I’ve posted two recent “discount to NAV” plays recently, LADR and CET. I also had a disappointing call on CPLG, which thankfully I decided to exit. While I think those names are different than most stories, I am generally wary of “discount” plays and even sum of the parts.
You: Can you listen to my pitch?
You: So it trades at a discount to NAV…
— ShitFund (@ShitFund) December 29, 2020
As I stated in the LADR post:
“See, a lot of times investors buy financial assets below book value. But if the assets are earning a low ROE, the book value may be worth a low amount. Or you may not realize that book value for a long, long time (think of a 100 year bond with a 1% coupon when prevailing rates are at 6%… it will take a long time to get “book value”.)”
However, exceptions are allowed. In this case, we have a homebuilder with a strong management team trading at a large discount to book value. Recent trends are really encouraging as well. Somewhat like LADR, homebuilders sell down inventory and recycle it into new inventory. Rinse and repeat. Therefore, I like that we will eventually realize book value at NWHM.
This will be a quick idea and I’m going to start with the punchline first: I think there’s 80% upside on NWHM.
Currently, the market cap is ~$86MM. I like to go to the balance sheet and take out any intangibles and look solely at what liquidation would look like (note, the company does have deferred tax assets to shield itself in a literal liquidation). The company just refinanced $290mm of bonds and reduced debt with the cash on hand. As you can see, we could liquidate this company and easily earn more than where it is trading.
I’ll also note that the company just authorized a $10MM share repurchase plan, which ~11.5% of the company. They could easily do this will the cash on hand.
Background / Why did the stock get cheap?
NWHM started as an ultra-luxury builder (think $2MM+) in Northern and Southern California. That was a great market to be in just a few years ago, but with taxes increasing a few years ago for high net worth individuals (see state tax deduction limits, mortgage interest deduction limits) this hit the luxury market hard.
It also was the best market coming out of the housing crisis, so it has been strong for ~9-10 years. So recent weakening can be expected.
Lastly, we have COVID. While benefitting housing in general, it isn’t even across the country and there is concern that there will be an exodus from these high cost of living areas.
So you can get a general sense of what drove the stock down.
They also were levered and had bonds due in 2022 that people were concerned about (i.e. maturity wall into a slowing market). Therefore mgmt had been working down inventory, generating cash, and they bought back some stock and bonds at a discount.
With recent strength in the bond market, they were able to refinance those bonds and extend the maturity to 2025. They also have been opening lower-cost communities in Arizona, which is a hot market. They are trying to get their average ASPs down (not by lowering prices, but by targeting lower cost areas).
While I mentioned luxury was moving slower in recent years, it appears mortgage rates coming down significantly is giving the company a nice bump as well. Take a look at recent absorptions for NWHM.
Why Buy NWHM Now?
First, recent results are improving materially. Q3 and Q4 are typically seasonally slow periods in the market, but the company noted on its latest call that sales are bucking those trends
Second, I think NWHM could be a take-out candidate. While luxury isn’t where most builders are focused, there is a struggle to obtain good lots right now. I think Toll Brothers (another luxury builder) could easily acquire the company and getting it at NAV would be a coup for TOL and for NWHM shareholders right now.
I’ll also mention the Chairman, Larry Webb, is known for selling out of his homebuilder (John Laing Homes) prior to the last downturn at a huge multiple (something like 3x BV).
Lastly, we have a lot more time than we did before now that the company refinanced its bonds.
Where could I be wrong?
Interest rates could move back up and slow home sales materially. We saw this at the end of 2018. Even modest move ups in rates tend to make people “pause” a home buying decision.
There could be impairments, which shoots the discount to NAV thesis in the foot. However, the threshold to actually impair something for a builder is really high. I’ll also say, NWHM has had some impairments, but they haven’t been “50% of book value” meaningful. Lastly, they wouldn’t be talking about moving up price if they were concerned about impairments.
Foreign Buyer in California. This is kind of a “known unknown”. We know that foreign buyers have been scooping up US real estate and actually decreased purchases in 2019. But we don’t really know how much impact it would have if it evaporated. I think this is more of a tail risk.