2011 | 2012 | ||||||
Price: | 590.00 | EPS | $26.97 | $34.98 | |||
Shares Out. (in M): | 6 | P/E | 21.9x | 16.9x | |||
Market Cap (in $M): | 3,540 | P/FCF | 0.0x | 0.0x | |||
Net Debt (in $M): | -829 | EBIT | 0 | 0 | |||
TEV (in $M): | 2,711 | TEV/EBIT | 0.0x | 0.0x |
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28 | |
Sorry, typo: search for member name cnm3d | |
27 | |
I tried to find the real estate data you suggest by member "cmn3d" but couldn't seem to locate it... any suggestions? Is there a ticker to go with it? | |
26 | |
Yes. It's an interesting collection of Cali real estate managed by Leucadia. For example, they have a grape farm that is carried on the books for ~$5m, earned $1m in net income last year, and is for sale for $25m. All the land was acquired super cheap and the company is debt free, cash rich. They could probably move the raw land above book and they have a bunch of lots at a completed development that they are in no rush to sell, but could get well above book value based on historical sales. They claim to have interest in their lots at a completed development but they are waiting for better prices. I think over 12-18 months it could get liquidated for ~$25/share, but they have a bulletproof balance sheet so there is no rush.
They bought a big parcel in January out of bankruptcy for $11m. People were talking about a several hundred million dollar development on this parcel in 2003-2005, took on debt, got arrogant, and went bankrupt as the bubble burst and environmental regulations tripped them up. Its abstractly very undervalued since Leucadia have a great track record in real estate and I think that SoCal is long term sound based on the confluence of climate, demographics, and geographic barriers. SoCal was a good idea taken too far and now its cheap. Nothing exciting will happen for quite a while so it doesn't attract much interest. I have a small position, but we're talking 3 years minimum for stuff to play out and people to get excited about the business again. | |
24 | |
Charlie479,
You make some interesting points. I'll give you my thoughts in the order you presented them:
fixation - it's not that I have a fixation on the options, it's that this is by far the most common reason buyers of NVR seem to believe that NVR can achieve for many, many years something like double the ROE of other homebuilders. Without some advantage conveyed by the "asset-light" model, it becomes very hard to make the case that ROE's will be excessively high and therefore that NVR should be valued at well more than twice book value.
1. My understanding is that a large majority of the additional options since 2008 are ones that were previously written down and subsequently repriced and put back on the books.
2. You only speak of one side of the equation. Land prices and house prices have also fallen. NVR's ROE has dropped precipitously which tells me that the current options are much less valuable than they used to be.
3. 30%! that would be amazing. But ROE is about 10%. Are you subtracting out net cash? If so, then for the LTM it's a 19% return on non-cash assets. Pretty good. But 0% return on cash - why would anyone pay 2.5x book value for cash? Let's say they're the Apple of homebuilding and somehow get returns on non-cash assets to 30% (about triple the typical homebuilder). If they compound their non-cash assets at that rate for the next 5 years and then you add the current net cash you roughly get to today's value. So to be a buyer today and get a decent return, you have to think they do well north of 30%. That's a value stock? Also, if opportunities are available to buy these high return options, why do they have so much cash?
4. Definitely true. Homebuilders and land developers do this all the time. NVR competes with lots of other companies for land deals and options deals. That's my point. You have to believe NVR's ROE can be more than double other large homebuilders' for many, many years. During the huge bubble and bust the option model was clearly better, but why would it convey any advantage when the environment isn't so extreme? NVR makes a tradeoff of not using their balance sheet but paying higher prices for land. Under normal circumstances, the result gets you to the same returns as the other builders which is why other builders do some option buying and some land purchasing - it depends on the price which one provides better returns. Isn't it a disadvantage if you can only use options even if outright purchases are cheaper? I'd rather have the flexibility to do whichever would generate the highest risk-adjusted returns.
5. They controlled over 100,000 lots at one point, a lot fewer presently. In the normal course many of those options would have expired, but NVR got a nice windfall from being able to reprice some options during the depths of the bust. I don't think they can do that anymore but in the interim I believe they are still living off of that windfall. I suspect (only a suspicion) that they will have a very difficult time replicating their option pool going forward. My guess is that this means NVR's ROE will look like every other homebuilders'.
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22 | |
oliver1216,
I think you're fixating on the land options and missing the main point, but let me try to satisfy the fixation anyway. The massage afterwards is free but gratuities are appreciated.
