|Shares Out. (in M):||51||P/E||0||0|
|Market Cap (in $M):||586||P/FCF||0||0|
|Net Debt (in $M):||203||EBIT||0||0|
|TEV (in $M):||789||TEV/EBIT||0||0|
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Green Brick Partners, Inc. (GRBK) is a land developer and homebuilder operating primarily in Dallas, TX and Atlanta, GA, with additional activity in Vero Beach, FL and Colorado Springs, CO. Their operations include suburban townhouse (34% of LTM homebuilding revenues), second-time plus move-up (30%), first-time move-up (16%), age-targeted (16%), urban (4%) and first-time (new offering). The company owned 6,414 lots and controlled a further 2,855 lots through options as of Q3 2019.
GRBK trades at a 1.1x tangible book value, 9.5x LTM adj. EBIT and 10.4x LTM adj. earnings. These strike us as reasonably cheap multiples for a company with the following attributes:
1. A better than average mousetrap that meshes the benefits of local homebuilder entrepreneurship with the benefits of corporate scale
2. A conservative, thoughtful and well-aligned management team whose primary focus is on profitability and returns, led by Jim Brickman who is also a 3.6% shareholder
3. A top-notch capital allocator in Greenlight Capital’s David Einhorn who is Chairman and whose firm owns 48% of the stock
4. A strong financial profile including a secure balance sheet (28% gross debt / cap at Q319), solid margins (23% LTM gross margin and 10.9% LTM EBIT margin, as adjusted) and decent ROEs (10.9% LTM)
5. A good growth opportunity with solid inventory in attractive markets characterized by growing demand and constrained supply
While we do not expect to triple our money overnight in GRBK, it should be a steady compounder through a cycle. Buying close to book value should protect downside as the bulk of shareholders’ equity is tied up in land, lots and homes under construction that should be worth close to the company’s basis, even in an ugly economy. Company leadership, who are disciplined capital allocators and large owners of the stock, went into these investments with expectations of 20%+ IRRs.
As the founder and CEO, not to mention significant shareholder, Jim Brickman is a key figure at GRBK. He has operated in the real estate markets for four decades. His conservatism stems partly from his experience in the S&L crisis in the 1980s. Later, while working on the liquidation of lender Amresco as part of his time on a creditor’s committee, he came across a white paper written by Einhorn on Allied Capital. Brickman contacted Einhorn in 2002 and they became friendly, speaking frequently while Brickman aided Einhorn in his research on Allied Capital. In Einhorn’s book on his Allied Capital short (“Fooling Some People All of the Time”) he called Brickman “one of the best forensic detectives I have ever met.” In a Dallas Business Journal article (11/6/15), Einhorn said, “Jim is tireless and has terrific business ethics and terrific judgment and is able to suss out opportunities as they are and figure out when ones need to be pursued.”
In 2008, Einhorn backed Brickman in a real estate investment firm called JBGL Capital. JBGL was formed to take advantage of the real estate crisis then underway, buying distressed residential real estate projects, including developed lots, completed units and notes secured by property. They sold lots to builders, sometimes providing the financing in a market where banks were reluctant to lend. In 2011 the firm acquired 50% of The Providence Group, a builder in Atlanta, in 2012 they bought 50% of CB JENO Homes in Dallas, and in 2013 they bought 50% of Southgate Homes, also in Dallas.
In 2014, they morphed JBGL into GRBK, taking it public through a reverse merger with a shell called BioFuel. Greenlight (along with Third Point) had owned a large stake in BioFuel, which had been in the ethanol business. The reverse merger gave GRBK a substantial tax asset in BioFuel’s large NOL. Greenlight and Third Point both put up over $20 million each in fresh equity capital as part of the reverse merger and Greenlight provided a $150 million term loan. The transactions left Greenlight with just under 50% of the company, while Third Point owned 17%. In July 2015 the company raised $170 million in a public offering at $10 per share, using the proceeds to repay the Greenlight term loan.
In August 2017, GRBK acquired a 49.9% interest in Challenger Homes in Colorado Springs from entrepreneur Brian Bahr, with an ability to acquire another 20.1% after three years. GRBK issued 1.5 million shares (~$15 million) to fund the acquisition. Challenger focuses on entry-level homes. Challenger did 410 closings and $131 million of revenue in 2017. The deal has gone well; the stake contributed $7 million in equity income to GRBK in 2018.
