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An Ominous Message From Centex

The company's warning may be a harbinger of a new wave of negativity from homebuilders.

When

Centex

(CTX)

speaks, investors listen.

The company's huge earnings miss in the spring served as one of the first indicators of the bad news that punished the homebuilder sector in the following months.

Centex's news this week is even worse, and it could possibly herald a replay of that spring selloff, especially given the sector's recent rally.

Late Thursday, Centex cut its second-quarter earnings guidance in half and said net orders for period ended Sept. 30 fell 28%.

The Dallas-based company lowered its estimate for the quarter to 65 cents to 75 cents a share from a July projection of $1.40. Analysts polled by Thomson First Call had an average estimate for earnings of $1.33 a share.

Centex's preannouncement was driven by the company's desire to cut down land positions aggressively, said Susquehanna Financial analyst Stephen East in a research note.

Centex expects its option deposit and pre-acquisition walk-away costs on land to be in the $85 million to $95 million range this quarter. Additionally, land valuation adjustments are expected to be about $40 million to $45 million, which includes the company's share of such amounts for a joint venture.

"We see this as a painful but required piece of the strategy to get the balance more in line with the realities of today's housing environment," East wrote. "This charge is meaningful for the quarter, but over the last three quarters, charges (pre-tax) equivalent to only about 4% of the equity have hit the income statement."

Centex's net orders for the quarter were 6,828 homes, a decrease of 28% from last year's second quarter. The company said the results reflected record levels of contract cancellations, driven in many cases by the inability of buyers to sell their existing homes.

East cut his full-year earnings estimate for the company to $4.42, down sharply from $5.61.

In a research note, Bank of America analyst Daniel Oppenheim said he expects Centex to lower its full-year guidance when it reports earnings later this month. The company's current profit forecast for fiscal 2007 is $7 a share. Oppenheim lowered his estimate to $3.90 from $5.75.

For fiscal 2008, Oppenheim expects $1.15.

Shares of Centex recently were down 3% to $53.45. Some analysts and investors recently have argued that builder stocks should no longer be valued on earnings but instead on price-to-book metrics.

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Centex currently trades 30% above its book value. On the basis of Oppenheim's 2007 fiscal earnings estimate for the company, the stock trades at 13.7 times earnings for fiscal 2007 (which ends in late March for Centex).

Because Centex doesn't follow the standard calendar fiscal year, it began talking about 2007 earnings in

late April. The news at the time served as the first peek at next year, and it spooked investors and helped lead to a rapid selloff in the sector that ended in mid-July.

Since that time, builder stocks have climbed as investors began to believe a bottom in the market was near. Centex is up 24% since July, but the stock is still down 25% for the year.

It's important to remember that no other homebuilder has given 2007 estimates. The consensus analyst prediction for Centex is now $4.13, compared with the $9.46 the company earned in fiscal 2006.

Shares of other builder stocks moved lower Friday after the Centex warning.

KB Home

(KBH) - Get KB Home Report

fell $1.38, or 3.1%, to $45.95;

Toll Brothers

(TOL) - Get Toll Brothers, Inc. Report

dropped 78 cents, or 2.6%, to $30.01; and

Pulte

(PHM) - Get PulteGroup, Inc. Report

shed 87 cents, or 2.5%, to $33.59.

Some have argued that builder stocks have already priced in scenarios like the one Centex unveiled Thursday. When builders begin reporting earnings later this month, look for other companies to record large charges for walking away from land.

The next wave of bad news will be a test for the sector, whose recent run may in part also been

buoyed by a drop in the 10-year Treasury note. With the 10-year note's yield back up to 4.74%, builder stocks might have a lot to prove in coming months.