We have been long-term members of the Value Investors Club.  Over the years, we have recommended many stocks, but we have not recommended a homebuilder since we recommended Toll in 2003 and Centex in 2001.  Our hope is that this recommendation of TRI Pointe works out at least partially as successful as our previous homebuilder recommendations. 

TRI Pointe is a mid-sized, high quality, well-managed homebuilder.  The company’s shares appear deeply undervalued, likely because the company is only seven years old and is not on most investors’ radar screens.  At $10.19, the shares are selling at only 8.5 X estimated 2015 EPS of $1.20 and at only 5.7 X our estimated  2018 EPS of $1.80.  The company has large land holdings in California that, in our opinion, are valuable “hidden assets”.  We value the shares at 13 X earnings and therefore believe that, two years from now, they will be worth $23, or more than double their present price. 

TRI Pointe was founded in April of 2009 by three former top executives of William Lyon Homes who each had worked at Lyon for roughly 20 years.  Initial financing for the start-up came from Barry Sternlicht’s Starwood Capital Group.  Barry Sternlicht remains Chairman of the Board of TRI Pointe – and Starwood owns about 7% of the currently outstanding shares. 

TRI Pointe became a public company in early 2013 when about 14 million shares were sold to the public at $17. The principal underwriters were Citigroup and Deutsche Bank.  At the time of the IPO, TRI Pointe was a small company, with 2013 revenues of only about $250 million.  Then, in mid-2014, TRI Point purchased Weyerhaeuser’s home building operations (WRECO) in a reverse merger.  In 2013, WRECO had revenues of $1.2 billion – so WRECO was nearly five times the size of TRI-Pointe.  In the merger, Weyerhaeuser’s shareholders received about 80% of TRI Pointe’s shares, but TRI Pointe’s management continued to manage the company.  

There were three important advantages to the WRECO merger: (1) an estimated $30 million of synergies; (2) WRECO had been under-managed by Weyerhaeuser (which was more interested in its timberland holdings than in homebuilding); and (3) importantly, WRECO owned or controlled 27,380 lots, including about 16,000 owned lots located in areas of California where land is constrained and is particularly valuable.  The 16,000 lots in California are far in excess of TRI Pointe’s intermediate-term needs.  Therefore, the company’s strategy is gradually to sell some of the acreage to other homebuilders or to developers of commercial properties. In 2015, an estimated $100 million of excess land was sold.  The pre-tax profits on the sales were an estimated $50 million.  The company has indicated that land sales in future years should average about $100 million per year.  Our best guess is that the profit margin on these sales will average about 50%.    

There is an additional advantage to the 16,000 lots in California.  As homebuilders sell homes, they normally need to spend funds to replace the land under the homes that are sold.  However, because TRI-Pointe has considerable excess land, the company can redeploy a greater percentage of its cash flows for organic growth or for acquisitions.  Management says that it is acquisitive.  If management can be as astute about future acquisitions as it apparently was about WRECO further upside is possible.

           We believe that WRECO’s revenues can grow at a 15% CAGR over the next three or so years: 12+% from volume (before any acquisitions) and 3-% from price.  Our 12+% volume growth estimate assumes that the construction of new housing units (homes and apartments) in the United States increases to close to the 1.5 million per year level three years from now.  We, and most industry consultants, believe that about 1.5 million new housing units per year are required to meet the needs of the population: 1.15 million to satisfy population growth and about .35 million to replace homes demolished because of age, condition, style, fire, flood, etc.   

If 1.5 million units per year is the normal level for housing demand, then overbuilding during the 2002-2007 housing boom totaled 1.6 million units, but underbuilding since then totaled about 5.6 million units, leaving a potential deferred demand of about 4.0 million units.  The bulk of the deferred demand temporarily has been filled by grown children continuing to live with their parents or by families doubling up in one house (often a family living with parents).  But, it seems probable that a material percentage of the doubling up is temporary and will abate over time as young families are able to save sufficient funds to afford their own home.  I note that my valuation for TRI Pointe does not give any value to the deferred demand.  

My estimate that housing completions could return to the 1.5 million level in about 3 years is predicated on my belief that, based on historical norms, single-family houses remain quite affordable – and, further, that most families prefer to own their own home than to rent an apartment.  Two main components of affordability are the price of houses and mortgage rates.  With respect to price, our analysis is that, adjusted for size and content (the average new house is about 20% larger than the average house built 25 years ago – and today’s average new house is more likely to contain air conditioning, security systems, higher-end appliances and climate controls, etc.), house prices have increased about in line with inflation (I used the CPI-U index) since the 1980s and 1990s.  With respect to mortgage rates, they remain far below the levels of 20-30 years ago.  It may seem hard to believe, but the 30-year mortgage rate averaged 10.4% during the 1980-1999 period. I note that, in spite of the 10.4% average mortgage rate, housing completions during the 20-year period averaged 1.45 million per year, at a time when the population of the United States averaged about 244 million.  Adjusted to the current population of about 320 million, the level of housing construction during the 1981-1999 period would be the equivalent of 1.90 million units today.   

Our $1.80 EPS projection for 2018 is based on the following estimates: 

I note that, if the company can make one or more accretive acquisitions over the next few years, or if the housing market turns tight, our $1.80 EPS estimate for 2018 could prove to be conservative. 

I also note that TRI Pointe’s tangible book value should be close to $14.50 per share in mid-2018. 

Thus, TRI Pointe has all the value characteristics of a deeply undervalued value stock and, at the same time, has particularly attractive growth metrics: first as residential construction  returns to more normal levels – and then as a particularly capable and aggressive management finds ways to grow the company though market share gains or through acquisitions – or through both.