1. They are not having problems obtaining lots through options. Since the bubble burst, they have been able to steadily increase the number of lots controlled. They had 44,983 lots at 12/31/08, 46,337 at 12/31/09, and 52,310 at 12/31/10. Developers are apparently still willing to enter into these non-recourse option agreements.
2. The price of these options is not going up. They're going down. This is not surprising because when the price of the underlying drifts down or stagnates like land has recently, call options tend to get cheaper. This is good for NVR as a buyer. In 2007, NVR controlled 67,600 lots with a total notional of $6.9 billion with $405 million of deposits (aka "premium"). This works out to $6,000 per lot or a premium of 5.9%. The following year it fell to $4,500 and 4.9%. In 2010 it was still lower at $3,600 and 3.9%.
3. They're able to generate a decent return at current option prices. 30% pretax return on tangible capital is decent, albeit not stellar (though I think that has less to do with land options than lack of scale volume).
4. Many other builders use options to control some of their lots (but they also control other lots in their inventory by owning land too). These limited-recourse fixed-price purchase agreements that we're calling options are not an unusual arrangement. Land options are not some tricky thing that NVR invented that will disappear because developers 'have caught on'.
5. These option agreements are not as long in duration as you think. The 2002 inventory of optioned lots would basically all be exercised or expired by now. From 2002 to 2010 NVR has sold 108,419 homes. It's been awhile since I've owned or looked closely at NVR (except now - thanks for the memories, VIC!) but I do not remember seeing a secret stash of optioned lots at HQ that would have been big enough to deliver that many homes. Also, are we even sure that land options struck at 2002 prices would be considered "really, really cheap" today?
One could construct a legitimate bear case for NVR here but I think basing that case on the land options would be using a weak foundation, in my opinion. | |
21 | |
I second Nails4's last question. I think it's likely to be true that they have a pile of old and/or repriced options that date back a number of years and I question whether those options can be economically replaced. I would think a buyer of this stock would need to know the answer. | |
19 | |
HomeFed (HOFD) is a bizarre Leucadia controlled land development company in SoCal that is publicly traded. They have sold options on land recently. It's going to depend on the developer. They have no debt and buy land very cheap so they can be flexible. From their 10-K:
"As of February 9, 2010, the Company has entered into an agreement with a homebuilder that has not closed to sell 32 single family lots for aggregate cash proceeds of $7,000,000, pursuant to which it had received a non-refundable option payment of $650,000. The option payment is non-refundable if the Company fulfills its obligations under the agreement, and will be applied to reduce the amount due from the purchaser at closing. Although this agreement is binding on the purchaser, should the Company fulfill its obligations under the agreement within the specified timeframes and the purchaser decides not to close, the Company’s recourse will be primarily limited to retaining the option payment."
I think in an uncertain homebuilding environment, options become more attractive to both parties. A developer selling options on a lot to a homebuilder has the benefit of some income while giving the homebuilder some flexibility in selling homes on the lots. A developer doesn't have to sell an option unless the strike price is attractive. It's to the detriment of a developer if they offload land and put a builder in a position where they have to offload homes they built. It would put downward pressure on future land and home sales in surrounding lots since real estate transactions love comps.
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18 | |
Utah, you're making my case for me. Why would anyone sell a call option? Simple - to maximize their profit. The more successful the seller of those options, the worse off the buyer is (in this case NVR). To expect a buyer to continually be able to make outsize profits buying options is to continually expect the sellers to misprice those options too low. I think that's a lot to count on in order for an investment to work out satisfactorily.
In any burgeoning bubble we will no doubt find, in retrospect, that options were priced too low as prices increased rapidly. But now that this bubble has burst what's the case for expecting NVR to be able to continue to find mispriced options (i.e. find foolish developers) indefinitely?
And why is everyone just assuming favorable option deals exist? Has anyone actually looked at any land option deals and examined the pricing terms? I'm surprised to find on a board focused on value investing so many people who are unconcerned about PRICE. The price of the options makes all the difference. Are these options cheap now? After the bubble are they deemed too risky by the sellers after NVR and others walked away from so many options? Are they available at all? If they are available why is NVR sitting on such a large pile of cash which earns no return?
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15 | |
False analogies nothwithstanding, the act of homebuilding in its entiretly entails purchasing land, developing the land and then selling the land. The highly experienced integrated homebuilders have over many, many years generated decent but not great investment returns on this entire process as a whole (very low double digits). You could, in theory, bifurcate the process into high ROI and low ROI activities. This means that if NVR's ROI is higher than the entire process, then the land developers' ROI is lower. But shouldn't the party taking the higher risk (i.e. the land developer) get a higher return? If they're not getting a higher return, then it's back to my original assertion - NVR's theoretical future high ROE relies on the foolishness of developers. Can this be counted on in the future or was it an artifact of the bubble? Isn't it possible that post-bubble risk aversion could increase the cost of options so that they are economically detrimental compared to outright land purchases? Has anyone looked into this or are the owners of NVR comfortable blithely assuming that options are always better, no matter the price?
