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Berkshire Hathaway bought a manufactured homebuilder, Southern Energy http://www.sehomes.com/, headquartered in Addison, Alabama last week for a multiple of 32% of revenues.  We own shares in another manufactured homebuilder, Cavalier, headquartered in Addison, Alabama at a lower multiple which has gotten even lower.  Addison, Alabama has a population of 600 people.  How is that possible?

Amazingly the market didn’t seem to notice Berkshire’s purchase and CAV has just kept falling to what now looks like just a stupid price for a profitable company with an excellent balance sheet.  In an industry with demand at a 40 year low.

Cavalier trades at less than 20% of revenues adjusting for excess cash and real estate for sale, on what is a pristine balance sheet.  It trades at 4 times trailing earnings, though that is not a number to anchor too as we will explain below. 

We are not big fans of sell side research but it is interesting that the two analysts covering Cavalier have price targets of $6 and $10.  The $6 price target initiated last week.  The stock trades at $3.20.  Hmm.  Our price target is $5.50-$6.50 or roughly a 50 cent dollar bill at the current price.  $10 is not indefensible if the industry were to turn after an 8 year depression, but I don’t think we need anything macro to change to get $5-6 for this stock.

Cavalier Homes is just plain cheap.  The stock has been in an irrational free fall since it broke 5 and the current price looks simply wrong.

If you put the revenue multiple of Berkshire’s purchase of Southern Energy on Cavalier (discounting the revenues to $220 million for the reason you’ll see below) and adjust for the balance sheet (also explained below) Cavalier is a $5 valuation at the Berkshire price.  Berkshire is not known for paying top dollar.  $5 is not our target price.

Another way to look at Cavalier’s valuation is to take net current assets plus land and buildings at cost and subtract all liabilities and that will get you to the current market cap.  It is trading at a very very conservative definition of book value.

Cavalier is a manufactured homebuilder.  There is an excellent overview of the manufactured home sector on VIC in Rosie918’s painful in hindsight though well researched recommendation of  CHB a few months ago.  CHB has a very different balance sheet than CAV and we have no interest in CHB as it trades at 50% of sales vs. less than 20% of sales for CAV.  The macro numbers for the sector are in that writeup so I am not going to review the case that this sector is seeing demand at a 40 year low in the midst of a “housing bubble”. 

We don’t have a strong opinion either way what the collapse of that bubble means to the manufactured housing sector, but can we all stipulate that DR Horton and Cavalier are not on the same cycle?  Cavalier trading at 4 times earnings means something different from TOL et al trading at 4x earnings.  And 4x earnings is not necessarily why we own Cavalier.

The reason we like Cavalier is the balance sheet.  Call this a Ben Graham cigar butt, but it looks like a 60-90% profit with a little patience and the money spends the same whether we make in CAV or Google.

At $3.25 the market cap is $59 million.

They have about $10 million of cash in excess of debt, it could be 12 but lets be conservative.  That gets you to a $47 million enterprise value.

Half of their factories are mothballed and they have $8 million book value of real estate for sale (that is not all of their idle factories).  Management has told us they do not expect to take a loss on that, so 8 is not a bad number.  This is real estate that has nothing to do with the current earnings power.  Say they get book value for that, the enterprise value falls to about $40 million.  There are a couple more idle factories but lets just leave those out to be conservative.

Now lets look to the income statement.  Lets start with the most basic line – revenues.  Last year revenues were $272 million.  We’ll take that down to $220 million, but at $40 million of enterprise value that looks interesting – valuation of 18% of revenues.

Last year they earned $12 million pretax.  They don’t pay taxes, thus the low single digit P/E. Adjust it for the balance sheet and we could argue this is trading at 3x trailing earnings.

OK, here’s the caveat.  50% of their manufacturing capacity is on the Gulf Coast and last year there was a bit of housing destruction there by somebody named Katrina.  They got a big order from FEMA for temporary housing which was 25% of their revenues last year and that was what made them so profitable in the fourth quarter of last year and the first quarter of this year.  So we recognize that as one time and discount the revenues last year and the earnings for those two quarters.  The second quarter they were back to breakeven-ish without the FEMA orders.  So it is not really trading at 3 times earnings.

Or is it?

We don’t discount that 25% of revenues dollar for dollar – they shifted capacity to FEMA to get that order out which would have been used for their normal business.

The real calayst here is that Katrina might still be a positive going forward.  Half their factories are close to the Gulf Coast.  That FEMA order was to put up temporary housing.  The housing stock on the Gulf Coast has still not been rebuilt.  We still see this as a catalyst which has been delayed, but at some point housing has got to be rebuilt there.  Management will tell you that they still see this as a source of orders in the near future given where their factories are located.

But even if this catalyst doesn’t fire we have a very cheap valuation.

And one more thing to think about.  We are going into peak hurricane season.  This is not why we own the stock, but if there were to be another big hurricane on the Gulf Coast you can see how this stock reacted to that last year.  Not counting on that, but if it happens we get paid early.

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