Disclaimer: This post is not financial advice, and is not a solicitation to purchase or sell any securities. For more info, please review the disclaimer.
First, read this legendary write-up by Charlie479: https://www.valueinvestorsclub.com/idea/NVR_Inc./1871818862
What do they do?
Unlike most homebuilders … they make money!
NVR, Inc. builds homes, as well as townhomes and condos, under the brands Ryan Homes, NV Homes, and Heartland Homes. These are built to order and have already been sold to customers who retain the ability to cancel under certain circumstances. For instance, a customer that loses their job, can’t get a mortgage, or can’t sell their current home may cancel their order for a new home. NVR builds homes in 4 regions:
Mid Atlantic: Maryland, Virginia, West Virginia, Delaware and Washington, D.C.
North East: New Jersey and Eastern Pennsylvania
Mid East: New York, Ohio, Western Pennsylvania, Indiana and Illinois
South East: North Carolina, South Carolina, Tennessee, Florida, Georgia and Kentucky
What’s their moat?
NVR relies on economies of scale in their key markets, along with an option-based land acquisition strategy, and only builds homes for customers who have already agreed to buy them. Given their long track record, excellent, returns on invested capital, strong market position, backlog of orders, and finished (or to be finished) lots under option contract, NVR has a strong moat compared to other competitors in the market, allowing them to earn outsized returns despite a minimal customer-facing moat. People have wondered why other homebuilders have not fully copied NVR for 25 years, but I think it’s clearly a matter of incentives, determination and scale.
However, NVR’s consumer-facing moat is much weaker. While their homes are often built to the consumer’s preference, I don’t see evidence that NVR homes are fundamentally better or worth customers paying a sizable premium.
What are the unit economics?
Since 2022 the average sales price per house is about $450k. Gross Profit has ranged from $107-$117k per house in the past 3 years, which has been the recent high in terms of margin, and certainly per house profitability. Opex has been in the 6-7% range since 2017 which comes out to $23- $29k per house and an operating profit of $81-94k per house. At almost 23k houses sold last year, that gets you to about $1.8B in Operating Income.
Note, for simplicity I’m ignoring NVR Mortgage Finance, where they originate mortgages and then sell them on with minimal credit risk, but this segment generates another $130-150M of operating income. They also have about $150m of Other Income from interest earned on their cash, but this is a result of their capital structure, and not truly part of their ongoing operations.
What does the future look like?
Nobody knows. I share many investors’ concerns about NVR overearning in the COVID and post-COVID time period due to strong housing demand and a sluggish home resale market. This has led to higher ASPs for NVR along with higher gross margins.
After looking at US average and new home average and median prices I am more confident that NVR’s higher ASPs can be maintained. Additionally, their backlog still looks strong with avg backlog price up 4% y/y to an all-time high. Over the last 20 years, NVR homes have gone from a substantial premium to a modest (10%) discount to the average home price. The Median home price is lower than the average, but NVR is now at only an 8% premium to the median new home price. This represents a slight bump from the 6% premium they were at from 2021-2023, but is dramatically lower than any other time in the last 20 years. Of course, if national Real Estate prices go down significantly, then there will be tough times for NVR Inc. and shareholders.
In a bearish scenario, if you were to lower NVR’s average selling price to $430k, and homebuilding gross margin to 20%, while keeping the homebuilding OpEx relatively high at 6.3% (5.8% last and 3-year avg) and lower their units sold to 19,000 (average of 2018 and 2019 levels), you would get about $1.1B in Homebuilding operating income, which is a 5.1% OI Yield to EV. While I think NVR would be modestly overvalued at around 20x earnings, given the high ROIC, and growth runway I’d be comfortable owning this company.
If the future looks like the present, NVR is currently yielding almost 7% FCF / EV, has been growing settlements 5%+ and likely benefits from inflation as new home prices have increased a couple percent a year as well. 7% FCF yield with 5-9% prospective revenue growth and similar or slightly better FCF growth and excellent Return on Invested Capital is compelling.
What’s the valuation?
One persistent concern I’ve seen from investors is that management pays themselves quite a bit. Some of this is a function of long-term options grants that have benefited from strong stock performance, and some of this is a cost to shareholders. Given how well the business and stock have performed over time and the requirement to own 4-8x base salary in stock it’s difficult to complain too much, but the important things are
1. We are treating stock based compensation as an expense in our calculation of FCF
2. If you look at the fully diluted market cap or enterprise value it’s about 7% larger than the one we see on BBG, so we’re using the fully diluted number in our denominators.
I find headline numbers are often misleading, but here the ~7% trailing FCF yield largely mirrors the 14-15x P/E or Forward P/E that you see on BBG. ROIC is exceptional, 80+% excluding intangibles, and growth has been strong with a 5.5% Unit CAGR and 1.7% price CAGR over the past 10 years resulting in 7.3% (homebuilding) revenue growth and 19% (overall) free cash flow growth.
What are the main risks?
1. Recession – obviously if there’s a big economic slowdown then housing is cyclical and it may take a while for sales and earnings to recover. During the Great Recession revenues were down more than 50% and FCF was down more than 60%. However, we’re still nowhere near those excess / levels of supply. While I have confidence in their long-term business quality and earnings through the cycle, this is a cyclical stock.
2. Over-earning normalizes more than expected. If home prices finally correct on higher interest rates, economic challenges, existing homeowners finally moving, etc. and gross margins drop precipitously on reduced scale, then returns will likely be lackluster for at least a few years.
3. Geographic mix
a. South East lower GM %. The South has generally seen positive net domestic migration while the Mid Atlantic and North-East have seen negative net domestic migration. South East gross margins have been lower, oftentimes in the high-teens range. I believe South East gross margins have structurally improved due to greater scale, but continued mix shift towards the South East may depress margins
b. ‘Drain the Swamp’ Risk – I have heard concerns that NVR’s core markets in DC and Virginia (the greater DC area) have experienced strong home appreciation, but this tailwind may reverse if DOGE or other initiatives are successful in shrinking the governmental footprint. Personally, I think that would be a great problem to have, and minimally impact the stock, but I’m not holding my breath.
Conclusion
Overall, NVR is a compelling opportunity to buy a business with great returns on invested capital that grows revenue at mid-to-high single digits (FCF has grown even faster) at a 7% trailing FCF yield. Given the last 3-4 years of steady ASPs, stronger Gross Margin, FCF, and strong backlog (about 6 months of Revenue) with an all-time high in Average Backlog Price; I like the stock.