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March 5, 2005
On February 10th 2005 Dominion Homes reported net income of $20.2
million, or $2.47 per share for fiscal 2004 compared to net income of $31.8
million or $3.94 per share in 2003. Revenues for 2004 decreased 4% to $542.0
million, from the delivery of 2,837 homes, compared to revenues for 2003 of
$563.5 million, from the delivery of 3,070 homes. Gross margin declined to
22.1% in 2004 from 24.0% in 2003. The reduced gross margin reflected higher
real estate costs and efforts to reduce its investment in home and land
inventories.
Shares of Dominion have weakened since the company reported its quarterly
results. While the results did not come as a surprise to us, the selling may
have been a knee-jerk reaction by investors who were caught off guard by the
sales decline. Incidentally, we believe the share price already reflects a
housing slowdown in Dominion’s key markets. Shares of the company now trade
at roughly a 17% discount to its book value of $23.52 per share. We expect
Dominion to be free cash flow positive this year, which could be used to pay
down debt or repurchase shares. Finally, Dominion could be a takeover
candidate given its small size, large real estate holdings and low stock
price.
July 8, 2005
While Fed Chairman Alan Greenspan continues to increase the federal funds
rate at a measured pace, long-term interest rates have been falling. This
has resulted in a flattening of the yield curve. Since mortgage rates tend
to be correlated to long-term rates, demand for new housing in the U.S. had
remained strong. In fact, according to the U.S. Census Bureau, sales of
single-family homes rose by 4.4% to 1.30 million in May compared to 1.24
million in May of last year.
Dominion Homes, the Ohio-based homebuilder, appears to be benefiting from
stable to declining long-term interest rates. On Thursday July 7th the
company reported that home sales for the three months ended June 30th, 2005
increased 28% to 655 homes compared to 510 in the same period last year. In
addition, the sales value of the homes sold increased 24% to 123.1 million
compared to 98.0 million last year.
Dominion Homes appears to be an attractive investment at this time. The
shares currently trade at a 23% discount to their book value of $23.12. It
is also interesting to note that the company's Chairman and founder, Douglas
Borror, has been buying stock .He recently purchased over 31,000 shares and
presently controls over 48% of the company. Given the company's low stock
price and the added costs of complying with the Sarbanes-Oxley Act, Dominion
Homes is a prime candidate for privatization. Furthermore, Dominion Homes
could also become an attractive takeover target for a larger industry player
due to its low comparative valuation and the fact that is a significant
public homebuilder in Central Ohio and Louisville Kentucky.
October 14, 2005
On October 7th, Dominion Homes reported that it sold 433 homes in the
third quarter compared to 598 homes sold in the third quarter of 2004, a 28%
decrease. The sales value of the homes sold during the quarter decreased 25%
to 81.8 million compared to 109.4 million last year. As of September 30th,
Dominion had a backlog of 771 sales contracts, with a sales value of 154.6
million, compared to a backlog of 845 sales contracts with a sales value of
$166 million at the same time last year.
It is important to keep in mind that the homebuilding industry is
cyclical and during times of economic uncertainty, homebuilding stocks can
be volatile. This is what we are currently experiencing with respect to
shares of Dominion Homes. US consumer confidence has fallen to a two year
low as the affects of hurricanes Katrina and Rita continue to be felt in the
U.S. Consequently, many potential new homebuyers are postponing their home
purchase in the face of higher home heating and gasoline costs and a
recent rise in long term interest rates.
However, patient investors who are willing to ride out the current
economic uncertainty could be well rewarded. Shares of Dominion Homes now
trade at less than 50% of its $23.38 book value and under 14 times this
year’s expected earnings of $0.85 per share. Further, given the company's
low stock price and the added costs of complying with Sarbanes-Oxley
legislation, Dominion Homes is a prime candidate for privatization. With
shares of Dominion Homes now trading at a three year low, a going private
transaction becomes even more attractive for the Borror family given they
already own 47% of the company. Finally, Dominion Homes could also become an
attractive takeover target for a larger industry player due to its low
comparative valuation and the fact that is a significant public homebuilder
in Central Ohio and Louisville Kentucky.
January 6, 2006
On November 2nd, 2005 Dominion Homes (DHOM)
announced third quarter results. Revenues were $106.3 million from the
delivery of 549 homes, compared to $162.6 million from the delivery of 820
homes during the same period the previous year. The average delivery price
of homes during the third quarter of 2005 was approximately $191,000
compared to $196,300 for the third quarter of 2004. Net income was $1.2
million or $0.14 per diluted share compared to $7.5 million or $0.91 per
diluted share for the third quarter of 2004. The lower net income for the
third quarter of 2005 is principally due to the delivery of fewer homes
compared to the third quarter of 2004.
While DHOM’s share price has changed little since our
last update, we remain patient. The shares now trade at a 55% discount to
its $23.61 book value. We believe, that much of the anticipated slowdown in
housing demand is already being reflected in DHOM’s depressed stock price.
It is interesting to note however, that while investor sentiment towards
DHOM has been quite negative, the company is still earning a profit and is
expected to be profitable in 2006.
Looking forward to 2006, we have identified two
potential catalysts which would be positive for DHOM shares. First of all,
given the company's low stock price and the added costs of complying with
Sarbanes-Oxley legislation, DHOM is a prime candidate for
privatization. With shares of DHOM now trading at a three year
low, a going private transaction becomes even more attractive for the Borror
family given they already own 47% of the company. Finally, DHOM
could become an attractive takeover target for a larger industry player due
to its low comparative valuation and its large undeveloped real estate
positions in Central Ohio and Louisville Kentucky.
