Builders FirstSource (Builders) was formed in 1998, as BSL Holdings, Inc., through a partnership between JLL Partners, Inc. and certain members of Builders' management team. On October 13, 1999, the company's name was changed to Builders FirstSource, Inc. Builders is a leading supplier and manufacturer of structural and related building products for residential new construction in the United States. According to ProSales magazine's 2006 ProSales 100 list, Builders is the sixth largest building products supplier to professional homebuilders in the United States. The company has operations principally in the southern and eastern United States with 68 distribution centers and 59 manufacturing facilities, many of which are located on the same premises as our distribution centers.
We maintain our Sell rating and lower our target price from $7 to $5 on BLDR shares. While we believe that there are many positives associated with the company's business model, we do not believe those positives can overcome the extremely difficult conditions in the housing industry.
Weakness in the housing market appears to getting worse. This weakness contributed to declining home sales and lower lumber prices, which weighed on the company's results. During the third quarter, Builders' sales declined 27.4% year-over-year while earnings per share declined from $0.60 in 2006 to $0.00 in 2007. Management noted that housing activity in its markets declined by 35% year-over-year with weakness across the board. What's more, it appears that we are long way from seeing the housing market reach a bottom. According to our Housing Analyst, Mario Ricchio, inventory levels remain stubbornly high, speculators are still in the market, cancellations rates are high, and nationwide home affordability is quite low. The combination of these factors point to an industry that needs to work off excess inventory, squelch speculative juices, limit cancellations, and have long-term interest rates decline to make houses more affordable. Until these issues are contained and the supply/demand situation reaches equilibrium, weakness in the housing industry will persist. Companies in the industry are no longer trying to sugar coat the situation. Builders FirstSource expects the difficult market conditions affecting its business to continue to have a negative effect on its operating results and year-over-year comparisons into 2008. We agree and are modeling further weakness in its business for all of 2008. Moreover, the meltdown in the subprime lending market now prevents many first-time buyers and potential buyers with lower incomes from buying homes. As a result, we expect Builders' sales to decline by 26.7% in 2007 with EPS falling 94% year-over-year.
Despite the industry headwinds, there are some positive associated with Builders FirstSource. These positives position to Builders to deliver solid growth when the housing market finally stabilizes and begins to turn. During this slowdown, Builders is scaling back its capital expenditures and not building new facilities. Instead, it is seeking out attractively-priced takeover targets that will help boost growth when the cycle turns. The company is also focused on taking market share from weaker competitors. Lastly, management is working to reduce its cost structure, which should help stem the bleeding in its operating margins. This includes reducing headcount to match its lower sales levels. When industry conditions finally improve, Builders will be positioned to experience impressive operating margin expansion. But, this scenario is several quarters away.
Bottom-line, we would avoid owning BLDR shares until there is clear evidence that the housing industry is stabilizing. We will get that evidence only when fewer new homes are built and the inventory of existing homes for sales declines to more reasonable levels. At this point, we think the risk is that conditions in the housing market will worsen before they begin to improve. As conditions worsen, estimates for Builders FirstSource will have to come down, and that will cause further downward pressure on its stock price.