Standard Pacific: Bargain or Trap?

To get a sense of Standard Pacific's credit rating in relation to other homebuilders, I employ a financial model I've developed based on the famous Z-score calculation by Edward Altman, a professor at New York University's Stern School of Business who specializes in corporate bankruptcies and financial distress.

My conclusion is that Standard Pacific carries a very weak credit profile that has only gotten worse over the past year.

The Z-score 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 12 months)/Total Assets
• Z = Overall Index or Score

A Z-score of 1.8 is considered the upper bound of distress for a firm.

My Z-score model uses the same ratios and weighting but slightly tweaks two inputs of the Altman model. The change is that I adjust homebuilders' working capital levels to exclude long-term inventories, and I add back impairment charges to EBIT in order to reflect normalized earnings.

The higher the Z score, the less risk of bankruptcy. My analysis shows that Standard Pacific's Z score has declined significantly over the past year, similar to the ugly situation playing out at competitor Hovnanian (HOV Quote). Both companies now have Z scores below 1.8, which signals significant financial distress.

Z Scores for Builders: SPF vs. HOV
2q07	SPF	HOV
Z score	2.1	1.9
3q07	SPF	HOV
Z score	1.8	1.7
4q07	SPF	HOV
Z score	1.5	1.6
1q08	SPF	HOV
Z score	1.4	N/A

If Standard Pacific can manage to survive, the stock is probably underpriced relative to Hovnanian. Both companies have declining credit profiles and exposure to very weak housing markets, yet they trade at much different price-to-book ratios.

Hovnanian has a price-to-book ratio of 0.54, vs. Standard Pacific's 0.25.

If both companies can manage to survive, then a possibly profitable trade today could be shorting Hovnanian and going long Standard Pacific.

Here's the data used to calculate Standard Pacific's Z-score:

Data for First-Quarter Z-Score Calculation
		SPF
1q08 data	working capital:	1,969.00
	current assets	2,446.80
	current liabilities	477.8
	long-term inventories	-1,207.50
	adj. working capital	761.5
	total assets	2,953.00
	retained earnings	450.4
	adjusted EBIT (ttm)	-5.6
	market value of equity	211
	book value of total liabilities	2,143.00
	sales (ttm)	2,539.30
	EBIT (ttm)	-993.2
	impairments (ttm)	987.6
	adjusted EBIT (ttm)	-5.6