Description

The New Home Company is a high-end, west coast homebuilder that is able to earn attractive returns with less risk and lower capital intensity than the industry by leveraging its strong reputation and relationships, primarily in Southern California. Management is heavily invested alongside shareholders, they have a strong track record, and they are likely sellers of the business down the line. At 9x earnings and a 10% discount to tangible book, it is also one of the cheapest public homebuilders.

Business Overview

Homebuilding is a bad industry—competitive, cyclical, seasonal, and capital intensive. There are some scale benefits (COGS/purchasing, cost of capital, and SG&A leverage) that put smaller player players at a disadvantage.  Mid-cycle returns are modest and often inadequate for the risk taken.

Homebuilders also tend to be undisciplined and unsophisticated—anyone who has worked in both CRE development and homebuilding will confirm this. Builders tend to over-focus on land development and drivers over which they have little control; conversely, they tend to focus less on the basic manufacturing drivers over which they have more control—turnover, costs, and capital-efficiency. This helps to explain why—in such a competitive, low-moat industry—certain operators with differentiated models and thoughtful leaders (e.g., NVR, Rayco) have demonstrated the ability to generate consistently superior returns. We believe NWHM’s differentiated model and strong focus on capital efficiency puts them in this select group.

NWHM builds homes under three different models:

·         Fee building—they act as the general contractor for the landowner/developer. This business consumes no capital, and it involves no risk to NWHM, as all costs are reimbursed by the developer plus a 5-6% margin. This allows them to leverage their G&A and purchasing scale.

·         JVs—in these structures, NWHM puts up a minority of the capital but has significant control over the project. While the capital invested in these ventures is at risk, the terms tend to be favorable to NWHM: (1) they may get promotes above certain hurdles; (2) these JVs feed their fee building business; and (3) they are in a strong negotiating position with their partners should the market turn south.

·         Wholly-owned—this model is the most similar to the traditional model, but NWHM places an emphasis on lot optioning rather than ownership (68% vs. 23% for peers). This means that only 25% of their inventory is in land & deposits (vs. 61% for peers). This mitigates their risk in the case of a major market downturn, and it enables them to manage their capital more efficiently.

Beyond their differentiated model, management’s strong reputation is the firm’s key competitive advantage. When CEO Larry Webb founded the company in 2009, he brought together many members of his team from John Liang Homes:

·         They have a strong reputation in Southern California as the premier builder

·         Their customer satisfaction rankings are at the top of the industry, and they are heavy award winners with the relevant associations

·         This reputation has translated to their having strong relationships with key landowners & developers. For example, they are the builder of choice for the Irvine Company (and the former manager of homebuilding operations for the Irvine Company is one of their founders).

·         They are the builder of the personal homes of many of the key executives of major California developers (e.g., Irvine Company, Fivepoint).

Their reputation and relationships give them access to superior deals and terms:

·         The fee building business with the Irvine Company gives them scale that enables them to earn better returns on their core businesses

·         Developers give them lot options with very favorable terms—they are often not required to purchase the lot from the developer until after they have delivered the home!

·         For example, they were able earn a 50% IRR on their Meridian JV, a project where the landowner was theoretically holding all the cards (infill project on Fashion Island in Newport Coast).

No spec building: 70% of their inventory is backlog, versus 45% for the peer group.

They are building at the extreme high end of the market—ASPs in their lowest-end communities are $750k; this is the ASP for Toll Brothers.

Management & Owners

CEO Larry Webb was the CEO of John Liang Homes, which he took private in 2001 in a management buyout, then sold in 2006 for a 5x MOI (our estimates).  He brought key members of his team over when they founded New Home in 2009. He and his team own meaningful equity in the company.

Management has bought small amounts of stock in 2016. The last significant insider sale was in mid-2015 around $17.  CEO Webb was a meaningful buyer of the stock in 2014 above $12.

Founders and directors have affiliations with important landowners and stakeholders (e.g., Irvine Company, Related Companies, Tricon, IHP, Watt)

CFO John Stephens is one of the company’s few executives not to come from John Liang. His first CFO post was with Standard Pacific, followed by MDC. He voluntarily moved to New Home from MDC last year. NWHM is multiples smaller than both.

Why is it undervalued?

Lumpy and seasonal—Homebuilding is a seasonal industry, but NWHM has even more seasonality, with 50% of earnings falling in Q4. Additionally, earnings can be lumpy, as some high-end ($5mn+ per home) communities can drive a high proportion of revenue.

Bad Industry—This is a generally unattractive industry where scale matters, and they are one of the smallest public builders. It may take several years for the market to recognize their unique advantages.

Size—NWHM is small and illiquid. Its scale has not yet inflected to make the returns from its superior model evident.

What is it worth?

TBV is $10.50-11.00, and I expect their ROE to be just above 10% this year—depressed by the recent equity raise and inflecting in out years.

Considering the quality, risks, growth profile and scale, NWHM should trade at industry average multiples or above, suggesting a price target of ~$13ps, though it is easy to see this target moving up over time as ROE expands with scale.

Key Risks

Key Man—Reputation and relationships are New Home’s main competitive advantage. If Larry Webb (67), Wayne Stelmar (60), and Tom Redwitz (60) were to leave the company, the investment thesis would be impaired.  Similarly, key developers are represented on the Board, and their departure would be a concern. Note that this aspect also makes a sale of the company a likely exit for these key stakeholders.

Housing Cycle—A downturn in the California housing market would hurt them.

Leverage—Like all homebuilders, NWHM has a lot of debt, though industry leaders DHI and NVR tend to carry less debt than their peers.

Reliance on premium product—New Home’s ASP is in excess of $1mn, with some key developments having ASPs over $5mn. Softness in the high end of the market could be a problem for them.

International (Chinese) Buyer—Restrictions on capital flows among the Chinese elite have slowed the market for investment in western real estate by these investors, but international buyers account for less than 10% of NWHM’s buyer base.

Catalyst

Not a catalyst-driven idea, though another strong Q4 (wherein 50% of the company's sales are expected to fall) could move the stock.