Sunday, July 23, 2006

“Back in the Day”—Like, 6 Months Ago...


“Back in the day,” as an expression, is making a resurgence the origins of which I can’t fathom.

My daughter and her friends suddenly began using it a month or two ago, and this morning I saw it twice in the same article in one of the major-but-slowly-becoming-minor New York newspapers. (I imagine some character on South Park or Desperate Housewives has been using it as a catch phrase—the way most language gains broad usage these days.)

When my daughter’s friends use the expression they are not, I should point out, conjuring up images from early America or even the Eisenhower era. They are usually referring to as far back as, oh, six months ago.

In teenage-years, of course, six months does seem to pass in an agonizingly slow crawl, such that teens look forward to marking the half-years between birthdays in order to be able to round up their ages—15 plus six months becomes 16, 17-and-a-half becomes 18, and so forth.


Adults, meanwhile, begin to face their own mortality at warp speed, because six months goes by like a weekend. To those of us over 50, “back in the day” really does mean “back in the day.”

In any event, back in the day—and by that I mean 25 years ago—Caterpillar Tractor ("Cat" to Cramer’s Mad Money home-gamers) was what we called a classic cyclical stock in that it was perenially supposedly going to earn $5.00 a share in earnings next year. (Adjusted for stock splits, that old $5.00 earnings number equates to a mere $1.25 today.)

But "next year" never seemed to happen for Cat, at least not for many next years, thanks to persistently high interest rates and the rise in Japan’s Komatsu—which played Toyota to Caterpillar’s General Motors. In the face of eternal optimism from Wall Street’s Finest, Cat's stock languished for, it seems, ever.


I remember those days because I had been given the responsibility for following Cat along with other construction and equipment companies, and Cat was the easiest company in the world to keep track of, because all you had to do was take last year’s reports from the Street, cross out the date and replace it with the current year, and you had a pretty serviceable piece on the company.

Then, the world changed—thanks, I think, to the collapse of the Berlin Wall, which set off a decade-plus worldwide construction boom and began to lift many formerly leaky cyclical boats. Cat’s management, sharpened by their battles with Komatsu, did better than most, steering the newly-sleekened vessel into uncharted waters of earnings well above the old $5.00-per-share glass ceiling and rewarding shareholders with a ten-fold increase in the stock price.

All of which came to mind this week on the heels of the Caterpillar quarterly earnings call, during which Cat management unreservedly expressed its view that the boom-times look set to continue, housing slowdown or not.

Said CEO Jim Owens right at the outset:

Bottom-line, we had a suburb second quarter. We raised our outlook for the full year and we don't see 2006 as a peak.

This was followed by the investor-relations person's similarly “upbeat” assessment:

Another interesting statistic...ROS [return on sales, or net margin] would be the best...for any full year since 1966.

To put 1966 into perspective -- that was three years before man walked on the moon but unfortunately 20 years since the Cubs last appeared in the World Series; and as a Cub fan that's a statistic I track.

This is the kind of high-fives chatter that makes somebody who remembers what “back in the day” actually means a little nervous.

It wasn’t that long ago—six months, in fact—that the CEOs of certain publicly traded homebuilders were declaring an end to the vicious housing cycles of years past and complaining about the benightedly outdated low P/E multiples Wall Street was according their stocks.

Check out the unadulterated bullishness expressed by D.H. Horton CEO Don Tomnitz in an earnings call "back in the day," just six months ago...


January 19, 2006:

First, we would like to thank all of our employees for another great quarter. Specifically, we wish to express appreciation for our sales people for a fantastic quarter of sells relative to our competition. Your 19.2% first quarter sales increase is the leader in the clubhouse. D.R. Horton, America's Builder, the largest homebuilder in America for the fourth consecutive year, continues to distance itself from the competition.


Our first quarter of fiscal 2006 was another record quarter as we once again generated double-digit increases in new sales orders, revenues, net income, and EPS, while continuing to expand our operating margins and growing our bottomline faster than the topline.


Now compare that to his more recent assessment of the company's prospects, from just last week...

July 20, 2006:


We would like to start off by thanking our people for their hard work during a time when the market conditions are more difficult in the homebuilding industry. We've experienced a changing home sales environment since the beginning of the calendar year which became much more evident during our third quarter.

The current housing environment is characterized by an increase in the use of sales incentives in certain markets, higher than normal cancellation rates, and an increase in the supply of new and existing homes for sale. It also reflects a decrease in consumer sentiment. As some home buyers are fence-sitters today pending price stabilization and respective markets.

