American Axle is a crappy company. But I currently view that we are going to see a large increase in auto production to (i) meet demand which we are unable to do right now and (ii) restock to baseline inventory levels. So with the stock at a ~40% FCF yield, I’m interested.
This could be a value trap, but my thesis is simple:
SAAR came way down during COVID, but demand held in
Semiconductor shortages have limited production to catch up, which will sort itself out over time. But it will take time. And this will result in a prolonged auto upcycle
Credit is cheap + average age of vehicles has continued to tick up which tells me there’s room for even more restocking.
US personal savings averaged $3.5 trillion during first 5 months of 2021, nearly 3x the level seen in 2019. We could see a decline in the average age of vehicles in the car parc for the first time in many, many years
Inventory continues to decline. Days supply of autos is now around 20 days compared to long-term averages of 60 days. Auto producers need to meet current demand + restock inventories to some sort of normal level
Add this all together, I think the next 3+ years will need to see above average production to catch up.
Here is SAAR, auto inventories and the average age of cars on one chart:
What is a levered bet on this? Shitty auto suppliers. And that is where American Axle comes in to play (and I’m open / reviewing others). AXL trades for ~4x EBITDA for a reason – when auto production collapses, they get crushed. But on the other side, they can generate great FCF when the cycle is in their favor.
How often do you see sell side pointing out the FCF yield is ~40%?. That is also an appeal here – the FCF yield to equity is quite high and I don’t think expectations are high for this company. At the very least, there is a lot of doubt in this cyclical name that the cycle will be short-lived.
$AXL used to have “a balance sheet problem.” While it might’ve only been 3x levered, it was on a business worth 4x, so it mattered. That’s a 75% LTV, which is pretty high. But they generate cash flow now and will definitely in this market.
I should go ahead and point out why they are not great:
~40% of sales are to GM. If GM needs to take a plant down, like in the case of no semi’s, that won’t be ideal. This also means GM has significant power of AXL. Fiat Chrysler is another ~20%
Pretty capital intensive, as 6-7% of sales is spent on capex in normal times.
Investors view anything related to powertrain parts as secularly challenged from EVs (however, AXL did note it is quoting $1.5bn of new & incremental work, with 80% related to hybrids / EVs). In an EV world, perhaps there is less AXL content needed
So there lies the main risks. The other hard part is where this company should trade. I am not calling for a re-rating. I just think earnings / FCF will likely be much higher than consensus expects for the next 3 years. Leverage is down to 2.5x and once they get to 2.0x or less, I think that FCF will really start accruing to the equity.
If this stock underperforms – I’ll know why. I bought a value trap.
I think LGIH stock is potential multi-bagger. Well, it already has been one, but I think it can do it again. When you add in solid growth, good demand fundamentals and a high ROIC business model, it spells opportunity for long-term investors.
Take a look at some of its growth metrics over time. It does around $480MM of EBITDA now, which is about 2.2x from 2 years ago, and 4.0x from 4 years ago. Also… it was the only homebuilder among the 200 largest U.S. homebuilders to report closings & revenue growth from 2006 to 2008 when the housing market experienced a significant decline. So management clearly is focused on growth.
LGIH did $12.8 in EPS for 2020, but I see the path to $23.3 in EPS by the end of 2023 (discussed more below). Therefore, shares are trading at just ~7.25x my 2023 estimates.
LGIH is interesting too because they provide monthly home closing cadence. The May 2021 was up 42% Y/Y and YTD is up 44%. On one hand, easy comps with April/May, but on the other hand, I think they will keep this strong cadence going for a decent period of time.
The main goal is to convert renters to buyers. They even send direct mailers to apartment complexes pitching renters on buying a home.
Now, in talking to some folks about LGIH’s process, it’s clear some people think LGIH is akin to a used-car salesperson (i.e. pushy). However, as we’ll discuss more, the model appears to work really well. Consumer reviews are also pretty solid.
