Description

Centex is primarily a home builder but is also involved in construction products, mortgage lending, and real estate operations. They have been in business since 1950 and are one of the largest and best run home biulders. They have the financial muscle to outbid and outnegotiate the smaller local players for land, supplies, workers etc. They also enjoy the support of the cities and counties who need their business to generate tax revenues. Risks - Centex businesses are cyclical and with interest rates rising and the possibility of the economy slowing, CTX may be at or near the top of this cycle. However the stock is already priced for this. There also may be execution risks invoved with diversifiing into businesses they may not be experts in. However, despite the cyclical nature of the industry, there will always be demand for a housing - home ownership is the American dream. Management is made up of seasoned vererans of several industry cycles. Management and the company are buying stock suggesting they believe it is undervalued. CTX also has a strong balace sheet (debt/cap of 39% and EBIT/I over 8.0). Over the last 14 years, CTX was profitable every year, each new peak exceeded the previous peak and book value grew each year. Peak to peak earnings hve grown at a 5.7% or better pace for the last three cycles. CTX has plenty more room to grow before they run into other large players because the homebuilding industry is very fragmented with the top ten contoling only 12% of the market. Even though management's goal is to double earnings over the next five years, I will assume only 5%-6% growth in the valuation of CTX which is in-line with the long-term growth rate of the economy.

Valuation - The stock currently trades at 4.7X earnings, .85X book and has an EV/EBITDA ratio on 4.1 based on LTM data all of which are at or near historical lows even after adjusting for cycles. Using CTX's historical PEAK multiples(p/e, p/b, ev/ebitda)for the last four cycles and using the TLM data yields an valuation range of $26-$50. Using historical acquisition multiples (p/e, p/b, ev/ebitda) results in an avg. valuation of $36. Discounted cash flow analysis - Using the LTM free cash flow of $227 and assuming a 5.7% growth rate for the next 10 years, 3% perpetual growth and a 10% discount rate yields a value of $36. Using the mean of three valuations or $37 as the estimated intrinsic value, CTX is selling for a 47% discount to its IV. Assuming a 5-6% growth in IV and a five year holding period, the estimated pre-tax total return would be around 20% based on its current price.

Catalyst

Market psychology is negative because many believe the industry is at the peak in the cycle. Also, since the anticipated slowdown has not yet occurred, the maximaum negative point may not have been reached yet. However there are a few potential catlysts including: (1) potential rotation out of growth/technology into value, (2) The low valuation of CTX itself, (3) possibility that the industry downturn does not materialize or is shortlived, (4) M&A activity is picking upwhich could lift valuatons for the group and CTX. Realistically, there is no overwhelming catalyst yet and it may be too early to buy CTX but over a 5-year time horizon, the total return based on current levels should be very satisfactory.