Tag: stocks

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.

Will Exxon Need to Cut its Dividend? $XOM

Saudi Arabia and Russia are in a price war — increasing the supply of crude oil at a time when we are seeing an unprecedented collapse in demand due to the coronavirus (COVID-19). Exxon has gotten crushed this year, down 45% YTD with a 9% dividend yield. They’ve consistently paid, and grown, the dividend over the past 37 years. Exxon’s dividend offers a juicy proposition for a company that is rated investment grade and at a time when the 10 yr treasury yield is <70bps.

But let’s do some quick math to see if the dividend is covered, first by looking at 2019 figures. As shown below, Exxon did $1.5BN in FCF.

This is not good. The Exxon dividend cost $14.6BN in 2019.

One thing we could do is look at what bare-bones capex is. In other words, what did the company spend in 2015/2016 when the oil outlook was also bleak? Cutting capex down to those levels would help preserve cash:

So now we have ~$10.5BN of FCF, but that still doesn’t cover the Exxon dividend. The other problem is that cutting capex is not what the company wants / intends to do. As stated in their March 5, 2020 investor day, they will actually be spending more than 2019:

On April 8, Exxon said it would cut this figure by 30%

Even so, cutting capex back doesn’t help. And the bigger problem is that oil was roughly 100%-200% higher in 2019 than it is right now.

What other ways could the Exxon dividend be maintained?

  • They could sell assets, but what price would they get in a time like this?
  • They could issue a bond to help cover it – but do you want an increase its debt load? Is jeopardizing the company for the dividend worth it?

I think its a matter of when, not if. Besides, I personally don’t think the oil industry is dead – there must be good long-term investment opportunities out there for them now that so many players are distressed.

Will Coronavirus Kill the Media Tech Giants?

We’re all locked inside. And that means we’re all watching Netflix, shopping Amazon, and perusing Facebook & Instagram and googling places we wish we could visit. That means all of these companies will benefit from the virus, right?  I’m not so sure that advertising revenue is going to hold up that well from Coronavirus. Are Facebook and Google’s revenue at risk from Coronavirus?

Facebook put out this somewhat misleading press release. In a gist, it says app usage is skyrocketing…

But….

“Much of the increased traffic is happening on our messaging services, but we’ve also seen more people using our feed and stories products to get updates from their family and friends. At the same time, our business is being adversely affected like so many others around the world. We don’t monetize many of the services where we’re seeing increased engagement, and we’ve seen a weakening in our ads business in countries taking aggressive actions to reduce the spread of COVID-19.


This tells me revenue is at risk. Both Facebook and Google sell ads… and those ads are sold to small-and-mid-sized businesses which have seen an unprecedented impact from Coronavirus. The tech giants have been growing superbly well as they take share in advertising, but weren’t really around in the past downturn. Therefore, the business model hasn’t really been tested through a real recession.

Advertising is cyclical. This makes some intuitive sense. When business is going well, you have extra funds left over that can be used for generating more sales. Or competition is higher because there is room for it and so you need to maintain market share. YOU may even be the new entrant trying to gain that share.

In a downturn, cuts have to be made. If I am a restaurant, I can’t really sacrifice much on food costs or labor or else my customers may have a bad experience.  If I also have a feeling that consumers don’t really want to spend money right now (e.g. unemployment is going up) then why not cut my advertising spend? It ripples through the chain.

As the saying goes, “Half the money I spend on advertising is wasted; the trouble is I don’t know which half.” This has historically resulted in cuts to spend since CEOs don’t feel like they are getting the bang for the buck.

Here is a snapshot of “old school” advertising companies’ peak-to-trough in the Great Financial Crisis (GFC).

Note, for the TV broadcasters I am using 2-yr average results given election years play a factor in results.

I also use gross profit given incremental margins matter so much in advertising. Quick Segway: If I have an existing network of 10 billboards in a town and 9 of them are on rent, you can see how getting that last billboard on rent would result in meaningful profit to the bottom line. My sales go up ~11%, but my costs barely go up. True in nearly all advertising and very true for Facebook and Google. Ok back to the main points.