Spec homes – big contrast from other builders
LGIH is 100% spec homes. Almost the opposite of NVR
“Spec” means they build the home without the buyer already secured. NVR only builds on the optioned land once it has the buyer.
Everything is typically included, so there are not specific options that each buyer needs to select. They have 4 to 5 home plans in each community that allows LGIH to build and sell faster and drive on.
Now, clearly LGIH seems more risky, though in a tight inventory market, the market needs spec homes. Its model is also still low cost.
Also, LGIH was the only top 200 builder to grow from 2006-2008
Focused on entry-level:
Average price point is around $250k, which is square in the entry level price point (meaning first time home buyers).
Given lots are expensive these days, LGIH is typically acquiring lots outside of city centers, but also targets areas where there is some retail anchors to attract consumers.
This segment of the market should have demand for years to come, given millennials deferred purchasing homes post-GFC and have been renting for longer.
Still earns strong returns
The average & median builder earns around a 12% EBIT margin, with DR Horton and Lennar near the top given their massive scale (16.1% and 15.5% respectively) and the smaller builders near the bottom, such as Beazer and Taylor Morrison around 10%
LGIH earned a 18.3% EBIT margin
Another interesting thing to note, going back to strategy, is LGIH’s absorptions blow competitors out of the water. Again, 4 is the average absorption rate per month in 2020. LGIH is around 7. The gap was even wider pre-COVID (i.e. before the buying boom).
This means LGIH is selling almost double the amount of homes in a period of time as competitors.
So what drives LGIH’s high returns on capital?
Dupont formula: profit margins (high for LGIH), asset turns (high for LGIH), and leverage (actually low for LGIH).
As LGIH gains size, I think ROIC will continue to grind higher. Now, they’ve gotten pricing, which helps ROIC and margins, but look at ROIC as size has scaled.
As a quick aside, it’s funny to contrast everything we’ve talked about so far with New Home, a luxury builder I wrote about a few months ago that still trades below book value. New Home is small, so its EBIT margins are low. It’s also a luxury builder which just given the nature of the product is slower moving. However, I still think it’s cheap and it’s likely a take-out candidate in a market thirsty for inventory.
Ok – back to LGIH. To my knowledge, only a couple firms cover LGIH. I only could find JP Morgan and BTIG.
Here lies the opportunity. I think LGIH will be a long-term compounder and it’s relatively undercovered. Based on my estimates, I think LGIH will do about $23 in EPS in 3 years (from ~$15 LTM). So with the stock trading at 7.4x that forward EPS today, that seems too cheap to me.
Sure, I’m looking 3 years out on a cyclical business, but I’d rather have LGIH stock than buy a questionable SAAS name for 20x sales.
The risk to the thesis is, can they keep up the growth? Well, 2020 will definitely be a tough comp. Right now, we are still lapping the easier part of 2020.
However, the risk to LGIH’s growth is not the same as NVR for example.
Recall, NVR uses solely options on lots and those don’t exist in every market. LGIH’s risk is acquiring lots at attractive prices and selling them in high demand areas – lot prices are going up, but so is entry level demand. I think LGIH will just pass that through.
There are other obvious risks to homebuilders. Interest rates, the economy, etc. etc. But I think this cycle is going to last awhile. Sure, we could have a buyers’ strike like the end of 2018 as rates were rising, but I think we actually need several years of housing starts >2MM (vs. new cycle high of 1.5MM right now) to sustain demand.
I watch the builder stocks from time to time. In some ways, they’re HODL’ers. They are so volatile. But a few are worth grabbing on to and just taking along for the ride.
So bottom line: LGIH stock may not be a straight path up, but I think it will compound earnings for a long period of time.
Today will be a quick idea on Civeo. The bottom line is that CVEO stock trades at ~25% FCF yield, is only ~2.5x levered, and there is a “forced” seller I think is driving down the stock.
