Zacks Analyst Blog Highlights: D.R. Horton, International Paper, Berkshire Hathaway, Masco and Visa

Mar 30, 2011, 09:30 ET from Zacks Investment Research, Inc.

CHICAGO, March 30, 2011 /PRNewswire/ -- Analyst Blog features: D.R. Horton (NYSE: DHI), International Paper (NYSE: IP), Berkshire Hathaway (NYSE: BRK.B), Masco (NYSE: MAS) and Visa Inc. (NYSE: V).


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Here are highlights from Tuesday's Analyst Blog:

Home Prices Keep Falling

In January, home prices continued to slip, although the declines were less widespread than in recent months. The Case-Schiller Composite 10 City index (C-10) fell 0.22% on a seasonally adjusted basis, and is down 2.03% from a year ago. The broader Composite 20 City index (which includes the cities in the C-10) also fell by 0.22% on the month and is down 3.03% from a year ago. The second down leg of housing prices continues.

Of the 20 cities, eight were up on a month-to-month basis, and 12 were down. Year over year, though, just two metro areas saw gains and 18 suffered losses. Washington DC was the strongest by far, with prices up 3.59% from a year ago. San Diego managed to squeeze out a 0.08% rise.

This is the 7th straight month-to-month decline in the composites, and the third straight month that both of the composites were negative on a year-over-year basis. Seven cities hit new post bubble lows in their home prices.

Look at Seasonally Adjusted Numbers

There is a seasonal pattern to home prices, and thus it is better to look at the seasonally adjusted numbers than the unadjusted numbers. Most of the press makes the mistake of focusing on the unadjusted numbers. The small rebound in housing prices we saw from the spring of 2009 to the summer of 2010 has now mostly evaporated. The C-20 index is just 0.67% above its interim low in April 2009. The C-10 is holding up somewhat better and is now 2.16% above April 2009 levels.

Longer term, though, the declines between the two indexes are very similar. From the April 2006 peak of the housing market, the C-10 is down 31.44% while the C-20 is off by 31.30%. The Case-Schiller data is the gold standard for housing price information, but it comes with a very significant lag. This is January data we are talking about, after all, and it is actually a three month moving average, so it still includes data from November and December.

Existing home sales have been weak relatively weak in recent months. While the inventory-to-sales ratio is down from the June peak of 12.5 months, it is still elevated at 8.6 months.

The second leg in the housing price downturn is not over. Housing prices are going to fall again in coming months. It seems likely to me that we will set new lows before the second down leg is over.

The Best and the Worst

Of the eight cities that posted month-to-month gains, Washington DC led the way with a 0.85% rise, Atlanta (up 0.73% and Dallas (up 0.52%) were also strong, at least for the month. On the downside, the Twin Cities were hit hard, with prices tumbling 1.49% on the month. Seattle was the only other city with a decline of more than 1.0%, falling 1.05% from December. Miami (down 0.79), New York (-0.71%) and Charlotte (-0.65%) were also very soft.

On a year-over-year basis, DC was the strongest city by far with a 3.59% rise. San Diego has managed to cling to a 0.08% increase, but that does not mean things are going well there. As recently as July, the year-over-year gain was 9.26% in SD.

There were eight metropolitan areas where the year-over-year declines were more than 6%. Phoenix fared the worst with a 9.15% decline, and shows no sign yet of rising from its ashes. Detroit has been hit almost as hard, down 8.08%. Portland is down 7.80% year over year. The Twin Cities are down 7.54% while Chicago is off 7.40%. In other words, significant year-over-year declines are happening in just about every corner of the country.

In every city prices are below where they were in April 2006, but there is a huge variation. Las Vegas is the hardest hit, with prices down 57.87% from the peak, followed by Phoenix, down 55.31%. Three more cities are down more than 45%, Miami, down 49.40%, Detroit off 47.50% and Tampa, with a 45.71% decline.

At the other end of the spectrum, there are just three cities that have managed to avoid a double-digit decline. Dallas, where prices are down only 5.45% since April 2006, Charlotte off 6.98% and Denver where they are down 9.67%. (Note: the percentage declines I am quoting are from when the national peak was hit, the numbers in the graph are relative to that city's individual peak, so there is a little bit of difference.)

Post-Tax Credit Housing Market

The homebuyer tax credit was propping up home prices a year ago, but now with that support gone, prices are resuming their downtrend.  People had until June 30 to close on their houses, and they had to agree to the transaction by April 30.  The credit was up to $8,000, so almost nobody would want to close their deal in early July and simply leave that money on the table.

The tax credit is a textbook example of a third party subsidizing a transaction. When that happens, both the buyer and the seller will get some of the benefit. The buyer gets his now when he files his tax return, the seller gets hers a year ago in the form of a higher price for the house.

