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Credit Suisse Crashes Builder Party

An influential analyst downgrades the sector following a recent rally.

Homebuilder stocks fell Thursday after one of the sector's most respected analysts downgraded the stocks to underweight, saying that the group is priced to perfection given the continuing deterioration of fundamentals.

Credit Suisse analyst Ivy Zelman said in her report that price-to-earnings ratios are at peak levels and that even normalized earnings after a messy 2007 cannot justify the valuations.

Calling the sector a "crowded trade," Zelman said the group is "priced for perfection" based on investors' assumption that orders, cancellations and inventory will all sequentially improve in the fourth quarter of this year and the first quarter next year.

"Several big name investors have added credence to this claim, squeezing shorts in the process," she wrote. "In talking with investors, we have the perception that whether the market has found a floor isn't a debate. It is being taken as a given."

Builder stocks dropped on the report, reversing some big gains from recent weeks.

Toll Brothers


was down $1.18, or 3.6%, to $31.83;



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fell $2.19, or 3.9%, to $54.29; and



was losing $1.48, or 3.9%, to $36.53.

Zelman is continually mentioned by sources as being the most reliable and smartest of the Wall Street analysts who cover the builders. Her call Thursday could prove to be influential in coming months, especially as some investors are

cashing out profits in the sector after its recent run.

Homebuilding stocks have enjoyed a nice rally after bottoming in July. As of Wednesday's close, the Philadelphia Housing Index was up 28% since that time, despite a string of mostly negative news on the sector.

On Toll Brothers' earnings call earlier this week, Zelman grilled Chief Executive Robert Toll about his claim that certain housing markets around the country were bouncing along the bottom. Her point was that sales might be bottoming, but not prices or margins.

In her note Thursday, Zelman reiterated that investors should focus on profits in the sector. "While unit trends have shown some signs of improvement, we portend that units need to be viewed in conjunction with pricing and margin, which continue to deteriorate," she wrote.

Zelman also said record housing inventories could get worse over the next few months. "We are dubious that the increased supply won't heighten the need for incentives and aggressive pricing in the spring," she wrote.

As well, resale inventory could also surge, as homeowners and speculative investors look to test the selling market in the new year.