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These days, any mention of the housing market in conversation usually elicits a prolonged groan (especially if you live in California or Nevada). Homebuilders nationwide are feeling the pinch of a tight credit market, falling land prices, and mounting inventories. However, while the outlook for real estate is pretty dismal, times like these always make me ask myself: What would Buffett do? The answer? He would start looking for well managed, undervalued companies that he could pay bottom dollar for. While I don’t think now is the time to buy by any means, tenured and cash rich companies like MDC Holdings (NYSE: MDC) may have a place on my watch list moving forward.

Housing Outlook is Unclear

Don’t get me wrong, we could be in for a rough ride in the housing market for some time. In fact, some economists think home prices could fall another 25% over the next 2 years. Even more frightening is research done by Yale professor Robert Shiller, which shows that home prices always revert to the long term mean growth trend of 0.4%. As you can see from the graph below, the market was still well above this trend line at the end of 2007.

Overview

In my opinion, now is the time to start formulating a strategy for the market of tomorrow. As a contrarian, I want to know who has a strong track record, conservative financials, and a solid plan for the future. I am patient, and I have tried to learn that planning ahead is good policy. That’s why I like Denver based MDC Holdings, a fortune 500 company which operates subsidiary Richmond American Homes (a homebuilder operating mainly in the west and mid-atlantic regions) and HomeAmerican Mortgage Corporation (not to be confused with American Home Mortgage).

Opportunity

I know, I know, California and Nevada (two of the areas MDC operates in) are probably the worst places for real estate right now. In fact, MDC’s 2007 earnings took a huge hit due to impairments (basically reductions in the value of land) in those areas. However, what I like is cash, and MDC has plenty of it. In fact, the company had a cool $1 billion dollars in its war chest at the end of 2007 (twice what it had in ‘06). Not bad for a mid cap stock with a market cap of only $2 billion. Further, it has kept a tight reign on costs (expenses were down 36% Y/Y vs. 06) and has one of the lowest lot supplies in the industry. MDC also increased operating cash flow by 63% in 2007 vs. 2006.

Metrics

A quick look at key metrics shows a Price-to-Book of 1.33 vs. the industry average of 5.0. Also, Price to Free Cash Flow is a conservative 3.78 vs. the industry average of 24. However, I’m not excited about the 5 year average ROI of only 5.68. I was certainly hoping for stronger metric there. Of course, earnings have taken a hit due to impairments, so EPS metrics aren’t pretty right now.

Risks

Yep - there are plenty. I listed some above (housing outlook). Also, it’s not a positive sign that both the CEO and COO both recently started selling shares / exercising stock options. That is typically a near term red flag, but the those transactions could also be unrelated or could have been pre-planned.

Summary

The key here is long term. We know housing is in the tank, and will likely remain there for some time. We also know that MDC operates in tough markets that potentially have further to fall. However, because of its cash position and long tenure (the company has been around since 1972) I want to keep an eye on this one. This is not, by any means, a recommendation to buy or sell. However, MDC Holdings may be a name to slip into the vest pocket for review at a later date.

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With the US economy looking more and more like it is headed for a recession, investors will likely take positions in more defensive sectors such as consumer staples, health care, and utilities. In my opinion, this makes stocks like Mirant Corp. (NYSE: MIR) look attractive at current valuations.

Overview

In a nutshell, the company sells electric power, capacity, and services to a variety of customers in the Mid-Atlantic, Northeast, and California. A quick scan of company history reveals a checkered past, as the company entered bankruptcy in 2003. However, after further review, it appears that a solid management team was put in place in 2005, including Yale Law alumnus Edward Muller (who was brought over from Edison Mission Energy).

Opportunity

Based on research by the US Energy Information Association, demand for electricity will continue to grow in 2008 and 2009. Further, the core operations of the company are situated right smack in the middle of key regions which have problems meeting the growing demand for power (such as the Mid-Atlantic). This has been a key driver of EBITDA, which increased a whopping 51% in Q3 ‘07 vs. Q3 ‘06! I also like that the company is making strategic divestitures and returning proceeds to shareholders through buybacks.

Metrics

I like what I see from a metrics perspective. The stock’s trailing twelve month (TTM) P/E of 7.3 is well below the utility industry P/E of 18.7. More importantly, TTM Price / Free Cash Flow is an attractive 10x vs. the industry average of over 40x. TTM margins are above average across the board (e.g., EBITDA margin = 31%). Debt / Equity is a conservative 0.48, and Return on Equity (one of my favorite data points) is a solid 29% vs. the industry benchmark of around 15%.

Risk

Power generators are often at the mercy of commodity prices such as oil and natural gas. These prices will likely remain high for some time. In addition, while necessary and extremely important, costs of environmental compliance can impact bottom lines as well.

Summary

With a near team recession possible and energy demand continuing to grow, MIR looks like a reasonable buy at its current valuation. We’ll keep a close eye on this stock moving forward.

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