Bloody Home Builders’ Bonds
by Steve McDonald, Investment U Contributing Editor
Tuesday, June 19, 2012
“The time to buy is when there’s blood in the streets.”
– Baron Rothschild
These days, home builders have bloodier streets than most.
The problem with this sage advice is that most investors – bond investors included – can’t follow it. It goes against everything we’re made of to buy into anything that’s still bleeding.
But, despite the overwhelming evidence against the average guy buying into a bargain, I will again make another attempt to push you towards where the big boys play.
So let’s take a look at home builders…
Talk about cheap. Especially the bonds!
Unless you believe there are now fewer people who will need a place to live than there were before the collapse, you have to agree housing is an essential commodity.
Not all builders are essential, but having a place to live is. In my thinking, that always gave builders an extra edge.
The other extra edges builders are enjoying now are ultra-low interest rates and four years of pent-up buying pressure. These things pushed their numbers back to bleeding-but-still-breathing.
Still, anything related to housing leaves a bad taste in the mouths of most. That’s why there are still bargains out there.
Take Beazer Homes! Please!
Here’s a badly beaten-up company – Beazer Homes. Nothing went right for a long time, but that’s changing for Beazer and the whole industry.
New home starts and contracts signed are turning upward – not skyrocketing, but improving.
A number of home builders, Beazer included, are snapping up distressed homes, fixing them up and renting them. Almost a no-brainer if you have the cash.
And option activity is pointing to an improvement. This is almost exclusively institutional buying, which is usually a good signal.
We’re approaching almost five years of virtually no new building…
It has to pick up! The surplus of homes from the boom is shrinking in all but the worst hit areas.
What was bad news for home owners for five years is great news for those getting into the housing market. It’s the best buying opportunity of most of our lives. Low interest rates and prices are in the toilet.
This is a huge opportunity if you can get beyond the bad-taste stage of this industry.
A Really Cheap Bond
Beazer currently has a cheap bond that will give you a minimum expected annual return (MEAR) of about 12% for the next six years.
Stop for a second and think about how much 12% per year is. The market is in high gear with its yo-yo imitation. Treasuries are paying nothing and have a very high capital risk at these prices. And forget CDs and savings.
The income component alone on this play has a current yield of 10.56%. That’s about 20 times money market rates.
A whopping 10.56% in income and a MEAR of 12% alone should rinse any bad taste from the past few years, but the capital gains will push you over the top on this one.
This Beazer bond is selling for about 86, or $860. At maturity, it’ll return $1,000 to its holder. That’s a capital gain of $140 per bond if all you do is go to sleep and hold it to maturity.
But the real beauty is there’s a very good chance this bond will run up in price to the par area, $1,000, long before maturity. That means you could be in the enviable position of having to decide if you should hold it for the 10.56% income for the next few years, or sell it and take the quick capital gain.
Throw me in that briar patch!
It gets better! (Don’t you love this?)
There’s a call option on this bond at 104.563, or $1,045.63, on June 15, 2014. That means the company has the right to buy back this bond on that date for $1,045.63 per bond.
If Beazer does call the bond (it isn’t a guarantee, but they could), your annual return goes up to 19.7%.
Assume You’ll Hold Until Maturity
As with all bonds you should always assume you’ll hold to maturity. If things improve faster than we expect, you can take an early exit. But always assume you’ll hold it.
This makes for a more tranquil investing life and allows for all kinds of negative things to happen – short of reorganization – and you still get paid.
At maturity, here’s what your total return looks like.
You’ll receive 12 interest payments of $45.62 per bond for a total of $547.50. Plus, capital gains of $140, for a total of $687.50 from an initial investment of $864 per bond, for a total return of 79.57%.
A return of slightly over 79% from anything is enough for most investors to sit tight and wait to get paid. Most of us held stocks for at least as long and made a lot less.
The big hurdle is, can you get by the bad taste of four, almost five years of a bad beating? Especially since housing took as bad a beating as any I’ve ever seen.
But here’s the trick.
Warren Buffett said in a CNBC interview in the first week of December 2009, you remember when the abyss was right next door, “I love it when things are really bad.”
Now I’m not much a Buffett follower. What he does isn’t magic, in fact it’s usually just good old fashioned, solid investing. Plus, he also gets a lot of sweet deals you and I will never get in on, but on this point he’s right on the money.
In this market, bonds or stocks, you have to able to move a little outside your comfort zone to make any real money. You have to think like a skilled investor and see a beating to the other guy as an opportunity.
It isn’t always pretty, but it’s usually profitable.
The nice thing about housing is that it already bounced off the bottom. Institutions are moving in for the kill – always a good sign – and the numbers for builders have been improving for several quarters.
This is not the bloody mess it was two years ago.
As always it comes down to an investor’s level of experience and development. Have you reached the point where you see beyond the bad news and move where the big boys are already playing?
Move at your own pace, but move…
Good Investing
Steve McDonald
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