May 19, 2006
On May 8th 2006, Dominion Homes reported first quarter financial results.
Revenue totaled $61.8 million on the sale of 315 homes, versus revenue of
$92.6 million from the delivery of 478 homes in the same period last year.
The company’s backlog at the end of the quarter was 590 sales contracts
compared to a backlog of 780 sales contracts last year. Although the company
produced a net loss of $3.9 million or $0.49 per share in the quarter, it
should be noted that the first quarter is seasonally weak for homebuilders
with the bulk of the sales for the year occurring during the spring and
summer months.
During the company’s first quarter conference call, investors were
introduced to Jeff Croft who was hired in March as Dominion’s President and
COO. Croft comes from Pulte Homes, one of the largest homebuilders in the
U.S. where he previously served as an Area President. Croft, who has a
finance background, will now oversee Dominion’s strategic and capital
allocation decisions. In fact, during the call, Croft indicated that one of
his priorities is to sell the company’s excess land position and use the
proceeds to reduce debt. He also stated that he is committed to bringing the
company’s cost structure better in line with Dominion’s current sales level.
Reducing interest and overhead expenses is an important step in returning
Dominion Homes to profitability and we are pleased to see that Jeff Croft is
proactively addressing these issues.
On a final note, it is worth repeating that Dominion Homes is an
excellent candidate to eventually be taken private. The company currently
has a market capitalization of under $100 million which, as a small
corporation, makes it quite onerous to remain public given the relatively
high cost and time required to comply with the Sarbanes Oxley legislation.
Also, the company’s stock remains undervalued relative to its assets. In
fact, Dominion’s shares are currently trading at less than one half of its
book value per share of $22.83. One feasible option could be for Dominion
Homes to go private by way of a management led buyout. CEO Douglas Borror
and his family currently own 47% of the company which leaves just over 4
million shares in the public float. The other option would be for Douglas
Borror to put the company up for sale. Dominion could be an attractive
target for a larger homebuilder looking to enter the Ohio market. In effect,
given Dominion’s current stock price, it would be cheaper for them to
purchase Dominion Homes then to go out and buy the necessary land and
equipment at current market prices while assembling a sales and labour force
from scratch.
September 1, 2006
Home sale conditions in Dominion Homes’ markets continue to be
challenging. New building permits declined 27% in Columbus, 39% in
Louisville and 20% in Lexington during the first six months of 2006.
Dominion’s recent financial results reflect this reality. For the second
quarter of 2006, the Company reported a net loss of $5.9 million or $0.79
per share versus net income of $2.5 million or $0.31 per share a year
earlier. Revenue in the quarter was $75.8 million from the delivery of 398
homes versus revenues of $105.2 million on the delivery of 548 homes in the
2nd quarter of 2005.
On a positive note, Dominion managed to reduce its land position at the
end of the quarter to 16,593 lots from 17,311 lots at the end of the first
quarter. In addition, it reported a $3.7 million or 22% reduction in SG&A
costs in the 2nd quarter. Also, management believes a further 10% reduction
in SG&A costs can be achieved in the third and fourth quarters. In fact, in
conjunction with its quarterly results, Dominion announced that its
executives would be taking reduced salaries and forgoing any bonuses this
year. Given the performance of Dominion’s share price recently, it is good
to see that management is willing to share in the pain. Although these cost
reductions will probably not be enough to produce a profitable second half,
we view it as a step in the right direction as the Company begins the
process of realigning its cost structure with a lower backlog of sales.
Finally, it is interesting to note that during the Company’s 2nd quarter
conference call, Dominion’s CFO William Cornelly, made a comment to the
effect that Dominion has fairly significant public company costs relative to
its other fixed costs. This statement reinforces our view that Dominion and
its shareholders would probably be better served if it were made a private
company. This could be accomplished by either selling the company to a
larger homebuilder or via a management led buyout of the company. We feel
that to a private buyer, Dominion would be worth considerably more than is
current public market value.
January 12, 2007
We purchased Dominion Homes (DHOM) in February 2005 at what we believed
was a washed out price of approximately $23 a share. The shares, which
reached an all time high of $40.28 in March 2004, were trading at just ten
times earnings of $2.35 per share, and just above its book value of $22.70.
Although we expected earnings to be lower in 2005 and possibly 2006, we
calculated that free cash flow would increase substantially. As orders
declined, working capital would be freed up as the Company reduced its land
purchases and drew down its inventory of completed homes. Our hope was the
funds would be used to pay down debt or even repurchase shares. We believed
this would give DHOM the financial cushion to withstand the forthcoming
housing correction and that earnings would eventually return to prior
levels. Finally, given DHOM’s small market capitalization, dominant market
position and large real estate ownership, we believed DHOM was an excellent
candidate to be acquired by a competitor, or taken private by family
insiders.
Unfortunately, housing demand slowed sharper than we expected in Ohio and
Kentucky and DHOM struggled to find new buyers for its homes. Unit sales
declined 24% in 2005, and 30% in the first nine months of 2006. Despite
rising costs and falling sale prices, DHOM continued to invest in new
housing projects. This hurt margins and left virtually no free cash
remaining for debt reduction or share repurchases. With many economists
predicting another tough year ahead for housing markets, we are concerned
about both the company’s ability to generate free cash flow and its
deteriorating balance sheet. While DHOM sales could eventually return to
previous levels, we are however, no longer comfortable with the company’s
debt level given that earnings and free cash flow are likely to remain
negative for the foreseeable future. After considerable analysis, we decided
to sell our shares upon learning that DHOM’s debt had been sold by its banks
to two hedge funds. We are concerned that the hedge funds’ interests may not
be aligned with the interests of equity holders.
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