I would also add that even a foolish developer would at least target a decent return on capital. If they priced their investment to have a 10% cash on cash return (is that enough to justify the risk?) do you expect NVR to get a 20% return on its investment on top of that? 1 + 1 = 3? Without dumb developers, I just don't see how it adds up. (note: I'm not dismissing the claim that NVR is a particularly good builder, I just can't see how that can get them from a 10% ROE to a 20% ROE over a whole lot of years. A couple hundred basis points maybe. There are plenty of companies that know how to build homes cheaply).
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14 | |
I don't think you framed your argument fairly. Even if the land business were decent it doesn't mean it's as good a business as NVR's building business. Thus, if NVR can use options on a value neutral basis vs. owning the land, if the options strategy allows it to direct a greater portion of its resources toward building and have less capital tied up in a lower returning land business, it's a good thing to do. Actually, depending on the return discrepancy between land and building, you can argue it's not a bad decision to use options even if they have worse economics than owned land (on a standalone basis), if by using options they can direct a greater portion of capital toward building.
There is no economic law that says all economic activities pay a similar return.
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13 | |
The 3 replies all agree: it's beneficial NOT to have land on your books. Perhaps, but doesn't it depend on the price? At a sufficiently high option price, buying the land outright would be the better deal. How does the current price of options compare to what they were a few years ago? No one seems to want to answer that question but instead assume options are ALWAYS better. That can't be true, it depends on the price.
NVR doesn't like to hold land but SOMEONE has to hold the land don't they? It's the land developers and either they're getting a terrible deal from which NVR benefits or they are adequately charging NVR the cost associated with tying up all that capital. If it's the latter, then there is no benefit to the option strategy. And why wouldn't developers weigh the total cost of a sale of all the land versus the risks and costs of capital associated with selling options and choose the higher value? Unless we think they are fools willing to bear all of the costs and risks associated with holding land and not adequately charge for it.
Now that bubble lending is over and developers have to put real money into their investments, I think there's a serious danger that NVR can no longer get option deals that provide the outsize returns on investment needed to grow the book value sufficiently to provide returns for investors. I think this is borne out in their mundane ROEs generated since the bubble burst (average ROE of only about 11% over the past 3 years). I don't see how they can get ROEs back to a level sufficient to justify a 2.4x P/B (~20% for nearly 10 years, in my opinion) unless land developers decline to charge NVR the cost of holding land. Regardless, in order for this to be a value stock one has to be CERTAIN that NVR can do just that. You sure?
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12 | |
oliver1216,
I'll echo what september and utah1009 have said. NVR generates a good return on book value because homebuilding (without land development) is itself a decent-return activity; NVR wasn't getting those high returns because they were screwing the land developers. Note that NVR is still generating 30% return on tangible capital in one of the worst homebuilding environments in history, when it's now pretty unlikely anyone is capturing any supposed option-related excess returns.
If you took away the option agreements, and restructured the industry so that land owners sold to homebuilders on a just-in-time basis (as homes were sold), I think you'd still see the homebuilding operations with good ROCs and the land developers with poor ROCs (but maybe decent ROE after leverage). They're two different businesses with different return characteristics. Options just happen to be the way NVR separates itself from the land business.
There are plenty of industries where high ROC lines of business persist alongside low ROC lines. Hotel management companies work alongside property owners, shipping/logistics companies work with trucking companies, seismic operators work with ship owners, etc. Why do all of the people in the low return businesses keep doing this and not get into high return businesses? It could be the same reason that investors keep buying low return businesses: hope springs eternal for the turnaround always around the corner. | |
11 | |
In terms of the balance sheet, all of the assets/working capital are on someone else's balance sheet. NVR had property write downs of ~$500m since the bubble burst. That's peanuts next to Pulte Home's >$5bn in property write downs. Theoretically, all the land that NVR can/will develop exists, a developer can only extract so much of the final price, and NVR vis a vis other builders can pay more for land since their costs are lower. It's clearly an advantage in not having the land on the books.