There is more—much more—as follows.

Here are comments from Tomnitz on Horton's expected homebuilding unit sales for 2006...


Back in the day:

...part of the issue is...that we are staffed both on the homebuilding side as well as the financial services side, to close 58,000 units this year. And as Stacey has mentioned before, we will close 35 to 40% of those in the first half of the year and the remainder in the second half of the year.


And it's not something that we can get day laborers to come in and do our work. We were staffed up to hit that 58,000 target, so we're telling you at the end of the year when we close 58,000 units, our SG&A will be 10% or less.


Today:

And if you go back to fiscal year '05 where we closed 51,172 homes, and we're basically looking forward to this year of 50,000 homes then I think you can sort of back into our SG&A levels and our overhead and that sort of thing that were at fiscal year '05, and clearly that's what our goal is to get back to FY '05 cost levels.

Now, I do not mean to pick on Mr. Tomnitz: his early-2006 bullishness was no more or less wild-eyed than any other homebuilding executive I heard on any conference call or read in any interview.

And I do not mean to suggest that, at its current price, the shares of D.H. Horton are not of value. I only mean to point out how quickly things can change in a cyclical business.

Here is his assessment of various markets, including California and Florida...

Back in the day:

We believe that if you look at California, that we have strong belief that our California margins will continue to exceed the Company average margins, which makes that a good investment for us. As we move money into that D.C. market and in the Florida market, those companies have consistently, over the last five years, earned a higher than average Company gross margin. And so as a result, we believe that as we move money into D.C. and Florida and the northeast that their margins will be every bit as good as we have been experiencing in California over the last four or five years.

Today:

California continues to get softer and incentives continue to increase. You can see by our sales decrease in Florida which has been a very good market, it's 25% down. That market is still experiencing increasing incentives and even though our Arizona market, our Phoenix market was up 11 %, I can tell you that market is going to get softer going forward. So we're looking at this future market with very very clear vision with no rose colored glasses on and we don't want to paint a picture of anything else other than what we're actually seeing in the marketplace out there. And if we're going to get punished and we're going to get pummeled because of the fact that we're being more accurate than some people think we need to be, so be it.

Finally, his current overall mood...

Back in the day:

Right now we’re feeling confident…

Today:

…the market right now is weak. We think the market could get weaker going forward and …we're going to position ourselves for a flat '07 over '06 and we're going to assume that it even gets tougher in '07.

And as you and I have talked privately one thing that I know, every time we've gone into a downturn in the homebuilding industry they've always been longer and deeper than we've all imagined so we're preparing for the worst, and we think this one will be longer and deeper than just the last six months.


Which is why the unbridled confidence expressed by Caterpillar management on that equally cyclical company's recent conference call would, if I owned the shares, make me nervous:


Well, certainly we have some of the strongest order backlogs we've had in modern history in the larger end of our machine and engine and turbine product line. So we like all of our products….

And the key market segments that we serve that we have been highlighting that we think have continued strength -- like mining, global oil and gas and other energy sectors like coal and the Canadian tar sands -- all tend to be relatively large end of the line oriented.


It seemed like it was only six months ago—that is to say, according to my teenager, "back in the day"— the homebuilders had the largest order backlogs in their history, too.

Hey, it was only six months ago!


Jeff Matthews
I Am Not Making This Up


© 2006 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.


10 comments:

Logicalthought said...

If corporate insiders were REALLY any good at forecasting the future, they'd be running hedge funds!

Shookrun.com said...

Jeff, can you please help me with the following homebuilder issue?

"Back in Q1/06," Tomnitz said DHI "generated double-digit increases in new sales orders, revenues, net income, and EPS, while continuing to expand our operating margins and growing our bottomline faster than the topline."

What he failed to mention is that DHI's CFFO bottomline usually grows much slower the its net income bottomline. Only once during the last 10 years, did DHI manage to show positive CFFO, relating to NI. From what I understand this is mainly caused by inventory build-up (too much of it?).

What's going on here??? (most other homebuilders show the same anomaly). How can a company show negative CFFO for so long without going into trouble?

Can you help me here on the mechanics of this sector?

extickerpimp said...

great piece Jeff. Please do the same on AMD as I'm not paying much attention anymore. Golfing, fishing and snowboarding takes up too much time.

DaleW said...

If corporate insiders were REALLY any good at forecasting the future, they'd be running hedge funds!

Oh, well. Some members of the lower castes have to heat your water and bathe your feet so you don't have to trouble yourself with such trifles when you have larger matters on which you must ruminate.