In April 2018, GRBK acquired an 80% interest in GHO Homes in Vero Beach, FL from entrepreneur Bill Handler and his family. GHO focuses on the retirement market. GRBK funded the deal through its revolver, with Handler contributing $8.3 million for his 20% stake. There is a three-year put-call on the remaining 20% interest. GHO did 242 closings and $85 million of revenue in 2017.
In June 2018, GRBK announced a stock offering of 10.7 million shares, with the company planning to sell 2.5 million and Third Point offloading its entire stake (8.2 million shares). The stock was $12.25 at the time, but the announcement caused a dislocation. The deal ended up pricing at $9.50 and the company declined to sell any new shares at that price. We suspect GRBK became a small, non-core position for Third Point, who had been required to hold the stock to avoid violating Section 382 and limiting GRBK’s use of then-large NOLs. Senior management bought shares personally later that month at around $9.50.
In October 2018, GRBK announced the launch of Trophy Signature Homes, a wholly-owned subsidiary selling entry-level homes in Dallas under newly hired division head Stewart Parker. Parker had been division president in Dallas for Lennar and Century Communities. GRBK had 1,100 lots for Trophy at the time of announcement, and around 1,600 as of Q3 2019. They have just begun selling homes. Management expects this business to be higher turn given it will use standardized processes to build from a small number of fixed home plans. In December 2019, GRBK announced plans to expand Trophy into Houston, constructing homes there by Q2 2020. They hired Kevin Meuth as division head. Meuth had been division head in Houston for several large builders, including Ryland, Pulte and Meritage.
David Einhorn is GRBK’s Chairman. His only other public board seat is with Greenlight Capital Re. GRBK is currently Greenlight’s largest equity position according to Bloomberg. Here is a quote from Brickman in the same Dallas Business Journal article cited earlier: “David believes you don't have to be the toughest, or the most ruthless guy to succeed, but you have to stick to your knitting and know what you are doing. You have to be persistent and do things that are common sense things and that's how he approaches being our chairman of the board. We think the same way.” Greenlight’s former long-time CFO, Harry Brandler, is also on the GRBK board.
GRBK’s business model is somewhat unusual, and quite purposeful. It’s really several models, all variations on the theme of aligning interests. At the heart of these models is an understanding of relative competencies. On one hand, entrepreneurs’ local knowledge and relationships make them the nimblest homebuilding operators in a market. On the other hand, larger corporate entities can better utilize their scale and diversification to develop lots, access capital and withstand cyclical downturns. Separating the two allows homebuilder partners to focus on their core competency of building and selling homes, and corporate to focus on its core competency of accessing and allocating capital.
In their largest markets (Dallas and Atlanta) GRBK uses a controlled builder partnership model. In these, corporate, which holds the capital, acquires and develops land (or options developed lots from third parties). The builders decide when they want to pull down finished lots and begin construction. Corporate then provides land and construction financing to the builders. The builders make their money by producing a homebuilding profit after paying GRBK’s interest (13.8%+) on land and construction loans. This typically works out to around 2-4% of gross revenue, which is a sizeable take for a builder entrepreneur employing someone else’s capital. The high cost of capital encourages builders to control cycle times and overhead costs and move inventory. While these builders did not put up capital at the outset, they are required to retain some earnings in the business to act as “skin in the game.” They also maintain clawback provisions. For its part, GRBK makes money on the margin it earns selling land to the builders, on the interest payments on the land and construction loans, and on its share of the homebuilder profits. GRBK claims to generally earn 20%+ unlevered returns acquiring, developing and selling land to its builders (or third-party builders) at market prices. GRBK’s controlled builders must finance all home construction with GRBK.
In FL with GHO they have a controlled JV model. In this model, corporate and the JV partner are shoulder-to-shoulder throughout the chain. The JV partners together control the capital and make land acquisition and development decisions. Then the JV decides when to build and the partners share in the profits.
In CO with Challenger they have a noncontrolling interest in the homebuilder. This arrangement is like the controlled JV model except the builder partner is the controlling owner. The homebuilder purchases and develops its own land or purchases developed lots from third parties. GRBK’s CEO and CFO sit on the board (which has five directors).
In parts of TX GRBK also operates more in the standard model, with the homebuilding operation overseen by a corporate division president and operated by a team of corporate employees. GRBK uses this model with the new Trophy Homes. Going forward they will also use this model for the higher-end Southgate Homes division. Southgate used to be a controlled builder partnership but converted to the internally operated model in December 2019. Southgate’s ASPs are around $700k, which has been a difficult price point to make money in the current market. GRBK compensates the Dallas Trophy division head primarily on long-term ROIC, with the ability to earn significant bonuses that act much like a carried interest after exceeding a high hurdle rate. We expect they will use a similar model for the new Houston Trophy division head and to-be-hired Southgate division head.
