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Hovnanian's Talk Rings Hollow

It's been consistently wrong on housing. Now its cash projections may be too optimistic.

There might be a recession looming, but don't believe it just because

Hovnanian Enterprises

(HOV) - Get Hovnanian Enterprises Inc. Class A Report

says so. The homebuilder's senior executives have been completely wrong over the past year about where the country -- and the company -- is heading.

Last week, CEO Ara Hovnanian told


: "Clearly, the risk of the economy overall going into a recession is heightened right now."

The fact that there might be a recession coming isn't surprising, given how bad the housing market has become. What


surprising is that the comments are coming from Ara Hovnanian, one of the most vocal housing bulls of recent years.

The timing of Hovnanian's bearish turn is perfect. It's suffering from high debt burdens and cash flow problems, making it a good time to talk up a recession. When your own company is in trouble, why not say the entire country is having economic problems?

Dial back to last December, when Hovnanian

missed estimates and reported a $115 million loss for the fiscal fourth quarter. Despite the bleak quarter, the builder forecast a nice profit for 2007 and assumed there would be zero additional impairments and land charges -- an absurdly optimistic proposition.

Larry Sorsby, the company's chief financial officer, told investors on the earnings call at the time, "We think it is behind us as long as the market doesn't worsen," referring to the writedowns.

Since then, the company has recorded an additional $184 million of writedowns, with more expected this year. Its stock has tumbled 70% to around $10, and it has missed analysts' quarterly estimates for three straight quarters.

Analysts now expect Hovnanian to record a loss of $3.15 a share for the current fiscal year, according to Thomson Financial.

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Of course, Hovnanian expected the market to improve by now.

In a


interview last December, Ara Hovnanian said, "We are not at the bottom

in housing yet, but I think there is reason for optimism that we will see the bottom in the beginning of '07."

The company's capacity for extreme optimism -- which it always hedges -- was also on display in its latest earnings release last week.

"Unless market conditions deteriorate further, we project adequate room to operate under our debt covenants, and thus we are not currently making any requests for modifications to our $1.5 billion unsecured revolving credit facility," Sorsby said in a statement.

But on the earnings call, several analysts pressed management about this debt issue, along with cash flow. What was revealed is that Hovnanian expects to create cash by selling its existing homes for sale, while not buying too much more land or purchasing the land from option contracts.

If the builder manages this dance properly, it can improve coverage ratios and maybe even pay down some debt.

This begs the question: Why hasn't there been cash so far? Other builders, including

Toll Brothers

(TOL) - Get Toll Brothers Inc. Report


MDC Holdings

(MDC) - Get M.D.C. Holdings Inc. Report

, have reported positive cash flow over at least the past three quarters.

Hovnanian has reported negative cash flow from operations during this period. This means the already highly leveraged builder continues to take on more debt to fund operations.

The company has one of the highest debt-to-equity ratios in the sector, at 1.4 times. Total debt is $2.5 billion. Balances on the revolving credit facility totaled $456 million at the end of July, compared with no balance at the close of October 2006, when its fiscal year ended.

Larry Taylor, an analyst with Credit Suisse, asked the company on its earnings call last week why it hasn't stepped harder on the brakes in terms of building new homes and buying land from option contracts. Slowing down both would create more cash flow.

Ara Hovnanian responded, "Obviously you don't want to choke off the land supply on good communities that are contributing. Clearly many of our communities are still profitable and are contributing to our performance."

But at some point, the company will probably become more aggressive in slowing down new building to create significant cash flow, Hovnanian said.

Some have already said Hovnanian's cash flow guidance is too optimistic. The builder said last week it expects positive cash flow of $175 million to $250 million for the quarter ending in October, along with another $100 million to $400 million for fiscal 2008.

Daniel Oppenheim, a Bank of America homebuilder analyst, wrote in a research note last week that the company is likely to come in at the low end of both cash flow targets. He believes that declining buyer traffic, rising cancellations and excess inventory point to further deterioration, and he sees risk of the company violating its debt covenants in the future.

Not everyone is so bearish about Hovnanian and the economy's outlook.

Greg Pillen, Hovnanian's marketing director for the Ohio region, decided to give his update on the national economy in a press release touting an aggressive sales campaign this weekend in Ohio.

"The confidence is returning," Pillen said in the release. "People have stayed out of themarket for almost two years, and that has built up demand. They see that the economy is continuing to be good and interest rates are staying low, and they realize that the deals have never been better."

So according to Pillen, the economy is good. Then what has been the problem for Hovnanian?

"People want to buy homes, but the media has made them nervous," Pillen said in the release. "They just need to realize that there's no better time to buy a home."

He must have overlooked the fact that his boss, Ara Hovnanian, is talking about a recession on national television. That probably won't do much to help buyer confidence in Ohio.

Neither Pillen nor Hovnanian returned calls seeking comment.