarter that exceeded expectations across nearly every operational metric.  Results improved during the course of the quarter, helped by the decline in mortgage rates.

In the quarter, Beazer bought back $7.5 million of common stock and retired $5.0 million of senior notes; but total debt increased by $46 million to $1.3 billion. The company borrowed under its bank credit facility to cover the $12.5 million of debt and stock buybacks, $9.5 million of capital expenditures and acquisition costs and $24 million of cash used in operating activities (mostly to increase inventories).

With the increase in debt and reduction of equity (caused by the net loss and share buybacks), Beazer’s debt-to-capitalization ratio increased from 66.4% to 71.1%.  Despite the cash burn, Beazer ended the quarter with $221.4 million of liquidity, including $86.4 million of unrestricted cash and $135.0 million available under its bank credit facility.

Net new unit orders declined 4.8% to 2,574 units and Beazer ended the quarter with a backlog of 1,989 units valued at $783 million, down 14.0% and 11.5%, respectively, from the prior year.  The decline in Beazer’s unit orders was among the worst in its peer group.

Oblivious to management’s positive view of the quarter, Beazer’s stock fell sharply on the day of the earnings announcement, plunging 12.2% on heavy volume to close at $12.51 on the day.  It has fallen almost steadily each trading day since then and now stands at $9.71, closing right on the low for the week ended May 17.

Yet, despite falling 30% from its May 2nd peak, BZH is still up nearly 2.4% on the year.  As a result of that decline, however, the stock has now significantly underperformed its peer group this year.  By comparison, the S&P Homebuilders ETF (XHB) is up 23.1% year-to-date.

Even with its high leverage, Beazer has been buying back stock.  To date, it has spent about half of its $50 million buyback authorization to acquire about 7% of its outstanding shares, including $7.5 million in the March quarter. During the quarter, it also spent $5.1 million to buy back some of its outstanding senior notes. Although the recent emphasis has been on buying back stock, Beazer expects that debt buybacks will exceed share buybacks for the full year.

Based upon management’s guidance, I project that Beazer will post earnings of about $0.20 for the 2019 third quarter (ending June 30) and a loss of $1.80 for the full year (which equates to a profit of $1.30 for the full year, excluding the impairment charge). I believe that my projections are within the range of analyst estimates, but below the average estimate. Even so, at the current share price of $9.71, the stock is trading at only 7.5 times my projected 2019 earnings (excluding the impairment charge), well below the peer group average of about 10.0 times.

That big apparent discount suggests that the market is skeptical about the company’s ability to achieve its guidance. Yet, with roughly $0.43 of the anticipated full year earnings (excluding the impairment charge) already in the bag, it does not seem like much of a stretch for the company to earn $0.87 over the second half of fiscal 2019.

In fiscal 2018, Beazer earned $2.24 in the second half, so my projection anticipates a 60% decline in 19H2 versus the prior year. That does not seem like much of a stretch for the company, especially since the active communities that were impaired in the 2019 second quarter will post higher margins now as a result of their lower carrying costs. If anything, my estimates seem low.

Beazer’s high leverage and low operating margins make it a speculative stock.  However, if the housing market is able to sustain its performance over the next 18 months and the second quarter impairment charge is not indicative of continuing problems, the stock should make up for its recent losses and deliver better overall performance vs. peers for the balance of 2019 and into 2020.

May 17, 2019

Stephen P. Percoco
Lark Research
16 W. Elizabeth Avenue, Suite 4
Linden, New Jersey 07036
(908) 975-0250

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