Tag: Compounder

How has NVR stock outperformed Microsoft?

NVR stock has absolutely crushed the competition. The company is a homebuilder, which isn’t a very good business, but has a differentiated strategy than its peers. Below is a chart comparing NVR to other builders.

This may surprise some people, but investing in NVR in the 1990s would have outperformed buying Microsoft!

Note, the starting point differs a bit from the chart above, but you get the idea. $10,00 invested in NVR stock would be worth $2.8MM today compared to only $1.1MM in Microsoft stock.

Quick overview of the homebuilding industry

Homebuilding is pretty simple — essentially acquire land and subcontract most parts of the building process out.

Therefore, if you had the capital and time, you could probably enter the industry. That’s probably why most homebuilders do not create much value for shareholders in the long run. There are several other reasons as well.

Trusting them to be good asset managers. Homebuilders want to acquire cheap land, so they acquire in areas outside of where they currently operate – going where they think the growth will be. This land is typically “raw” and needs to be  zoned & entitled, roads paved and sewer installed, etc. Now, builders typically let a land developer handle this, but enter into a contract to purchase that land when it is developed. By the time the land is developed and the builder is prepping to build homes, they are praying that demand will hold in or has moved in their direction, otherwise the investment in the “raw land” may not be fruitful.

In homebuilding, you are rebuilding the factory each year. Builders are constantly acquiring lots for growth. Think about it. What other business are you constantly selling your asset base down? In manufacturing, typically your factory creates products that you sell, but at the end of the year you still have the factor. In farming, I sell the fruits of my labor, but I still have the land for next year.

I liken homebuilding to oil & gas – if I drill one well, it will produce cash but for me to keep my earnings power constant, I’ll need to reinvest that cash into other wells.  Typically this means they are burning cash in the good times, as demand looks good in the future so they continue to acquire future inventory. In bad times, the builders need to generate cash, but do so at the worst time. They have illiquid assets that need to move quickly to generate liquidity so they have to take a haircut.


As you can probably tell, I think homebuilding is a bad business. But as I said when I launched this series, you can have a bad industry, but a great company. Oftentimes investors will write-off sectors and leave gems out like NVR stock.

So what sets NVR apart? NVR actually filed for bankruptcy in the 1990s have a debt-financed merger went sour as the economy went into a recession. They came out of that will a new, safer business model that is quite differentiated.


NVR Options Land

Summing up NVR in one picture: The company takes very limited land risk.

So for an initial deposit, NVR keeps flexibility of whether or not it will buy the lot. This helps it keep flexibility in a downturn so that its not still acquiring things that may be bad investments or it can divert capital elsewhere when needed (in fact, NVR is the only builder right now that can confidently buy stock on the cheap due to its flexible model and strong balance sheet). This also means it keeps very little land on the balance sheet compared to peers because it doesn’t own it.

This is very different than the rest of the industry:

Let’s compare how the cash flows then look for a traditional builder. Pay attention to working capital, which is mostly inventory movements (may need to click on picture to see better):

As you can see, Lennar generated cash in the financial crises, but it came from liquidating inventory. It then needed to replenish as the market came back. It was forced to sell when you’d want to be a buyer and forced to buy when you’d want to be a seller. 

Let’s compare that to NVR’s cash flows. It too sold down inventory, but as a % of earnings, it was much lower and emerged much stronger. It also didn’t need to impair large portions of its book like Lennar did.

NVR Builds Only After the Home is Sold. NVR does not typically take ownership of a lot until it has pre-sold a home and the buyer has qualified for their mortgage and then it begins construction on the unit. This also reduces risk that the company spends capital today for no reason.

NVR ships pre-cut materials to the job site at specified requirements. This speeds up the building process for quick & efficient assembly. The company is one of the few builders to maintain manufacturing facilities for framing products as well as windows & cabinets. This type of vertical integration helps control costs and provide efficiency.

Maintains leading market share on a local level. I shudder whenever a homebuilder acquires another where it doesn’t currently build. Think about it – what benefit does the transaction bring? Yes, it brings lots in a new region. Some would say diversity is good. But M&A is typically done at 1x book value or above. So how does that create value? You won’t get any purchasing scale or scale on labor used unless you expand your market locally. It’d be much better to buy a player where you already operate. Lower competition plus gain regional scale.

