Monday, March 15, 2010

Beazer Homes (NYSE:BZH): Cracks in Foundation But Property By No Means Condemned. Initiating Coverage With a Buy Rating - Citigroup

Citigroup's Homebuilding team is picking up coverage on Beazer Homes (NYSE:BZH) with a Buy rating and $6.25 target price, implying 37% upside.

Firm notes that according to Bloomberg, across the Street there are 5 Holds, 2 Sells and no Buy ratings. As such, they believe their investment thesis is an out of consensus call.

Based on valuation (BZH trades at ~0.8x Citi's estimate of 2Q10 TBV versus the peer group average of ~1.5x) and that fact that the rest of Street has seen fit to assign no Buy ratings to the stock, they think the investment community may not be distinguishing between BZH the company and BZH the stock. To be sure, BZH the company faces both operational and financial obstacles. That being said, the firm thinks the stock is cheap and that a positive near-term catalyst is likely to emerge in the form of a debt refinancing.

Company Overview
BZH is a top ten homebuilder based on closings. Like many of its peers, the company has shifted its focus to the first-time homebuyer segment (~65% of LTM closings). Through the downturn, BZH has exited many markets and as a result its operations are now concentrated in three regions: the West, East and Southwest. As of '08, BZH no longer operated a financial services subsidiary. BZH now utilizes a marketing arrangement with a third party financial institution to originate mortgages. BZH is headquartered in Atlanta. The company was founded in ‘85 and went public in ‘94.

Going With the Flow: Asset-Lite Strategy
BZH is pursuing an asset-lite strategy in which it attempts to minimize its land position and land development activities and focus instead on the building and selling of homes. Although BZH is targeting three to four years of total land exposure split evenly between owned and optioned land, it currently has one of the longer land supplies in its peer group.

Although asset-lite has become the predominant strategy among the public homebuilders, BZH has been less vocal than some of its peers about the importance of having an asset-lite strategy. Citi thinks BZH is deliberately trying not to over promise with regards to its ability to achieve its targeted land supply. While most of its peers which are acquiring new lots intend to monetize those purchases in the next 6-12 months, BZH's land acquisition strategy has somewhat of a longer dated focus. On its most recent conference call, BZH stated its land acquisition strategy is focused on “controlling positions that can generate home closings in ’11 and ’12.

Cracks in Foundation… — BZH faces both operational and financial challenges. On the homebuilding side, they think BZH is a below average operator. BZH's gross margins and inventory turns have trailed the peer group average while its SG&A as a percentage of revenues has recently exceeded the peer group average. On the financial side, even after factoring in the recent equity issuance and the company's tax refund, Citi thinks BZH's balance sheet remains highly leveraged with a ~61% net debt-to-cap compared to the peer group average of ~29%.

…But Property Not Condemned — Citi thinks investors are well served by distinguishing between BZH the company and BZH the stock. Their normalized earnings analysis suggests that for investors who are confident that BZH will survive, there is considerable upside in the stock relative to its current valuation. When calculating normalized earnings for BZH, they address the excess leverage issue by first "rightsizing" the company's balance sheet. Even after their "rightsizing" adjustment, they conclude that BZH is cheap.

Debt Refinancing Could Be a Positive Near-Term Catalyst — While their analysis suggests that BZH's near-term liquidity profile is adequate, they think an upcoming debt refinancing could be a positive catalyst for the stock. Next month the firm expects BZH to issue intermediate or long-term debt and use the proceeds to call its outstanding '12 debt. By removing the '12 maturity and terming out its debt structure, they think BZH would effectively eliminate any existential concerns.

Notablecalls: I must say that at least from the trading perspective, I like the call. What's there not to like:

- Sub-$10 stock with a relatively large price target and the only Buy rating on the Street.

- A beaten down stock that has managed to trap a lot of shorts. Short interest stands close to 20%.

- Catalyst ahead in form of an upcoming debt refinancing.

The problem with BZH is that they bought too much land at the wrong price. That means their margins will lag the peer group for years as it takes time to work off the expensive land inventory. But I guess with the stock down from the $80's (in 2006) to current $4-5 level, much of that is already priced in.

All in all, I expect BZH stock to trade up today to the tune of 5-7%, putting $4.75-4.85+ levels in play. It could go somewhat higher if the market continues its recent ramp. But I prefer to stay conservative as always.

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