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An upside earnings surprise by

M.D.C. Holdings

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

wasn't enough to boost the homebuilding sector Tuesday, as the group slid after one analyst said builders' earnings would decline in 2007 and 2008.

Banc of America Securities analyst Daniel Oppenheim, who turned very bearish on the group last fall, said he expects homebuilders, as a group, to report EPS growth of 10% in 2006, followed by declines of 9% in 2007 and 12% in 2008.

Oppenheim expects slower sales and price appreciation, along with pressured margins from increasing costs for land, labor and materials. He cut both

Meritage Homes

(MTH) - Get Meritage Homes Corporation Report


Toll Brothers

(TOL) - Get Toll Brothers, Inc. Report

to sell from neutral.

The Philadelphia Housing Sector Index fell 1%, led by a 4.3% drop at Meritage and a 4% decline at

M/I Homes

(MHO) - Get M/I Homes, Inc. Report

. Toll fell 2.1%.

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Oppenheim says he is now using a multiple of 8.8 times 2008 earnings projections to estimate price targets for the builders. Last week, Raymond James analyst Rick Murray also put out a bearish report on the sector. Murray wrote, "earnings for the public builders should remain flat to up modestly in 2006, although the current consensus expectations are for more robust growth, averaging 16%. In 2007 we estimate that EPS will show declines averaging 22%."

Robert Marcin, the founder of Defiance Asset Management and a

contributor, says declining earnings are no reason to stop buying the builders. The money manager admits builders' earnings might drop 10% or more in 2007, but says that at that point, P/E multiples for the group could double to 12 from 6, where the sector has been trading recently.

Marcin says homebuilders will rally on a soft-landing scenario for housing, just as steel companies have been rallying on a soft-landing scenario for steel prices. He cites steel manufacturer


(NUE) - Get Nucor Corporation Report

as an example of how a company's stock can rally even though its earnings are expected to drop.

Nucor's EPS is expected to drop 23% in 2006 and 12% in 2007, according to the mean analyst estimates published on


. However, Nucor shares have risen nearly 30% in the past three months and now trade at 12.8 times its 2007 EPS estimate.

"The point is that stocks trade at some valuation on normalized earnings when you have a down cycle," Marcin says. "Steel has traded up with a soft landing situation."

Marcin expects a homebuilder rally is probably six months behind steel. "Once people believe that conditions are more normal in the industry, they'll pay a much more normal value for the industry. The six P/E of the

homebuilding sector is because of moronic sell-side analysts calling a bubble in the sector," he says.

On Tuesday, M.D.C. beat Wall Street's fourth-quarter earnings expectations and guided toward a 2006 gain, while pledging to pull out of Texas.

The news comes less than two weeks after the Denver-based company became the latest homebuilder to post a drop in fourth-quarter orders.

For the quarter ended Dec. 31, M.D.C. earned $198 million, or $4.29 a share, up from the year-earlier $143 million, or $3.17 a share. Revenue rose 29% from a year earlier to $1.7 billion. Analysts surveyed by Thomson First Call had been forecasting a $4.01-a-share profit on sales of $1.68 billion.

M.D.C.'s home gross margins were hit by the greater mix of homes closed in California, where gross margins were below the company average. On a conference call, M.D.C. management said that much of the slimming of margins in California stemmed from higher land prices.

Still, fourth-quarter homebuilding operating margins were higher than margins in both the third quarter and the 2004 fourth quarter, amid increased revenue production in its markets.

The company said it believes that the overall demand for new homes in most markets remains strong, as evidenced by the year-over-year increase in the sales value of home orders. M.D.C. said it is reallocating capital from Texas to other markets with higher risk-adjusted returns. The company will continue to build on or sell lots in Texas, which it expects to complete by the fall of 2006, but it says it has no plans to buy new land there.

Paris Reece, the company's chief financial officer, said on the call that the company believes the move out of Texas will help margins.

The company earned $10.99 a share for all of 2005 and said it is "well-positioned for higher revenues, home closings and net income in 2006." Analysts are expecting a 2006 profit of $11.75 a share. M.D.C. shares recently were down 41 cents to $64.77.