Ok – “forced” seller is kinda click bait. The company completed an acquisition a few years ago, giving the seller some stock as consideration. That seller is now blasting out nearly every day, which I get into below.
Civeo provides hospitality services to commodity industries. So think about remote locations where companies are mining precious metals and pumping oil and gas, Civeo provides lodging, food service, and housekeeping for those companies.
Commodity prices generally have been completely bombed for several years now, particularly where the company participates. This includes oil, liquified natural gas, met coal (the coal used to make steel), and iron ore, though demand has still been OK (as I noted in this oil post). The nature of the business also means they typically are in highly commodity driven areas – Australia (given their met coal and other metals help serve the China / Asia demand), Canada (oil sands) and the US E&Ps.
As you can see, the stock has not performed too well in this environment.
The company currently operates around 28 lodges covering 30,000 rooms. They also own a fleet of modular assets that are typically used for short-term stays in the US and Canada.
ANYWAY – if you were to look at the company’s insider transactions, it would look UGLY. The Torgerson’s have sold 3% of CVEO stock (almost $7MM) in near-daily blocks since August 2020.
That is until you realize the Torgerson family were the sellers of a company Civeo bought, Noralta Lodge, for $165MM. Of the total purchase price, $69MM was issued in equity to the holders of Noralta.
This was a little over 3 years ago at this point, so no surprise following a COVID scare + some time since you’ve sold your business that’d you would just want to move on.
The Torgersons still own 11% of the company, so there is a long way to go, but I can’t call the end of this technical factor.
Nearly 25% FCF Yield
The seller is obviously not selling because the value of the CVEO stock looks too rich.
On the latest call, Civeo management guided to $55MM of FCF. This compares to a market cap of ~$230MM. Previously, the company used FCF to delever (after levering up for Noralta), but now that it is at 2.5x, there is a bit more flexibility. As I’ve talked about, I like these busted balance sheet names as they start to improve, but are still in the penalty box of equity holders.
When a stock trades at 25% FCF yield, the market is saying there is high bankruptcy risk. I don’t think that’s the case here. The term loan and revolver mature in 2023 and they generate plenty of FCF to keep lenders happy.
Fortunately, the COVID snapback has caused commodities to rip. If they stay elevated, who knows, but I think it will at least help the company extend contracts on existing lodging facilities and maybe sign some new ones (that will also help any concerns with credit facilities, but again – I’m not concerned there).
Back to the FCF yield guidance – there should be pretty good visibility. You have a set number of rooms available on site, you talk to your customers about need and what they are planning for the year, and you have a general gauge of commodities (are they up or down, is demand up or down) so you can try to win more business. This makes me believe FCF guide is a decent one to bank on.
Last thing I’ll say, the past 3 years the company actually generated $63MM of FCF on average. There was some working capital movements there, but it doesn’t seem unreasonable at all to me.
M&A Target (Seriously)
Using “M&A target” as an investment thesis is weak… yet here we are.
Typically its weak because its like, yeah sure… in SOME scenarios, this COULD get acquired (especially in a deal hungry private equity market), but any time I hear that, it doesn’t come to fruition.
In this case, Target Hospitality received a buyout offer from TDR Capital. Now, it was apparently a really cheap price of $1.50 and now Target Hospitality is trading at $3.40. Target Hospitality currently trades at 7.25x ’21 EBITDA vs. 6.0x for CVEO. HOWEVER, Target is also pretty levered still at 5x EBITDA vs. 2.5x for CVEO. Their cash flow has also been much less consistent.
I also think the capital markets are supportive and perhaps this company would be better suited as a private company, rather than a $230MM public company. Just saying.
News of a Pfizer vaccine has sent COVID-impacted names soaring. However, some areas still look very cheap, particularly in the movie theater space. National Cinemedia is a decent bet and could possibly be a multi-bagger. There’s obviously a ton of risk – this is almost a microcap stock right now – so do your own homework please!
