Is NVR Inc one of the better NYSE stocks?
Value Investing Case Study 30-1: An updated fundamental analysis of NVR, a NYSE home builder, based on the first quarter of 2022 financials.
I first covered NVR Inc (NVR or the Group) in my article for Seeking Alpha in April 2022. The analysis was based on the financials till Dec 2021. I had concluded that NVR was a good investment opportunity given the high inflation environment. The rationales were:
- In times of high inflation, the homebuilding sector will do well because of its favourable business economics.
- I favour NVR because of its return track record and its ability to create shareholders’ value. Both of these were over the Housing Starts cycle. NVR was also financially sound.
- At the current price of USD 4,445 per share then (19 April 2022), NVR was trading at a 23 % discount to its long-term cyclical value.
For details, refer to my article “NVR: A Good Jockey On A Strong Horse Riding Into A High Inflation Environment”
Since then, NVR had released its Q1 2022 results. This is an update incorporating the Q1 2022 results.
My conclusion is that NVR remains fundamentally strong. It is a good company given the high inflation environment. The market price of NVR had declined to USD 3,951 per share as of 28 Jun 2022. Despite the decline in the share price, there is still a good margin of safety.
Should you go and buy it? Well, ready by Disclaimer.
Contents
- Group Performance
- Valuation
- Share buybacks
- Conclusion
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Group Performance
For the quarter ended 31 Mac 2022, the Group achieved USD 2.4 billion of revenue and USD 426 million net income. These were 18 % and 71 % higher than the revenue and net income of the same period last year.
According to NVR, the improvements were due to strong demand. This resulted in “…significant appreciation in home prices, allowing us to improve profitability despite rising material and labour costs.”
The current quarter’s performance is a continuation of the uptrends in revenue and net income over the past 10 years. Refer to Chart 1.
The main concern that I have is with gross profitability. This is defined as gross profit / total assets. According to Professor Novy-Marx, this metric has the same power as the Price Book Value in explaining the returns.
The annualized gross profitability index for 2022 was 0.73. While better than that for the past few years, it was still lower than the 2005 index value. Thus, while there was revenue growth relative to 2005, the Group was not as effective in transforming this into gross profitability.
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| Chart 1: Performance Index |
There are of course challenges going forward. Management has highlighted the following concerns in the report:
- Demand for new homes and home affordability may be negatively impacted by both rising inflation and mortgage interest rates.
- The Group expects to continue to face cost pressures related to building materials, labour, and land costs.
Financial Strengths
NVR remains financially strong as of the end of March 2022, the Group had a negative Net Debt (Debt less cash) position. At the same time, about 51 % of NVR Total Capital Employed (TCE = SHF + Debt) comprises cash.
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| Chart 2: Sources and Uses of Funds |
NVR continued to generate positive Cashflow from Operations for Q2 2022. This is a continuation of the strong Cashflow from Operations track record.
- From 2005 to 2021 it generated USD 8.2 b Cashflow from Operations compared to its total Net Income of USD 8.1 b for the same period.
- NVR did not have any year with negative Cashflow from Operations during the past 17 years.
These cash reserves would enable NVR to withstand any negative impact of a slowdown in the homebuilding industry. Management had stated that:
“…we believe that we are well-positioned to take advantage of opportunities that may arise from future economic and homebuilding market volatility due to the strength of our balance sheet.”
Peer comparisons
In my Seeking Alpha article, I considered several performance metrics from 2005 to 2021. Note that this duration covers one Housing Starts cycle. During this period, NVR had the best results compared to its peers as per Table 1.
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| Table 1: Peer Performance Notes a) Gross profits/Total Assets. b) The data from Taylor Morrison was only from 2009 to 2021 and hence did not cover a full Housing Starts cycle. |
I carried out the same comparison for Q1 2022. As shown in Table 2, NVR continued to be the best performer.
