S&P 500 builder valuations - one of four in my series. Only 3 LT buy recommendations
February 19, 2008
– Comments (30) |
RELATED TICKERS: PHM
, CTX
, KBH
Before you begin reading my valuations on this grouping of builders, I suggest you click on the link and read my thesis on public homebuilders and why buying them in the spring summer timeframe could result in a long term profitable hold. There are almost no jokes in here, so if you need a laugh you will have to go back to some past blogs.
This is part one of a four part series... the other three parts will consist of the asset light builders, the high risk high reward builders, and the unique builders. Again, this is the five S&P 500 builders
Here are some other thoughts on the drivers of builder stock price increases over the next 5 years (the year of occurence is noted)
1) Short covering '08-'09
2) Balance sheet fundamentals '08
3) Premium to book vs. Discount to book '09
4) YOY revenue growth '09-'13
5) Earnings instead of losses '09-'13
6) Consolidation in the industry '10-'13
7) Accelerating earnings '12-'13
8) P/E ratios around 9 and net after tax margins of 6% '12-'13
9) Momentum investors (get the eff out) '13
My long term target stock price is based on a builder stock trading at 9x earnings with a net after tax margin of 6%. So the key to this analysis is top line revenue growth. At the end of the day I don’t care how much a builder makes in 2008 or 2009. Between short covering and analysts focusing on balance sheet and book value, earnings will be irrelevant. In going through a couple decades of financial information on the builders, I feel that a 6% net after tax margin is conservative.
Obviously, there are a number of macro events that can affect builders more near term vs. long term. Just remember, in 1998 oil traded as low as $12 a barrel and technology stocks were all the rage. 5 years later in 2003 which outperformed? A lot of people would say well that was different….. I don’t think so…… Rotation from one industry to the next occurs all the time. Personally I am more of a momentum investor than a value investor buying stocks in out of favor industries. However, I have a really good handle on the dynamics of the building industry and this would be a case where I can make an argument. I plan on putting my money where my mouth is this spring or summer.
The S&P 500 Builders (1st of 4 group valuations) CTX, DHI, LEN, PHM and KBH The S&P 500 builders are all land pigs. We shall see who learned their lesson in the next up-cycle. Each is focused on volume and market share. Tsk tsk…. How about RONA or a higher net income percentage? If you like to play it safe with your money and you want a value play with growth potential for the next 5 years, then park your money here. From 1/3/2000 (start of upturn) to 7/28/2005 (peak bubble) the stock prices of these 5 companies increased from 559% to 842%. The national single family permits went from an above average 1.2 million to an unsustainable 1.8m.
My expectation is if you can catch close to the bottom (the buy in prices I give) in the spring summer you will see a 300% increase in stock price in 5 years. Why? Although the 00-05 was bubble stock price increases, we are starting from a very depressed level of national sales this spring summer. My expectation is 500,000 single family permits (the lowest permitting activity since 1982 when we hit 400,000. Top line revenue growth potential is a big driver of my thesis. On average, the US should have around 1.0 million single family permits a year.
Word On The Street Word on the street is that the marching orders given by almost every builder is the same. This is different than in the past when different builders had different tactics when it came to selling homes (e.g. protect margin vs. build backlog). The national headquarters of the public builders are telling their field generals to sell at prices where gross margins equal SG&A (zero operating margin). Additionally, some divisions are giving their sales people more freedom to fire sell homes. This tells you the desperation out there to increase backlog during the spring selling season.
In a healthy non-bubble spring selling season you would like to see 5-6 net sales a month per community to build backlog. In the last quarter builders were getting on average 2 sales per month. I suspect that builders will get 2-3 sales per month and thus spring selling season will be considered a disappointment. None of my contacts sounds positive. Remember, my contact list consists of ½ dozen national builders and I am asking for national trends. So it’s not like I am just talking to some private guy in Tampa. This is big macro picture.