This is the kind of comment, Mr. i-banker, that makes many in this country dislike or hate Wall Street.

fgruben said...

back in the day makes me think " past performance is no guarantee of future results "

thanks jeff.

Logicalthought said...

>>This is the kind of comment, Mr. i-banker, that makes many in this country dislike or hate Wall Street.<<

I'm afraid I don't understand your antagonism, Dale. Firstly, if *I* were any good at predicting the future, *I'd* be running a hedge fund, but I don't because-- despite the fact that I do work on Wall Street-- I don't claim to be good enough to do that.

Secondly, isn't it logical to think that if the average CEO could earn, say, $100 million a year (or more) using his great predictive abilities (assuming he had them, which-- as I wrote-- most of them *don't*) to run a large successful hedge fund (or a Buffett-like investment vehicle of some sort), he would?

That's all I'm saying.

DaleW said...

I'm afraid I don't understand your antagonism, Dale.

Many people believe being a hedge fund manager, i-banker, analyst, or anything else Wall Street-related is not the summit of human existence. Many people also believe making $100M is also not the apex of human achievement. These being typical views of many denizens of Wall Street and the antagonistic reaction to that being the view of many non-Wall Streeters to that position, I brought it to light. I personally think there's nothing wrong with $100M or working on Wall Street, but I disagree being a hedge fund PM is the end-all and be-all of finance.

Also, I don't agree predictive abilities are what makes money for hedge fund managers or homebuilder executives. For hedge fund (or mutual fund) managers, it's spotting a lopsided odds structure in the pricing of a situation that makes the difference, with money management (capital allocation) and risk management layered on top of that ability that drives portfolio outperformance. As for homebuilders, there are tons of other issues at hand outside prediction, but perhaps that's a discussion for another day.

Logicalthought said...

>>...I don't agree predictive abilities are what makes money for hedge fund managers... it's spotting a lopsided odds structure in the pricing of a situation...<<

And unless one were performing some sort of arb trade, "spotting a lopsided odds structure" COULD be interpreted as utilizing "predictive abilities."

In a non-predictive sense, you could be implying that, okay, everyone agrees on the odds of a future event happening, but the stock is mispriced relative to those odds.

However, in a "predictive" sense, "spotting a lopsided odds structure" could imply that the market is misspricing the odds of some future event happening, because it (the market) doesn't realize that such an event is actually more or less likely to occur than it (the market) thinks. And if one is really good at those kind of predictive abilities, one can make a lot of money using them.

More to your main point: I implied that most CEOs are highly (although certainly not entirely) motivated by money, and that if they could make *significantly* more money running hedge funds than they could running companies (as in, say, $100 million/yr. vs., say, $2 million to $20 million/yr), they'd be doing it. The fact that they don't, I said, means they don't have the (predictive) ability to do so, and that's why they take the huge "pay cut" and stick with running companies.

You, on the other hand, seem to be implying that most CEOs would take that major "pay cut" (albeit, while still being highly paid) and stick with running companies, rather than getting a huge pay increase (again, as in, say, $100 million vs., say, $2 million to $20 million) to run a top hedge fund, even if they had the "predictive ability" to successfully run such a fund. I disagree with you, but I could be wrong. I guess it might make for an interesting survey, if they were to answer it honestly.

DaleW said...

And unless one were performing some sort of arb trade, "spotting a lopsided odds structure" COULD be interpreted as utilizing "predictive abilities."

The context of the discussion was predicting housing starts 3-6 months out. Tons of people in the real world aren't running their business for 3-6 months out and tons of people managing capital aren't managing it on that time horizon.

As for hedge funds, not everyone wants to run one and not everyone's end-all and be-all in this world is making $100M annually. Some people are perfectly OK to make only $20 million and run their own show or, gasp, make only $500K annually. It's arrogant to imply if someone were really smart, running a hedge fund would be the the thing they would be doing if they were really that good.

Anonymous said...

MY WIFE AND I FIRST HEARD THIS PHRASE BEING USED ON THE hISTORY CHANNEL'S SERIES TITLED "RESTORATION' AND SINCE THEN
WE'VE BEEN HEARING IT QUITE OFTEN ON NUMEROUS OTHER REALITY SHOWS LIKE "PAWN STARS", "AMERICAN PICKERS", "SWAMP PEOPLE" AND THE LIKE. WE ARE IN OUR LATE 70'S SO THAT MUST PUT US "BACK IN THE DAY".

JOHN & VALJEAN KOSKIE