Sink or Swim: Liquidity Issues Plague Builders

Standard Pacific's(SPF Quote) decision Monday to suspend its dividend is an example of how liquidity risk is now the most important consideration when looking at homebuilder stocks.

In a market in which some builders are even resorting to selling homes at a loss to create cash, it's important to determine which companies can manage to survive a downturn in housing that may last for several years.

A helpful tool in doing so is the Z-score model, which has been shown to be a very powerful tool in predicting corporate bankruptcies.

Edward Altman, an NYU Stern School of Business finance professor who is considered one of the world's foremost bankruptcy experts, developed the Z-score model in the 1960s and has been fine-tuning it ever since.

The model uses five ratios and weights them to create a single Z-score value for a company:

• Z = 1.2 X1 + 1.4 X2 + 3.3 X3 + 0.6 X4 + 1.0 X5

  where:

• X1 = Working Capital/Total Assets
• X2 = Retained Earnings/Total Assets
• X3 = Earnings Before Interest and Taxes (trailing twelve months)/Total Assets
• X4 = Market Value of Equity/Book Value of Total Liabilities
• X5 = Sales (trailing twelve months)/Total Assets
• Z = Overall Index or Score

The higher the Z-score, the less risk of bankruptcy. A Z-score of 1.8 is considered the upper bound of distress for a firm.

How They Fare

TheStreet.com calculated Z-scores for the 15 major homebuilders using the companies' most recent 10-Q filings.

Only two companies had scores below 1.8, thus putting themselves in the distressed zone: WCI Communities(WCI Quote) (at 1.5) and Tarragon(TARR Quote) (at 0.3).

Hovering right near the distressed zone are Standard Pacific, with a Z-score of 2.0, and Hovnanian(HOV Quote), with a score of 2.1.

Standard Pacific plunged 12% Monday after suspending its dividend payments to shore up cash. Hovnanian does not pay a dividend for its common stock, but does for its preferred stock. The company's fire sale of new home inventory earlier this month exemplified the sad state of the homebuilding business.

Beazer's(BZH Quote) 2.3 score may be a bit misleading, since the numbers are based on the period ended March 31. The company has delayed more recent filings because of accounting issues. Liquidity worries continue to surround the builder.

KB Home(KBH Quote) and Centex(CTX Quote) put in lackluster Z-scores of 2.3 each. KB Home's Z-score was not adjusted for the recent $650 of debt redemptions.

Z-score Model for Homebuilders
		SPF	BZH (*)	HOV	WCI	TOL	NVR	MDC	RYL	TARR	CTX	PHM	MTH	KBH	LEN	DHI
Z-score		2.0	2.3	2.1	1.5	3.0	6.9	2.9	3.2	0.3	2.3	2.5	2.8	2.3	3.0	2.6
Price/book		0.3	0.3	0.5	0.3	0.9	2.2	1.0	0.7	0.3	0.7	0.7	0.5	0.9	0.7	0.8
* Beazer balance sheet items are from last 10Q, for qtr ended March 30, 2007 Note: Z-score of 1.8 is upper bound of distressed zone