I’ve been told that an S&P 500 builder has a one billion dollar portfolio on the street and the highest offer is around 33 cents on the dollar. That leaves the question of whether or not the builder will fire sell for cash or choose not to pull down its pants. All the dumb money bought land in 2006-2007; everyone is a lot smarter in 2008 and wants deeper discounts. Hint, this top 5 builder has a low cash position so it is in a bad predicament. If it were smart it would have been the first to unload land…. Obviously they weren’t smart.
Additionally, another contact from a mid tier builder said that corporate is asking each division to come up with a portfolio of land to be included in a national portfolio of land to sell. This land will then be sold to a 3rd party. Basically, similar to the deal above and the deals we have seen in the past. My contact laughed that they were putting their dog $hit in this deal and every other division probably was too. Why? Because why would you put in your community positions that are actually generating sales? That would be stupid. The take away here is that when you see these huge land sales at 40 cents of book, this is impaired book. The sales price was probably 25-30 cents of non-impaired book value. The majority of the land in these big land sales is normally worthless C property. Sure there are B’s in there, but the equity players buying these large portfolios for the most part don’t know how to value land.
PHM Wow, I never thought I would say that PHM was a top stock to buy. PHM was one of the biggest land pigs during the go go years. A bigger future driver of PHM’s earnings will be the Del Webb 55+ product. The key is that in a new Del Webb community all the costs are up front in the amenity center and the big cash generation is back ended. PHM has opened a lot of Del Webb’s the last few years, so 5 years from now they should be much better cash cows. Additionally, in talking with people in the industry I would suspect that in a consolidation period PHM would be acquired vs. the acquirer.
Key thoughts I estimate Pulte will deliver 23,500 homes for the year ending 12/2008. This is a 47% reduction in closings from the 2005 peak. Pulte has done an incredible job of keeping backlog strong and it is happening as a result of their Del Webb unit.
Pulte’s gross margin before impairments is 11.6% and their SG&A is 8.9%. So they are generating operating profit even with these awful gross margin numbers. This is important…….. generating an operating profit and having a large backlog during what one could consider the worst quarter ever for builders.
A cash position of $4.20 per share should allow them to expand revenues more quickly vs. other builders. My expectation is that they have $9.00 in cash by the end of the year. Cash IS the key ingredient in expanding top line revenue growth.
PHM has more owned lots than anyone in the industry. A lot of this can be attributed to the big Del Webb land plays. Hopefully, PHM was aggressive in writing down their raw land positions, helping to drive earnings down the road in the big master planned communities. Normally I am against large land positions, but in the case of Del Webb I am ok with it.
The PHM footprint of profits in the past came from CA, FL, AZ and NV in that order
Buy In price from $9 to $10.
Peak price 7/28/05 was $47.92 with a p/e of 8.91
2008 normalized earnings stock value is $16.05
5 year price target $37 (311% return on $9 buy in)
5 year revenue growth projection 15-20% annually
KBH I estimate that KB Homes will generate 19,000 closings for the year ending 11/2008. This is a 41% reduction in closings from 2006, since KBH was one of the rare builders that closed more homes in 2006 vs. the 2005 peak.
KBH had gross margins before impairments of 10.1% and SG&A of 11%. The gross margin before impairments number is awful. I mean real awful. It is obvious that KBH has been fire selling to turn finished lots into cash. Such a poor gross margin means either above average write offs in 2008 or poorer land positions thus requiring heavier discounting. I will say that in Florida I consider PHM to have better land positions than KBH which isn’t saying much.
KBH’s saving grace is $17.20 a share in cash. This is going to allow them to expand top line revenue quickly and enter into the markets that have stabilized first. Cash by itself generates no top line revenue. Building up cash for the inevitable market turnaround then using cash to acquire or expand will generate above average revenue growth and thus earnings growth.
KBH has the highest leverage and the lowest lot count of the S&P 500 builders. I like leverage when there is no jeopardy of bankruptcy and I like the flexibility of less owned land.
