Description

CAV is a manufactured home maker. This is an opportunity to get into the stock just before a major industry recovery. The stock is trading a 3x its potential earnings power, 1.3x tangible book value, with no net debt and is currently breaking even.

Cavalier Homes, Inc. (CAV) designs and manufactures a range of manufactured homes with a focus on serving the low- to medium-priced manufactured housing market in the South Central and South Atlantic regions of the United States.

Industry background

The manufactured housing industry has experienced a huge boom bust. The boom was fueled by Greentree allowing to much favorable financing. This spurred manufactured homes sales which encouraged the two biggest manufactured home companies to build this huge dealer network to increase their own sales and to expand their manufacturing capacity. The boom actually got to a point where repossessions (of manufactured homes on which the owners defaulted) got resold to other un-creditworthy people and thus with another bad loan attached to it thus artificially inflating the bubble even more.

Then Greentree which had been bought by Conceco collapsed under the weight of their own bad loans and all of a sudden there was no financing available any more. Thus, without available financing manufactured housing sales and therefore shipments fell dramatically (see also the Cavco report on the value investors club site for more details) while most companies in the industry had added a lot of capacity. And, in addition, there was a continued flood of repossessions (caused by all the bad loans) being dumped on the marketplace which was destroying the market for new manufactured homes even more.

When the situation stabilized at a depressed level, Warren Buffett, sensing an opportunity, stepped in big by buying Clayton homes (which also has a mortgage division which is actually very well run) and then merging it with Oakwood which emerged from bankruptcy. Thus, Warren Buffett is going to use Berkshire Hathaway’s balance sheet in providing liquidity to this depressed industry and reaping the benefits.

Currently most if not all of the repossessions have been digested and auction prices of manufactured homes are up 20%. Several lenders (GMAC, US banc corp.) are circling the market to increase available mortgage financing. The winter is a seasonally weak period and among bankers sometimes there is a herd mentality, thus I expect that in the spring several lenders will be entering the market as their confidence in this business reverts back to the mean following Warren Buffett's entering the space.

CAV well positioned to benefit from industry recovery

CAV’s manufacturing capacity has shrunk dramatically. Currently, the Company has seven home-manufacturing facilities down from 16 at the peak, one plant that manufactures laminated wallboard and a cabinet-manufacturing operation. During 2001, the Company reviewed its product offerings and eliminated many redundant products by geographic location to streamline manufacturing processes, dramatically reducing the quantity of models offered.

In addition, CAV also originates mortgage loans by themselves which on which they make good money but it’s a small part of their business and because of their cautiousness it’s not expanding very fast. However it gives them some control over their destiny in case it takes longer for sufficient mortgage financing to return to the industry.

Third Quarter update

The company is basically breaking even right now (it broke even on a pretax level and it’s expected to do the same in the fourth quarter, on an after tax basis the company made $0.05 EPS in the third quarter). Inventories were down 49% in the third quarter. Next year, I expect the company to make $0.10-0.50 EPS with most of the money make during the summer. All the costs of the plant closing have occurred on 2003. With the companies 7 plants its full capacity earnings power is approximately $1 EPS. With capacity down 25-40% from the peak in the industry, it will not be difficult to get to full capacity when financing returns.

The company’s book value is 2.23 per share. The company has $24 million in cash and $18 million in debt. Given the fact that the company is breaking even in a seasonally slow period without the financing available in the industry, and the company has no net debt, it is fair to assume that book value provides a floor for the stock. When the company gets back to its $1 earnings level, its not hard to get to a $10 stock.

Catalyst

Lenders returning to the manufactured home market getting demand for manufacture homes normalized and CAV’s earnings power to $1 per share.