NVR’s strategy is to gain leading market share where it operates and growth areas stem from places its operated before. NVR has a dominant 20%+ share in its core markets — much higher than peers’ typical share of 7-10% when they have a leading position.

Combining the last two points translates into similar margins to peers. NVR did about 35% of the sales that Lennar did in 2019. Yet compare their financials. NVR is lower GMs (which is a byproduct of their business model), but also much more efficient with SG&A, as discussed. This leads to comparable margins to peers.

Land is the most capital intensive part of the business, so they (i) are earning similar margins as peers but also (ii) turning inventory much faster than peers. This translates into much higher ROEs… higher ROE in the long-run helps NVR stock outperform peers.

Breaking this out – look at NVR’s historical ROE!

Why doesn’t everyone operate this way?

  • Not all geographic areas offer options like the ones NVR uses, so it may inhibit NVR in the long-term. But also many builders in other areas simply don’t have this option.
  • In times of growth, NVR’s top line will typically lag peers as its business model acts as a governor. Through cycle though, we can clearly see the benefits
  • Gross margins, in the good times, can also be better because you are selling low cost inventory into higher prices

NVR’s sales and earnings aren’t the largest, but its differentiated strategy aimed at limiting risk has obviously helped in a cyclical industry. As you can see by NVR stock, slow and steady wins the race.

B&G 2018 Wrap Up: Not even the Green Giant is immune to food sector challenges. Been wrong on the name so far, but reaction creates solid entry point + high dividend. $BGS

B&G reported Q4’18 EBITDA of $59MM compared to $69MM in the prior year. While this was partially impacted by the sale of Pirate Brands to Hershey, it was still a tough comp due to input cost inflation (freight, procurement, as well as mix). As a result, EBITDA was 200bps lower as a % of sales than the prior year.

I expect B&G’s stock will react negatively to this (already down 10% after hours to $22) and I am disappointed with the stock’s performance since I wrote on it first in Aug 2017 (down ~25-30% depending on where it opens).

That said, I think there are a few positive take-aways from this quarter that will keep me grounded. Bottom line, I still think B&G is a long-term compounder. Food sector sentiment is particularly negative right now (especially with the KHC news) and 2019 should be an easier comp from a freight and inflation perspective.

  • Green Giant Continues to Grow at Attractive Levels, Despite Challenges in Shelf Stable:
    • Green Giant’s sales increased 4.9% this Q and grew 6.1% for the entire year. This has been mainly driven by new innovations in the frozen food aisle that have countered challenging trends in the canned, shelf stable category (down 8.2% for the year).
    • Part of the thesis in buying B&G is that these managers are good at buying mature assets, harvesting the cash, and restarting the process (rinse & repeat). They sold Pirates Booty to Hershey for $420MM after they bought it for $195MM in 2013. I continue to think Green Giant was a solid acquisition.
    • Given there are many other consumer staple brands struggling to date, I think this is an opportunity for B&G. They repaid $500MM of their TL with help of the Pirates’ sale so that also adds some capacity.
  • Company is managing other mature brands well. Would you have believed me if I said Cream of Wheat increased sales 4.3% this Q? Or Ortega was up 7.2%? Excluding Victoria, which saw a $2.5MM decrease in sales from a shift in promotional activity, I think the company is doing a good job with this portfolio.
  • Continues to generate significant FCF to support dividend. B&G pays $1.90 dividend which based on the after-hours quoted price currently amounts to a 8.6% yield. Typically, dividend yields that high imply the market thinks there is risk of being cut. Setting aside the fact that the company generated $165MM of FCF this year (reduced a lot of inventory), I still think the dividend is covered.
    • Using ~66MM shares outstanding, this implies a $125MM cash use.
    • Based on the company’s guidance range, this implies you are ~1.3-1.4x covered.
    • Said another way, based on my FCF walk, we would need to see EBITDA decline 17% from the mid-point of guidance for it to be 1.0x covered.
BGS Dividend RIsk

Personally, I’d prefer if the company bought back a significant amount of stock at these levels. Unfortunately, the stigma of keeping a dividend out there forever (which is dumb) prevents that from happening (as the stock would get crushed).

Guide from the company:

BGS Guidance