The KBH footprint of profits will come from CA, NV, FL and AZ in that order
Buy In price is $17.50 Peak price 7/20/05 was $84.40 with a p/e of 8.32
2008 normalized earnings stock value is $34.77
5 year price target $86.00 (391% return on $17.50 buy in)
5 year revenue growth projection 20% annually
LEN I estimate Lennar closes 12,000 homes for the year ending 11/2008. This is a 76% reduction in closings from the 2005 peak. Now you know why I talk about top line revenue growth given the total collapse of volume in 2008.
Lennar’s gross margin before impairments is 14.3% and their SG&A is 16.9%. This is terrible, a negative 2.6% operating margin! I have no idea why Lennar isn’t fire selling homes at a lower gross margin to build up backlog. Lennar has a backlog of 5 per selling effort whereas the other S&P 500 builders PHM, KBH, DHI, and CTX have backlogs per selling effort of 12, 15, 10 and 13. I believe one of the reasons why Lennar’s SG&A is so high is the fact that they have too many selling efforts (overhead). There is no excuse for an SG&A number this high…. None!
Lennar has $4.10 per share of cash which is respectable. However, if they can’t even generate sales through their current positions what is the point of buying more land or another builder for top line revenue growth. These idiots have a lot of work to do to right size their ship. However, they are not going bankrupt.
One of the things I do not like about Lennar is all the JV deals they have in play. Although I have not deep dived all of their JV deals, I consider it a major negative.
At this point in time I cannot recommend LEN and I feel there are better opportunities out there from a technical bounce standpoint or a fundamental buy and hold
The LEN footprint of profits came from CA and FL in that order
CTX I estimate Centex will close 25,500 homes for the year ended 3/2009. This is a 35% reduction in closings from the 2005 peak.
Centex’s gross margin before impairments is 12.5% and their SG&A is 14.1%. Again, I am not a big fan of negative operating margins especially when they are a result of high SG&A costs. The CTX philosophy appears to revolve around getting 3 net signups per selling effort each month. CTX had more orders than any other builder in the most recent quarter.
CTX has only 50 cents per share of cash which is horrible. A top 5 builder such as CTX should have significantly more cash especially since I believe they were able to sell off the commercial component of their business. CTX also has the highest debt level of the top 5 builders which wouldn’t be a concern if they had cash, but they don’t have cash. Their debt to equity stands at 53% and the days of ginning money through land sales are over.
CTX has the largest backlog of any builder and they have made statements that they would generate a lot of cash come 3/2008 which is their year end.
The CTX footprint of profits came from CA, FL and AZ in that order
Buy In price from $18 to $19.
Peak price 7/20/05 was $79.50 with a p/e of 8.19
2008 normalized earnings stock value is $30.24
5 year price target $61 (238% return on $18 buy in)
5 year revenue growth projection 15% annually
DHI I estimate DHI will close 24,000 homes for the year ended 9/2008. This is a 55% reduction in closings from the 2005 peak.
DHI had gross margins before impairments of 14.3% and SG&A costs of 13.3%. Thus, they generated positive operating margins this last quarter.
DHI has only 30 cents per share of cash which sucks. They also have the highest inventory value on their balance sheet of $8.5 billion and 143,000 lots owned. Given their current debt to equity of 40% they have the ability to take some big write offs or do some big land sales. However, like PHM…… DHI appears to be content with not selling their land at 30 cents on the dollar. It will be interesting to see if the DHI / PHM strategy of keeping land and writing it down is more successful than the KBH / LEN strategy of getting as much land off the books as possible.
The DHI footprint of profits came from CA, AZ and FL in that order. Note that none of the big 5 generated a substantial amount of profits from their Texas operations even though TX generates a lot of sales. Margins in TX are always lower than a lot of the other big permitting states and this has to do with easy entitlements.
At this point in time I cannot recommend DHI. I feel that they are going to struggle on the profitability side based on their abysmal average selling price and product mix. I also think that DHI is too heavily weighted in TX which is a losing proposition. TX is a pure volume state and it shows that DHI is more concerned with being the biggest and not necessarily the most profitable S&P 500 builder
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