Let’s start with what I am not doing: I’m not looking at stock charts and saying, “well in January, it was $x and now its at $y, so it has a lot of upside if it just goes back to $x”.
The problem with that is that a lot of names have issued a lot of debt and or equity. For example, American Airlines just announced it was going to issue $500MM of stock. They’ve also issued a ton of debt to pad liquidity. Based on Bloomberg, the current EV is around $39.5BN compared to $41.9BN at the end of 2019… yet the stock has been cut in half. The value is being transferred to debt holders.
In fact, following yesterday’s move, a lot of center-of-the-storm names don’t have nearly the upside I would want for the uncertainty. And this includes some movie theater chains that were too levered and entered this crisis in too fragile of a position (looking at you AMC… AMC’s 1L term loans and bonds are well below par, implying that the company will still need to restructure).
But National Cinemedia does have the upside. And I don’t think they’ll need to restructure at all.
Why National Cinemedia? Several Reasons:
Solid balance sheet means it can wait this pandemic out
“Asset Lite” business limits cash burn now, also means cash turns back on quickly as movies come back
Confident that movie theaters aren’t dead and that the notion that “PVOD” or prime video on demand taking share of traditional theaters is overblown
Movie slate was deferred in 2020, but makes 2021-2022 likely a blockbuster year
Solid Balance Sheet & Asset Lite: National Cinemedia is an advertising business. They typically run the ads that you see 30 minutes before a movie run by national accounts. They don’t actually own any theaters, so the business model is very asset lite. The downside is that if the theaters aren’t open, there aren’t going to be people paying for ads!
The other issue right now is that we are in a limbo with new movies. The studios have a huge production slate they want to release (see more later below), but they want there to be fans in the stands, if you will. In sum, the theaters can be open, but if there are no films, the theaters might as well be shut to National Cinemedia.
However, National Cinemedia has $217MM of cash on the balance sheet. At its current monthly cash burn rate of $11MM in October 2020, it can last ~1.5 more years in essentially hibernation mode. Management seems confident enough that they continue to pay a dividend of $0.28/share, or ~8.5% yield based on today’s price.
Confident in Theaters Coming Back: There seems to be this feeling that Netflix killed the theater. Wrong.
Look at box office sales over time:
You need to remember that because you may not go to the theaters, doesn’t mean others don’t. And the core group of movie theater attenders area die hard group. I hate to bring it up, but people still went back to the movies following the Aurora, Colorado movie theater mass shooting. If they still go back after that, I am confident they will go back now. There have been no COVID-19 outbreaks linked to movie theaters yet.
APAC is the leading indicator – already snapped back:
PVOD (Premium Video on Demand) is not a solution right now:
Here’s Disney on the matter:
“So we’ve got a pretty robust slate. And once again, we hope that the theaters are open. A lot of our films are films that the people who choose to go to movie theaters, the experience is very different than what they would have at home.So when you look at our box-office numbers over the last couple of years, we have — we drive a lot of people into theaters to see the Disney films. These tent-pole films become kind of part of zeitgeist of culture, whether it’s Marvel, whether it’s Black Panther that was a couple of years ago, but these are movies that people like to see in theaters and talk to their friends about. So once again, we hope the theaters stay healthy and can rebound from this COVID world we’re living in now.”
What about Mulan? That was released on PVOD? Well, it wasn’t Disney’s first choice and it largely was not a success. Disney had said in the past as well that it would not have been released this way if it weren’t for Theaters being closed:
“Well that — it has had some, but that was not the primary reason that we chose to release it this way. We chose to release it this way because the release date — as some people who were following just what was going on with theaters not opening and just shift, shift, shift, we had moved the release date several times. And we believe that, that movie — given that there’s so little new content out, that the movie was done and we wanted to get it out in the public domain. And so we chose to do it this way because we believed that it was the best way to get to the most people for them to enjoy it.”