Since the tax credit is now over, that artificial prop to housing prices has been taken away. Sales of existing houses simply collapsed in July, after the credit expired, and have remained depressed ever since.

The extremely high ratio of homes for sale to the current selling pace is sure to put significant downward pressure on prices. There is still quite a bit of "shadow inventory" out there as well. That is homes where the owner is extremely delinquent in his mortgage payments and unlikely ever to make up the difference, but that the bank has not yet foreclosed on or foreclosed houses that have not yet been listed for sale.

It also includes all those people who think that the decline in housing prices is just temporary, and are waiting for a better time to sell. As they do, it seems if they will play the parts of Vladimir and Estragon, waiting for Godot.

While it seems clear to me that the downward trend in home prices is likely to continue, we are unlikely to have a decline anything like the first downdraft in housing prices. The reason is in the next graph (unfortunately not yet updated for the current data). People need a place to live, but they do not have to own a house. They have the option of renting.

A house is a capital asset, and the cash flow from owning that asset is in the form of rent you do not have to pay. One of the clearest signs that we were in a housing bubble was that the prices of houses got way out for line with rental prices. While on this basis, houses are not yet "cheap" on a national basis, neither are they absurdly expensive the way they were a few years ago. If prices fall too far from here, it will become cheaper to own than rent, and lots of people who are now in apartments will start to buy.

Existing Home Prices Crucial

It is existing home prices -- not the volume of turnover -- that is important. The level of existing home sales is only significant relative to the level of inventories, since that provides a clue as to the future direction of home prices. If there is excess inventory of existing homes, then it makes very little sense to build a lot of new homes.

It is the building of new houses that generates economic activity. It is not just about the profits of D.R. Horton (NYSE: DHI). A used house being sold does not generate more sales of lumber by International Paper (NYSE: IP) or any of the building products produced by Berkshire Hathaway (NYSE: BRK.B) or Masco(NYSE: MAS). Turnover of used homes does not put carpenters and roofers to work. New homes do.

Existing home prices, on the other hand, a vital. Home equity is, or at least was, the most important store of wealth for the vast majority of families. Houses are generally a very leveraged asset, much more so than stocks. Using your full margin in the stock market still means you are putting 50% down. In housing, putting 20% down is considered conservative, and during the bubble was considered hopelessly old fashioned.

As a result, as housing prices declined, wealth declined by a lot more. For the most part we are not talking vast fortunes here, but rather the sort of wealth that was going to finance the kids' college educations and a comfortable retirement. With that wealth gone, people have to put away more of their income to rebuild their savings if they still want to be able to send the kids to college or to retire.

The decline in housing wealth is a very big reason why retail sales have been so weak. With everyone trying to save, aggregate demand from the private sector is way down. If customers are not going to spend and buy products, employers have no reason to invest to expand capacity. They have no reason to hire more workers.

Visa Inflates Escrow Account

On Monday, Visa Inc. (NYSE: V) announced that it will deposit about $400 million to its escrow account in order to fund its litigation costs. This action is considered equivalent to a repurchase of shares of the company. Meanwhile, the company used the funds allocated for the share repurchase program announced in October 2010 to raise the deposit money.

Accordingly, Visa will make the deposit under its previously implemented retrospective responsibility plan (RRP), the terms of which solely affect the financials of the company's class B shareholders. This financial impact takes place in the form of a reduction in conversion price of such class B shares into class A shares.

Apart from funding the litigation escrow account, under the RRP, such action can also be taken when Visa has to arrange funds for its U.S. financial institutions or their associates and successors.

As a result of this RRP, currently Visa has decided to fund its litigation costs through the repurchase of its class A shares worth $400 million on an as-converted basis. This is created as a back-up to provide coverage and potential payment for litigation settlements in the U.S. against Visa.

Such an account also protects the company's common shareholders from direct losses. However, the details regarding the repurchase share count and price is yet to be disclosed.

This is not the first time that Visa has entered into such risk-fund back-up arrangements. Besides, Visa stands as a defendant in several state and federal lawsuits filed by individuals and institutions such as interchange litigation where interchange rates are violated, faulty currency conversion practices and pricing structure. Previously, in March 2008, Visa deposited $3 billion out of the net proceeds of its IPO.

Again in December 2008, the company deposited $1.1 billion into the litigation escrow account, which was followed by a $700 million deposit in July 2009.

Last year, in May, Visa had deposited $500 million in its escrow account, which was followed by an $800 million deposit in September. These funds could otherwise have been used for growth purposes but litigation escrow limits the company's liquidity and usage of funds for growth projects.

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