What I find curious is that in terms of low cost commodity producers, NVR looks more process oriented (Southwest) than systemic (GEICO) in its competitive advantage. Plenty of low cost airlines pop up all the time, where as Allstate is getting murdered in car insurance and GEICO/PGR have never been doing better. The benefits are so clear of the NVR approach - high share price, high compensation, happy shareholders, happy management - all the agents are aligned to push for this at other builders. I don't understand how competition hasn't emerged by copying the process. Do you know of any homebuilders trying the NVR approach or are there any rumblings of it being attempted in the near future? They started on their current path when they were in distress and had a reality check. Is anyone else having this epiphany in the space? | |
9 | |
The shares are trading at just under 2.5x tangible book value. If one assumes cash is worth cash the situation is much worse - the market is valuing NVR's non-cash net assets in excess of 4x book value. If this is a value stock at the current price, the implication is that NVR must generate a very high return on its book value for many, many years. The assertion as to why this is possible rests on the notion that NVR's option strategy enables it to generate excessive returns and is sustainable. The corollary, however, is that if NVR is making outsized returns on its options then the seller of those options is making excessively poor returns. Who are these people and why do they keep doing this?
During the bubble NVR was able to generate very high returns (just as one would have buying options on internet stocks in the prior bubble) but have generated mundane returns since. During the bubble, banks would lend 95% of the cost of buying and developing land with only a 5% premium paid by NVR on an option to buy the developed parcels. This allowed developers, using no money, to spring up like flowers after a rain. NVR, at a low cost, put numerous developers in business and was able to secure 10s of thousands of lots, many of which they subsequently walked away from. But banks certainly won't do that anymore and developers actually have to have money in their investments now. A land developer has a choice: sell the whole property outright, sell individual plots, sell homes like a homebuilder or sell options to a homebuilder. Assuming developers who actually have skin in the game and know the market reasonably well are reasonable investors, how can we be comfortable that NVR can make the requisite excessive returns for an extended period of time necessary for shareholders to make even a moderate return? And how can investors expect high levels of return on investment if the company is spending a large amount of cash repurchasing shares at a high multiple to book value (which serves to lower book value per share)?
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6 | |
> Is there any way to quantify these savings on a per unit basis?
That's an interesting question. One possible approach: take cost of sales (excluding land impairments) and divide by the number of delivered homes in a year to get their average cost per home. If you call the company and can get them to share with you the average square footage per home sold (or maybe estimate from the blueprints of their most popular models), you can get an approximate cost per square foot. If you did this with several public builders, you might be able to get some idea of the difference in efficiency, although you'd want to choose builders operating in similar geographic areas and selling comparable homes. I'd be interested in seeing a recent comparison. Who wants to volunteer to do this? Not it.
If you don't want to go through that much effort and just want to get a rough approximation, you might be OK assuming that builders on average aren't able to charge a price premium for their product. If two builders build the same home, homebuyers aren't going to pay extra dollars per square foot (on average) for a NVR home vs a Ryland home or vice versa. If you make that assumption, then you're probably fine just looking at Cost of Sales (excl impairements) as a % of Sales. I looked quickly just now at a few of the builders and saw differences of as much as 700 bps, which is not that small on a ~$300k house. | |
5 | |
utah1009,
I think part of the reason you do not see a decline in G&A vs 2004 is because they did not adopt SFAS 123R (Accounting for Stock-based Compensation) until 2006. So, the 2004 number you are looking at has no stock comp expense whereas the TTM figure includes $64 mil of stock comp expense. These guys have also been pretty liberal with the options gravy. | |
2 | |
Nails,
It's a fair question and one that we have spent some time thinking about. During normal times, the answer is that NVR has a significant cost advantage over competitors which allows it to pass along some of the value to the buyer. Hence the buyer gets a better home for a cheaper price when buying from NVR.
The cost advantages have 2 primary sources. First is the local economies of scale that NVR achieves, which allows them to leverage the fairly significant on-site and market-related SG&A that homebuilding entails. Second is NVR's assembly-line like process.
These advantages while meaningful are not enormous though. This is why NVR has been a steady share gainer during normal years (they average about 60 bps of share gains per year).
In addition, NVR simply executes very well. They seem to get more efficient each year, and as they grow they get additional purchasing advantages on raw materials, etc. This allows them to maintain margins. The huge share gains we've seen recently (NVR has double share gains in the last 5 years) have a different explanation: their peers which were more poorly capitalized (debt and/or on-balance sheet land) exited the business. This is why our normalized case assumes that NVR's current 18% market share declines to 13.5% over time - some of these peers at least will come back into the business.
Hope that helps. |
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