Here is Bob Iger on whether Disney+ will be the new way to release movies. He says this because he knows that Movie Theaters still generate the bulk of a film’s profits:
“The theatrical window is working for this company. And we have no plans to adjust it for our business. Your comment about how those companies are faring on the market, I think, maybe is a reflection of how the other movie companies are positioning their films and their business. We’re not the only movie company. We had the biggest box office, but we’re not the only movie company. And I suspect that it’s not due to us or either a lack of conviction on our part or any suspicion that we might be — that we might not beat on the truth. But we’re not — it’s working for us. And we have no plans in the foreseeable future to change it and that”
Now there is news that MGM wants to sell its latest James Bond movie. Apple and Netflix reportedly offered a couple hundred million dollars and MGM wanted $600MM. The PVOD offer likely would’ve led to a big loss. It had a $300MM budget plus they had already spent tens of millions on marketing. And another problem – Daniel Craig and others own backend rights to the film based on how it does. This would’ve added to the cost of the film before MGM made any money.
I am not concerned about theaters living or dying. I think they will be around for many, many years to come.
My base case for NCMI is to generate ~$109MM of FCF before working capital changes, but if I am wrong, I still think there is a ton of upside on the stock. As shown below, my discounted EBITDA shows ~18-19% FCF yield plus they will have roughly half their market cap in cash by the time they reach these numbers (currently have about 85% of market cap in cash).
In short, I think NCMI can double from here, maybe more. There is a huge film slate just waiting to come out, so I think the vaccine news is actually game changing:
Obviously there are some risks. This company is tiny and while it may not have significant maturities until June 2023, its customers do. This can be complicated. You see, NCMI was founded as a JV between AMC, Regal, and Cinemark. They are the company’s largest customers, but also because it is a JV, they also own ~60% of the company.
AMC is the theater chain I am most concerned about filing for bankruptcy. AMC could reject its contract with NCMI in bankruptcy. However, this would be messy as it would create a giant unsecured claim and NCMI might end up with a huge chunk of AMC equity. I think AMC would avoid this situation and likely just re-instate the contract, but it is something I am monitoring. AMC doing an out of court restructuring would be the best outcome here.
Now with the S&P back up to near highs, many are calling out Buffett and saying he’s lost his touch. “Maybe he’s too old now” and “maybe he doesn’t care anymore now that he’s approaching 90 and loaded” or “maybe the oracle has lost his touch”.
I don’t really think that’s the case and think the negative sentiment creates an opportunity in Berkshire Hathaway stock. People who argue that Buffett is too old and “lost it” could have easily argued the same thing when he was 65 going on 70, 75 going to 80… Buffett has that itch that can’t be scratched.
I do think some of his methods are too old fashioned. I can’t actually confirm this is true, but he has said he won’t participate in auctions. What board would actually be able to justify selling to him without a second bid? Especially when times are good and they are a good business.
I’m taking Berkshire Hathaway’s current market cap and subtracting the market values of his equity holdings (note, I pulled this from Bloomberg, so it may not be 100% accurate). I then subtracted the cash to arrive at the value the market is ascribing to the “core Berkshire Hathaway” business.
I say core, but in reality there are so many subsidiaries within Berkshire Hathaway. You have GEICO, Berkshire Hathaway Energy, BNSF, Precision Castparts, just to name a few well known ones. If interested, I highly recommend perusing the list of subsidiaries on Wikipedia. I bet there are quite a few you didn’t realize he owned.
At the end of the day, you’re being asked to pay <8x earnings for the collection of businesses that Warren has acquired AND you have free upside from the cash if it is ever deployed.
Frankly, the real upside in the stock may be 5-10 years away when Berkshire Hathaway is broken up and people realize the sum of the parts is worth more than the whole.
Either way, look at the impact of Berkshire going out and deploying cash. Earnings could likely go up 30% from where they currently are and even deploying the cash at a worse multiple than where Berkshire trades today (i.e. dilutive), you’re still paying <9x earnings.