GRBK manages risk through their alignment structures and by primarily buying land that is in infill locations rather than at the edges of growing markets. There is a more limited supply of infill locations, which makes them less vulnerable to declines in down markets and more difficult for larger builders to acquire in size. GRBK’s properties appear to be in the more desirable markets (slide from Q3 2019 earnings release):
They also develop lots when they believe they can sell all the lots and homes within 2-5 years from the start of sales.
GRBK looks to invest capital both internally in new land and lots, and externally through M&A. Right now, they prefer internal growth as private builders are frequently too leveraged and too expensive. Trophy is the main growth vehicle, which they expect will earn strong returns by year three. If they do go down an M&A path, their preference is to buy controlling interests with existing management continuing to own a significant stake (like the GHO deal). They want entrepreneurs who know the local market and have strong relationships, plus a reputation for putting up quality product. Growing the controlled builder partnership model may prove difficult given how hard it is to find high quality but cash-strapped entrepreneurs looking for this kind of arrangement in today’s market.
One constant concern buying any homebuilder is understanding where we are in the cycle. This analysis is best done market by market. Below we show some statistics for the company’s primary markets from 1995 to 2018 using data from census.gov.
Atlanta is still well below the peak, with permits substantially below even 1995 levels.
Dallas has surpassed peak levels by value but is still below prior peak by number of permits, hovering around 2000’s levels.
Colorado Springs has a pattern like Dallas, while Vero Beach remains well below even 1995 levels by number of permits.
Next we can look at ASPs.
Atlanta’s ASP has compounded at 3.8% CAGR since 1995, while Dallas is at 3.5%, Colorado Springs at 6.3% and Vero Beach at 4.6%. These compare to an annual U.S. inflation rate increase of 2.2% over this period. Home price appreciation has clearly played a role in keeping a lid on unit volumes.
Another interesting set of data come from the public builders. While these data reflect national rather than local performance, they contribute to the mosaic of information. We looked at the median results for 17 public builders (note that some of these have histories that only go back for a portion of the timeline we show). This chart is meant to show the “typical” builders margin structure over time:
We can clearly see the impact of the housing boom and bust. The more recent results would appear to be about average – that is, mid-cycle – consistent with much of the data we’ve already reviewed.
Next we look at ROEs:
Despite returning to mid-cycle margins, ROEs never recovered to pre-boom/bust levels. That is because ROEs have been dragged lower due to slower inventory turns:
The industry’s inventory turns are running around half what they did in 2000. This gives some promise of upside should economic conditions improve homebuilders’ ability to turn inventory and drive ROEs back to historical levels.
While a downturn is inevitable at some point, the homebuilding industry is not overextended. Builders have not been able to overbuild due to labor shortages and other constraints in GRBK’s markets, and banks have been consistent underwriters.
This management team is untested in a downturn at the helm of a public company. We believe this team is disciplined, and as owners of the business they sit shoulder-to-shoulder with shareholders in the risk position. That said, the company can suffer if a housing downturn comes. In such an event, we would expect management to accelerate efforts to turn inventory into cash, trading reduced margins for balance sheet strength. Brickman will want to be positioned to take advantage of the resulting distress in the market.
Before looking at the financials, we list below a few adjustments we have made to the company’s reported results:
- We move the minority interest above the line. This line item represents the controlled builder partners’ share of homebuilder earnings. It is representative of the cost of GRBK’s business model.
- GRBK historically reported sales commissions on residential home sales in cost of sales. In 2019 they moved this cost item down into SG&A to conform with typical public builder practice. We have adjusted for this change retroactively using actual data where provided and assuming 4% of residential units revenue where we don’t have actual data.
- We remove interest charged to cost of sales from that line item and move it below the line.
- We move other income above the line. This is where GRBK includes financial services.
- We normalized the tax rate to 22% for all periods shown.
Some other notable items:
- GRBK came public in late 2014, so the financials prior to that point were as a private company.
- Lot acquisition, materials, other direct costs, interest and other indirect costs related to the acquisition, development, and construction of lots and homes are capitalized until the homes are complete, after which they are expensed.
- GRBK’s builders buy around 70-75% of their lots from GRBK’s land development operations and the rest from third parties. Land is typically around 20-25% of the cost of a home.
- Opening new communities requires fixed costs and up-front investments (including land acquisition, entitlements (though GRBK usually buys entitled land), infrastructure and amenities buildout, and construction of model homes). This dynamic reverses as the sales pace picks up, with cash flow peaking as a community closes out. Community life cycles typically last 2-6 years from land acquisition through home delivery, while construction of a single home typically takes 5-9 months.