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| Table 2: 2022 Performance Source: 1) The ROE and ROA were taken directly from TIKR.com quarterly report. The Gross profitability was computed from the annualized gross profits divided by the total assets for the quarter. 2) Lennar statistics were based on the quarter ending May 2022. |
In my Seeking Alpha article, I had concluded the following:
- In a high inflation environment, companies have to worry not only about higher costs. They also have to contend with the economic impact of the various measures taken to control inflation.
- The homebuilding sector has the business economics to overcome the high inflation effects. But this requires you to view them through a cyclical lens.
- Homebuilders that will do well are those with a strong management team and good business economics. This will be reflected by a track record of strong returns, shareholders' value creation, and strong financials.
- NVR fits this profile.
There is no reason to change this assessment.
Valuation
My valuation of NVR is based on a single stage valuation model for the firm = FCFF X (1+g) / (r - g)
Where:
FCFF = EBIT X (1-tax rate) - Reinvestment.
EBIT = Gross profit - SGA.
= (Revenue X GP margin) - (Revenue X SGA margin).
g = growth rate.
I derived the Reinvestment based on the growth formula of g = Reinvestment rate X Return.
r = WACC. The WACC was derived based on Damodaran’s build-up method for the Beta, the risk-free rate = 1.51 %, and the cash-adjusted unlevered Beta = 1.59
The value of equity = Value of firm - Debt + Cash.
Revenue is a function of the Housing Starts. I used the 2021 Housing starts of 1.595 m units and NVR 2021 revenue of USD 8.966 billion as the base. I assumed that the long-term average Housing Starts to be 1.5 million units.
The other assumptions are shown in Table 3.
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| Table 3: Assumptions Note that as I am looking at the value over the cycle, the revenue, GP margin and SGA margin were the same values as those in my Seeking Alpha articles. |
I valued NVR based on the following scenarios.
- Earning Power Value (EPV). I assumed that Reinvestment = 0.
- Earnings with growth. I assumed that growth is the long-term growth in the House Price index of 4.3 %
Chart 3 below summarizes the valuation.
- Asset Value (Mac 2022) = USD 802 per share.
- EPV = USD 2,932 per share.
- Earnings Value with growth (EV with g) = USD 5,681 per share.
The current market price of NVR is USD 3,951 (as of 28 June 2022). You can see that there is a 44 % margin of safety based on the Earnings Value with growth.
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| Chart 3: Valuation |
Rationale of assumptions
The homebuilding sector is cyclical and thus the long-term performance of NVR should be based on its value over the cycle. Hence, I have taken the past 17 years’ average values for the gross profit margin and SGA margins.
In my other Seeking Alpha articles, I have demonstrated that there is no growth in the long-term average Housing Starts. Refer to “MDC Holdings Is A Cigar-Butt Opportunity” and “The Market Is Not Pricing D.R. Horton As A Cyclical Group.”
Thus, the average long-term value of NVR is based on the revenue assuming 1.5 million units of Housing Starts. While there is no growth in the volume of Housing Starts, there is long-term growth in prices. I have assumed that this will be at the long-term HPI growth rate of 4.3 %. This will result in the growth in revenue at the long-term HPI growth rate.
Share buyback
From 2005 to 2021, the Group spent USD 8.98 billion to buy back 7.2 million shares. If there were no share buybacks, the number of outstanding shares would be higher by 7.2 million. The total assets and the shareholders’ funds would be higher by USD 8.98 billion.
The share buyback will affect two analyses – the intrinsic values of NVR and the strategic insights from comparing Asset Values with EPV.
I had earlier estimated the Book Value and EPV based on the shareholders’ funds and the number of shares outstanding as per the accounts. These values would be different if there were no buybacks.
Assuming the USD 8.98 billion was part of the retained profits, the adjusted intrinsic values assuming no buybacks would be.
Book Value = USD 1,100 per share.
EPV = USD 1,781 per share.
