Description

Cavco Industries -- recently spun-off from Centex Corp. – is a small, well managed manufactured home producer with three Arizona facilities; the homes are primarily sold through independent dealers in Arizona, California, New Mexico, and Colorado, but also through a few Cavco-owned retail locations. In a very weak manufactured home environment (2003 industry shipments are estimated at 130,000 units, or about half the 20-year trailing average annual shipments of 264,000 units), Cavco should earn about $1.10 to $1.20 per share. However, FCF per share is significantly higher due to depreciation in excess of capital expenditures and cash taxes lower than the reported 40% rate (due to goodwill amortization being deductible for taxes). Cavco has net cash of $6.75 per share (which should grow by year-end from continued liquidation of discontinued retail assets and from operating cash flow); after backing out the cash from the share price and backing out interest income from earnings, Cavco trades at about 10x free cash flow, which we would consider inexpensive given the current depressed state (wholesale shipments are now at a 40-year low) of the manufacture housing industry.


Cavco (Nasdaq: CVCO):
Shares outstanding = 3.15MM
Market Capitalization = $72MM
Net Cash per Share = $6.75
Book Value per Share = $30.05
Tangible Book Value = $8.67


Brief Overview of Manufactured Home Industry (from Cavco’s SEC filings):
There are currently approximately 22 million people living in an estimated 10 million manufactured homes. During much of the 1990s, the manufactured home industry expanded significantly with the number of retail dealerships, retail inventory levels, manufacturing capacity, wholesale shipments and overall competition increasing. Wholesale shipments increased from 171,000 homes in 1991 to a peak of 373,000 homes in 1998; the 20-year average is 264,000. One of the major contributing factors to this expansion was the level and availability of retail and wholesale financing. Beginning in 1999, consumer lenders began to tighten underwriting standards and curtail credit availability in response to higher than anticipated rates of loan defaults and significant losses upon the repossession and resale of homes securing defaulted loans. Certain consumer lenders in the traditional chattel (home-only) lending sector exited the market and rates for these home-only loans increased. Although a portion of the home-only loans have been replaced by land/home financing that generally provides more favorable credit terms to the retail buyer of manufactured housing, the effort, time and expense associated with closing land/home transactions is greater. In addition to the changing environment in retail lending, some of the leading wholesale lenders providing floor plan financing to dealers have exited the industry. There are currently three national lending institutions that specialize in providing wholesale floor plan financing to manufactured housing retailers (Cavco’s largest floorplan lenders are currently Bombardier, Textron, and GE). Lastly, competition from sales of repossessed homes has negatively impacted retail sales of new homes. Approximately 90,000 repossessed homes were resold in 2002, compared to a similar number of homes in 2001 and approximately 75,000 homes in 2000. Repos usually represent 10% of industry demand, but will be about 40% of demand in 2003. These factors have ultimately resulted in a prolonged and significant downturn in the manufactured housing industry since mid-1999 which has resulted in declining wholesale shipments, excess manufacturing and retail locations and surplus inventory. As a result of the foregoing factors, based on industry data, approximately 43% of all industry retail locations have closed since mid-1999 and industry manufacturers have closed approximately 96 manufacturing facilities, representing approximately 28% of the industry’s manufacturing facilities. In addition, inventories of new manufactured homes in the retail marketplace declined by approximately 36% from June 1999 to June 2002. Wholesale shipments declined by 12.8% to 168,000 units for 2002. This followed declines of 22.9% and 28.1% for 2001 and 2000, respectively. In the fourth quarter of 2002, the industry experienced a 24.6% decline in wholesale shipments as compared to the year-earlier quarter. The principal regional markets Cavco has targeted have also experienced a pronounced downturn. The number of manufactured housing units shipped in Arizona declined approximately 37% from 1998 to 2002. Even more severe declines were experienced in New Mexico and Texas, where the number of manufactured housing units shipped declined approximately 69% and 66%, respectively, during the same period; California has performed relatively well. Industry retail sales of new homes in 2002 declined 9% from 2001 levels, after declining 25% in 2001 from 2000 levels.



Cavco -- led by CEO Joe Stegmayer -- is well managed and has been able to outmaneuver its larger competitors. Prior to joining Cavco in 2000, Joe Stegmayer served as President and Vice Chairman of Clayton Homes and CFO of Champion Enterprises. The company is the largest producer of manufactured homes in Arizona and 13th largest producer of manufactured homes in the United States in terms of wholesale shipments (based on 2001 data). Due to the industry downturn, Cavco has closed two production facilities and thus now operates three manufacturing facilities in the Phoenix area. Current capacity utilization is about 65%-70%. In 2002, Cavco manufactured 5,816 floors (3,375 homes; 2,396 were multi-sectional) and market share in Arizona was 29% and about 7% in New Mexico. Homes produced by Cavco are primarily sold through a network of 311 independent retailers (which also sell competing products) in 15 states (143 in Arizona, 76 in California, 32 in New Mexico, 26 in Colorado) and also through company-owned retail operations. Approximately 90% of the homes produced by Cavco are sold in transactions covering both the home and the land on which it is placed. Management believes that Cavco is much more nimble than its larger competitors (Fleetwood, Champion), and thus can offer more customization and is generally more responsive to dealer and consumer needs. The company has been able to become the largest US manufacturer of “park cabins” (sub-400 sq. ft. cedar-shingled vacation homes) which helps offset some of the seasonal weakness in November and December. Management would also like to gain a bigger presence in commercial structures (sales offices for used car lots, schools, etc.) – today commercial sales are only about $1MM. Management anticipates growing geographically, first by shipping from existing plants (and absorbing the increased transportation costs) and then by perhaps buying a closed facility of a competitor. Cavco has kept much of its retail presence in Texas, so it can move quickly (into manufacturing in the state) when industry conditions appear to be turning in the state.

While we don’t anticipate industry conditions improving meaningfully in the near-term, the company should be able to generate about $165MM of revenue in a few years (perhaps three or so years) when industry conditions normalize and achieve an operating margin of about 9%. Assuming a 40% tax rate and no interest income, the company would earn about $2.80 per share. However, cash earnings (the company can offset about $4.5MM of goodwill amortization against pre-tax income, and depreciation is about $0.8MM higher than normal cap-x) is approximately $0.65 per share higher than reported income. Applying only a 10x multiple on these “normalized” cash earnings (excluding interest income) and adding about $10 per share of cash, Cavco shares could trade in the $45 per share range in three or so years.

Catalyst

Improvement in manufactured housing industry in a few years
Valuation