- Higher community counts are in part due to a shift towards smaller communities. This is due to limited supply of large contiguous lots in good neighborhoods and a desire to maintain shorter sales cycles and limit required up-front investment.
- Returns are somewhat understated in a growing company like GRBK because the company is sitting on a higher amount of idle assets than a non-growing company.
- High gross margins in 2013 related to the sale of land that had been accumulated at cheap prices shortly after the crisis. This impacted 2014-2016 as well but to a lesser extent.
- Low gross margins in 2018/2019 related to increased use of incentives to clear inventory as affordability issues hit prospective buyers, especially in Dallas. This pressure has largely abated in recent quarters.
- GRBK’s ASP is influenced by home price appreciation but also by mix and value offered, so it doesn’t help to read into this figure too much.
- In 2019 GRBK closed on a $75 million of 7-year senior unsecured notes paying 4% in a private placement with Prudential Private Capital.
Here are GRBK’s margins:
Although GRBK has experienced gross margin pressure the last few years, its builder partners have absorbed much of the impact. This has led to a largely stable EBIT margin. GRBK’s margins compare favorably to other small and medium-sized public builders, which are earning around a 19% gross margin and an 8% EBIT margin.
Here are inventory turns and returns on capital and equity:
ROE and ROTC have both climbed the last few years (absent the recent slight pullback due to gross margin pressure as discussed) as inventory turns have improved. Both are at healthy levels. GRBK’s inventory turns, ROTC and ROE are comparable to other small and medium-sized public builders, which generate turns of around 1.0x and are earning around a 10% ROTC and a 12% ROE. However, the leverage GRBK employs to generate its ROE is meaningfully lower at 28%, vs. 50% for the comparable public builders.
Management intends to grow ROE through the following primary strategies:
- Operational leverage. GRBK’s increased scale has given them better ability to negotiate deals with national vendors. They have also improved their building efficiency in part due to better technology systems and standardized processes.
- Overhead leverage. GRBK does not need to expand its home office as its revenue grows.
- Financial services. GRBK is ramping its fee-based mortgage and title businesses.
Each of these could contribute 1-2% to ROE over the next few years, which would bring consolidated returns to mid-teens levels.
This shows GRBK’s owned and controlled lot inventory levels. Lots relative to net new orders have held steady the last few years at just under six years:
This next chart shows some of GRBK’s basic operating metrics:
And this one shows some of GRBK’s per unit metrics:
- Cyclical downturn as discussed.
- Higher interest rates, higher land costs, higher land development and home construction costs (labor and materials), unfavorable tax treatment (mortgages and property taxes), reduced employment and stagnant wages could drive affordability out of reach. Home price appreciation has been high as shown earlier due in part to many of these factors.
- Regional problems in GRBK’s markets could occur, such as weather, local unemployment (oil and gas, etc.) or the entrance of new builders (like what impacted the Atlanta market in 2015). A large public builder could decide to decimate a market in a quest for share.
- Adverse regulatory changes could occur, such as the tax code or higher municipal barriers to land development.
- An exit by Greenlight, other than through a sale of the company, would weigh on the stock. The pool of likely acquirers is relatively small given GRBK’s unusual business model (though Berkshire’s Clayton Homes is one possible suitor).
- The company is relatively unproven as a homebuilder for first-time buyers, other than its experience with Challenger in CO. Management has been enthusiastic about Trophy but there could be unforeseen issues. Homes for this type of buyer are typically built through a high efficiency manufacturing model, with little customization. GRBK will have to prove its competency in this area (though it could represent a large growth opportunity if they do). They may do some co-development with established builders to help mitigate the risk.
The information contained herein has been derived from public information believed to be reliable but the information is not guaranteed as to accuracy and does not purport to be a complete analysis of any security, company or industry involved. All data and analysis are unaudited and should not be used as the basis for any investment decisions. Neither the advisor, nor any of its officers, directors, partners, contributors, employees or consultants, accept any liability whatsoever for any direct or consequential loss arising from any use of information in this analysis. The user of the information assumes the entire risk of any use it may make or permit to be made of the information.
Neither the advisor nor any of its employees holds a position with the issuer such as employment, directorship, or consultancy.
The adviser, through a partnership that it advises, holds an investment in the issuer's securities.
- Success of Trophy Signature Homes
- Improving ROE from operational leverage, overhead leverage and growth in financial services
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