Builders Have Further to Fall

Those P/E ratios are set jump further, since Wall Street estimates could end up being very wrong this year. According to Thomson Financial, most analysts still expect builders to be in the black for the year.

But analysts were already very wrong about Lennar and KB Home, as each were expected to report profits last week. Barron expects most builders to be unprofitable this year.

Negative earnings translate into negative free cash flow, which can get ugly at a time when many builders' debt loads are high.

"If all these companies were unlevered, you could hold them for five years and they would be OK investments," says a hedge fund manager who remains bearish on housing and is mostly short the sector. But that's not the case.

Take Hovnanian(HOV Quote).

At the end of the first quarter, Hovnanian had stockholder equity of $1.86 billion and long-term debt of $2.67 billion. The amounts to a 1.4 debt-to-equity ratio, one of the highest in the industry.

Oppenheim expects the company to record a 20% future drop in book value. With such a hit, the debt-to-equity ratio moves to 1.8.

Put another way, under this scenario, debt would amount 64% of Hovnanian's permanent capital structure.

Of course, if book value erodes further, Hovnanian could always preserve its existing debt-to-equity ratio by redeeming outstanding debt. In order to do that, the company needs cash, but the company had only $30.8 million of cash at the end of the first quarter.