I unequivocally agree that ALL homebuilders earned excess profits during COVID, including NVR due to the pricing power that came with increased demand that more than outweighed the increase in costs.
This is reflected in consensus earnings estimates which I referenced in the posting, falling -24% from 2023-2025.
Since I have no edge in predicting this year's earnings, I started with consensus 2023 net income and conservatively built out from there for a five year period.
As I mentioned in the posting, I believe that the public builders in general are well positioned because they are taking an increased share not only of new home sales, but of ALL home sales, given that many homeowners are effectively locked into their current homes with mortgages well below market. In addition, this factor is also supporting home prices in the resale market because of tight inventory. Most of the public builders produce entry level homes which are often purchased by first time homebuyers who are not encumbered by a below-market mortgage. Also, the public builders are able to provide financing incentives like rate buydowns, that are unavailable in the resale market. Finally, even with the COVID boom years, there has been a dramatic underinvestment in housing supply since the great recession and Millennials are now in their homebuyer years, so it's not unreasonable to envision a favorable supply/demand environment for the public builders over the next several years.
That said, while a rising tide raises all boats, not all builders operate the same. Only two builders have reduced their share counts over the last decade: NVR and PulteGroup (PHM). D.R. Horton, while an excellent operator, has not shown the same discipline in capital allocation.
All public builders have migrated towards NVR's operating model since the great recession, increasingly utilizing options on developed lots instead of bringing the risk and profit of land development onto their balance sheet. NVR only uses options on lots, essentially benefiting from someone else's capital expenditures. One reason that many other builders haven't completely adopted the NVR model is incentives. Land development can be very profitable in even a mildly inflationary environment, which masks the substantial risk assumed - until it doesn't (see TOUSA). If management is incentivized on revenue growth or profit growth, without factoring in ROIC or risk, there is an increasing chance that that builder will engage in land development.
NVR has proven itself since 1994 as being incredible capital allocators as well as operators. They are the only homebuilder that did not post a loss during the great recession and their discipline in returning capital to shareholders has boosted returns significantly.
Hi lordbeaverbrook, good info. How would you compare NVR to DHI in terms of investment attractiveness? NVR is arguably a higher quality operator but DHI is cheaper, how to weight those things? Thanks very much.
To be more specific: Is it your view that they haven't been overearning during Covid? Or is it your view that, given its expected growth rate in the coming years, it is still cheap even if you assume that not all earnings growth from the past few years will be defensible?
Hi Acquicap. Thanks for the write-up. How do you think about the potential that they have been overearning during Covid? Current price relative to 2019 FCF is 24.2, so one does have to have strong conviction that all/most of the stark increase in earnings during Covid is defensible. Thanks very much for any comments you may have.
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