Monday, April 18, 2016

Beazer Homes Looks Like Good Value

I've been nibbling on shares of home builder Beazer Homes (BZH) lately. The company is profitable and trades at a big discount to book value, most of which is made up of land and houses i.e. inventory.

In general, I'd say a home builder should be worth somewhere around its tangible book value. Sometimes it should maybe be worth more, perhaps due to good management as well as because land and inventory are booked at historical cost whereas this inventory should generally appreciate over time. And sometimes it should be worth less, perhaps due to bad management or because land purchased at cyclical highs (e.g. anything bought in 2005) may take some years to recover.

In general, though, because it's hard to get a sustainable competitive advantage in this industry (i.e. competitors can all flock to wherever out-sized profits exist), I'd expect book value to be a reasonable proxy for intrinsic value when conditions are normal. (Abnormal conditions would be a liquidity crisis or a period of dramatic declines in real estate prices.) Here's an article I wrote a few years ago that demonstrated home builders do tend to oscillate around their book values.

Beazer Homes currently trades at at a discount to book value of over 50%. Over the last 12 months, the company has generated operating income of $68 million and has a book value of $632 million. Meanwhile, it trades for just $300 million.

One reason for the big discount is likely due to the company's debt situation. There is $1.4 billion in net debt due at various dates of maturity. Because there are hard, liquifiable (not liquid like cash, but also not illiquid like specialized machinery) assets to cover this debt, I suspect it's likely manageable even if profits falter. The company's recent earnings over the last few years demonstrates, in my opinion, that the assets may also be understated.

Management is intent on deleveraging, which is music to my ears. They have an EBITDA/debt target that involves reducing debt through cash flow by developing less, and increasing earnings through cost reductions and improved sales.

One caveat I should also mention though is that deferred taxes are significant part of the company assets (as a result of tax-loss carryfowards generated during the recession). While these aren't exactly hard assets, they do have value as the company is generating profits right now and therefore these assets are turning into cash. Even if you discount these tax assets to some sort of present value, though, the company's discount to book is still rather large.

If you are still worried about the downside risk, you can also buy the debt of this company at double-digit yields to maturity. You get some extra safety by being ahead of equity holders on these land/house assets, but the upside is not as good.

One could argue that if rates were to rise, demand for houses and therefore house prices in general would fall. That may be true. On the other hand, there is also a lot of macro data to suggest there is pent-up demand for houses as buyers are returning to the market following a long cooling period after the housing bust. I don't put much emphasis on either view, as I find when you get too deep into the macro issues, you complicate things and increase the likelihood that you rely on some assumptions that may or may not turn out to be true and/or relevant. Here, I'm focused only on the company and its margin of safety.

Disclosure: Author has a long position in shares of BZH

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