Hovnanian Haze Thickens

In two months' time, the housing market must have gotten much worse. Either that, or Hovnanian Enterprises(HOV) was way too optimistic when it reported earnings in June.

At the time, the homebuilder reiterated its already-reduced earnings estimate of $7.20 to $7.40 a share for the year ending in October. On Friday, management slashed guidance to $5 to $5.75.

But even this new outlook might prove hopeful.

Homebuilders these days are facing weak orders, and the reliability of backlogs continue to be called into question. Earlier this year, management teams would downplay the order weakness by saying they at least had strong backlogs of homes sold but not yet delivered. That provided added comfort about revenue projections for the year.

Now, cancellation rates continue to rise, and the margins are dropping significantly on those homes in the backlog as more incentives are used to keep buyers from cancelling their contracts.

Hovnanian's new guidance for fiscal 2006 assumes gross margins of 23% to 23.6%. The previous forecast was 24% to 24.5%. Last year, the company's gross margin was 26.4%.

Alex Barron, a JMP Securities analyst who rates Hovnanian "market underperform," says he learned a valuable lesson when D.R. Horton (DHI) spooked the market in mid-July and slashed guidance.

"These guys have absolutely no visibility anymore," he says, referring to builder management teams.

Barron downgraded Hovnanian in June because he believed that the company's delivery assumptions were too aggressive for the year. Hovnanian's new delivery target is 17,600 to 18,200 homes, down from the previous assumption of 18,700 to 19,300. In its second-quarter earnings call, management said about 30% to 32% of its deliveries would come in the fourth quarter.

The back-heavy delivery guidance poses some danger considering that cancellation rates may not have peaked yet. Barron, for one, believes that cancellation rates could get worse by year-end.