Efficient Ryland builds on popularity of home sector. (Corporate Focus).

HOMEBUILDING is one of the few sectors besides defense seeing headlong gains this year, spurring a debate on Wall Street as to whether the sector is in a bubble.

Among local homebuilders, Ryland Group Inc. is the biggest winner by far. At a recent price of $113.06, it's up more than $40 per share for the year -- a 55 percent gain, eclipsing the not-so-shabby 29 percent rise of rival KB Home. Going back to its post-Sept. 11 low, Ryland is up 177 percent, from a dividend-adjusted close of $40.77 on Sept. 20.

Calabasas-based Ryland's operating results have underpinned its stock surge. Since the beginning of the year, Ryland has reported record fourth quarter and first quarter profits, and increased its earnings guidance for 2002 twice -- first to $9.50 a share, then to $10.25. It will split its stock two for one, effective May 15.

Ryland and other builders have been insulated from the weak economy. They got an assist from mortgage rates, which have been running at historical lows, and from buyers taking advantage of newer lending programs. Many buyers have found that it's cheaper to own a home than to rent. After Sept. 11, Ryland executives braced to offer discounts in order to keep sales volume rolling, but demand remained surprisingly strong.

"Lots of first quarter sales closed were post-Sept. 11 (purchases). We thought we'd have to give more incentives away, we just didn't need to," said Chief Financial Officer Gordon Milne at an investors' conference last week.

For the first quarter ended March 31, Ryland earned $26 million, or $1.83 per diluted share, vs. $16.1 million ($1.12) for the like year-earlier period. Revenues rose to $539.4 million from $514.2 million.

Conservatively run

Even with this success, the market is still skeptical of Ryland and other homebuilders. Because it's conservatively run, Ryland trades at a premium to many of its peers, but it's still only trading at 11 times trailing 12-month earnings. By comparison, the P/E ratio of the Standard & Poor's 500 Index is 45. (More aggressively run homebuilders such as Toll Brothers Inc. and D.R. Horton Inc. trade at P/E ratios comparable to Ryland's, but for different reasons.)

Investors, of course, worry about interest rates reversing. They also remember what happened when the last real estate bubble burst, taking many homebuilders with it. Just weeks ago, there were reports that mortgage lender Countrywide Credit Industries had to postpone a $500 million bond offering -- despite its high credit rating and record profits of late. (Countrywide officials didn't return calls.) Ryland itself is a turnaround story that nearly suffocated under a massive debt load in the mid-1990s.

Homebuilding executives and industry analysts alike say the companies have since the S&L-financed bubble a decade ago. They've all reduced their risk profiles, by speculating less on land (using options to tie up parcels until it's time to build) and by pursuing long-term, fixed-rate borrowing strategies.

They've become larger, allowing them to diversify geographically and by price bracket, and to cut costs by purchasing big-ticket items such as kitchen cabinets at a discount.

No acquisitions

Under Chairman and Chief Executive R. Chad Dreier, who came over from Kaufman & Broad (now KB Home) in 1993, Ryland has done all these things. But it's also distinguished itself from its competitors in a couple of noteworthy ways. First, it doesn't do acquisitions. "We don't need to go and acquire someone else in order to get into big markets. It's a lot easier for us to add 50 homes in each of our big markets than to go out and buy somebody," Milne said.

By dispensing with integration costs, Ryland has been able to focus more closely on its operations. "They particularly believe that through increasing the efficiency of the production process they will be able to increase their margins," said Carl Reichardt, an analyst with Banc of America Securities.

Like most homebuilders, Ryland also has a finance arm that's contributed to profits, but it has an agreement to sell each mortgage to Countrywide, usually on the day the home sale closes. This keeps the loans off Ryland's books.

As a result, Ryland is one of the most efficient operators in the business. It doesn't build until it has a buyer lined up, so it carries little inventory -- essentially, only sales that fell through for some reason, such as a lost job. Ryland turned over its inventory 2.4 times in 2001, compared with 1.4 times on average for the other homebuilders Reichardt covers. Its operating margins rose to near 20 percent in the first quarter, up from 13 percent in 2000.

Ryland's biggest strength is also a potential drawback. The company is seen as a straight-forward investment, but as the industry continues to consolidate, there is a danger that Ryland will be left behind by some of its more acquisitive competitors, such as D.R. Horton. Right now, Ryland's predictability is valued by investors. In a more upbeat market. it could be seen as a detriment. "We think some competitors get too focused on size and not enough on profitability," said Milne.

Financial Editor Anthony Palazzo can be reached at 323-549-5225, ext. 224, or at [e-mail].

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YEAR (Dec. 31)                  2001   2000

Revenue (billions)              $2.7   $2.3

Operating Expenses (billions)    2.5    2.2

Operating Income (millions)    225.6  134.8

Net Income (millions)          131.8   81.6

Earnings Per Share             $9.27  $5.92

SUMMARY

Business: Homebuilder

Headquarters: Calabasas

Chief Executive: R. Chad Dreier

Market Cap: $1.5 billion

Dividend Yield: 0.1%

Total Liabilities: $880.8 million

P/E Ratio: 11.1

Long-Term Debt: $490.5 million