You can see that the unadjusted EPV of USD 2,932 is 65 % higher than the adjusted EPV of USD 1,781. The share buyback will affect any ratios that use the number of outstanding shares or shareholders’ funds.
You will note that there is a big gap between the Asset Value and the Earnings Value. According to Professor Bruce Greenwald, you can get strategic insights by comparing the Asset Value with the EPV.
- In a competitive situation, you would expect the Asset Value to be the same as the EPV.
- If the EPV is greater than the Asset Value, it must be because the company has some competitive advantages.
- If the EPV is less than the Asset Value, it indicates poor utilization of the assets.
But for such a comparison to be useful, the Asset Value and EPV should not be “skewed” by an aggressive share buyback programme. That is why if you a going to use Greenwald analysis, you should adjust the Asset Value and EPV for the buybacks.
- Based on the original data, the gap between the EPV and the Book Value is USD 2,130 per share.
- After adjusting for the share buyback, the gap is USD 681 per share.
You can see that for NVR, the gap between the Book Value and the EPV has narrowed. But there is still a gap.
For further details on the Greenwald analysis, refer to “The Basics Of Valuation - Picking out Value Traps”
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Did the buyback create shareholders’ value?
Share buybacks would create shareholders’ value if they were carried out at prices less than the intrinsic values. Thus, one way to assess this for NVR is to compare its average share buyback prices with its intrinsic values.
I have estimated the intrinsic value of NVR as USD 5,681 per share based on its EV with growth. Given the 2021 net income of USD 345 per share, this is equal to an intrinsic value/earnings ratio of 16.5.
I will assume that any purchase price that is less than this 16.5 ratio indicates that the buyback was carried out at a price less than the intrinsic value.
Table 4 summarizes the share buyback statistics for NVR from 2005 to 2021.
- There were 15 years of share buybacks.
- 6 of them exceeded 16.5 while the balance 9 were undertaken at less than 16.5.
You can conclude that 9 of the 15 years or 60% of the time the share buybacks were carried out at prices less than the intrinsic values. In other words, 60 % of the time, the share buybacks added to the shareholder’s value.
Another way to look at the overall performance is to look at the buyback on a weighted basis. I used the number of shares bought for each year as the weights. On such a basis, the buyback price ratio was 15.2. The buybacks were carried out at less than 16.5.
The weighted ratio was computed as follows:
- Multiply each year ratio by the number of shares bought back in the respective year.
- Sum up the values for each year obtained as per above.
- Divide this total by the total number of shares purchased from 2005 to 2021.
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| Table 4: Share Buyback Analysis |
Note: The Purchase PE for each year = Purchase cost per share / EPS
I would thus conclude that the NVR share buyback programme added to shareholders’ value. This is of course a back-of-envelope analysis. The better way is to compute the intrinsic value for each year.
The share buyback was positive for NVR not only in terms of the prices bought. NRV generated a lot of Cashflow from Operations that far exceeded its investment requirements. The share buyback was a way to return the excess funds to shareholders. It also boosted the performance of some of the share based-metrics.
Conclusion
In my Seeking Alpha article, I concluded that NVR was a good stock to invest in a high inflation environment as follows:
- Over the long term, house prices have increased at a faster rate than inflation and construction costs. The long-term average Housing Starts are also not affected by inflation. This meant that if you value homebuilders from a long-term perspective, you are likely to have more reliable estimates.
- I carried out a valuation of NVR on such a basis. It indicated that there is a margin of safety at the current market price. At the same time, NVR was fundamentally strong. It had a track record of sector-leading returns and creating shareholders' value. It was also financially very sound.
- The key was not the track record. Rather the track record points to an underlying strong management and good business model. This is important given the uncertainty regarding the duration and short-term impact of high inflation.
This updated analysis supports the earlier conclusion. At the same time, the market price of NVR has declined even further to provide a higher margin of safety. As such I would consider NVR as one of the better NYSE stocks to invest in.
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