What Can We Expect from the Tech Behemoths

I highly doubt many people are truly thinking about Facebook or Google’s earnings declining at all in 2020, but it’s something worth pondering.

Facebook on its Q4’19 earnings call stated there are now, “140 million small businesses that use our services to grow.” Google, in its filings, specifically discusses how its targeted ads let small businesses connect with customers.

If the virus ripples through our economy, taking down small restaurants and bars, local gyms, and people pull back on buying cars from their local auto dealer — that could clearly impact Facebook and Google’s ad revenue. With most restaurants closed right now, why would I advertise as much?

Unfortunately, it’s impossible to see where Facebook and Google make their money by segment. It’s much easier to know that Yelp generates most of its money from restaurants promoting themselves in a competitive field. Not true for the tech behemoths though.

We have some financial history with Google, given its IPO was in 2004. The problem is that it was secularly growing during the GFC. Google does $162BN of revenue today. It did $16.6BN in 2007 at the “market peak”. It kept growing through the GFC, though growth did slow to just 8.5% in 2009 over 2008.

Sell side estimates currently expect 16.7% growth in 2020 for Google… on much larger numbers. Facebook is expected to grow 20%. These may prove aggressive.

Impact from the Virus

I do not think it is out of the realm of possibility that we could see sales growth slow meaningfully for the tech giants. This will lead to a reset of expectations, though admittedly, the two ad tech giants trade for reasonable multiples (believe FB is 12x earnings ex-cash). My larger fear is the reset of investors’ view of the business as whole — they may no longer be bulletproof.

That said, if I am in charge of an ad budget, this may accelerate my shift away from traditional media and to Facebook and Google. People are at home, shopping online, then why not. Plus, its super-high ROI advertising spend. In other words, I don’t pay Google unless someone clicks on the ad, so I’m only paying if the ad works.

This dynamic may finally get rid of the adage I mentioned above – I now know if my ad is working. And because of this we could see more resiliency out of the new advertising names and it could be a bloodbath for traditional names. However, it still holds true that I’m not going to buy an ad, or at least as many, when I’m struggling to pay payroll or rent.

Separate Challenges for Google

Google has been expanding in the travel space, in fact encroaching on ground owned by Booking’s Kayak or Expedia. Booking said in its latest 10-K:

Some of our current and potential competitors, such as Google, Apple, Alibaba, Tencent, Amazon and Facebook, have significantly more customers or users, consumer data and financial and other resources than we do, and they may be able to leverage other aspects of their businesses (e.g., search or mobile device businesses) to enable them to compete more effectively with us. For example, Google has entered various aspects of the online travel market and has grown rapidly in this area, including by offering a flight meta-search product (“Google Flights”), a hotel meta-search product (“Google Hotel Ads”), a vacation rental meta-search product, its “Book on Google” reservation functionality, Google Travel, a planning tool that aggregates its flight, hotel and packages products in one website and by integrating its hotel meta-search product into its Google Maps app.

 This is a problem for Booking and Expedia because they use Google to generate leads for their own sites. While Google may eventually consume these businesses, they also represent non-trivial amounts of their revenue.

Booking stated,

 Our performance marketing expense is primarily related to the use of online search engines (primarily Google), meta-search and travel research services and affiliate marketing to generate traffic to our websites.

How much was “performance marketing” expense?  $4.4BN in 2019 for Booking and $3.5BN for Expedia.

I bring all of this up for a reason: While Google may eventually compete away these businesses — today they matter. And those businesses are likely being crushed by the lack of travel demand right now, which will mean less spending with Google. These are just two companies, but ~5% of revenue for Google. Now imagine every hotel chain, restaurant, airline and so on also pulling back… Now weave in the decremental margin we discussed earlier…


This virus is truly something we haven’t seen before. It permeates everything we touch. Long-term, I think Facebook and Google are amazing businesses to own, but don’t be surprised if 2020 is a hiccup and expectations are reset. It’s quite possible they suck up ad revenue that is lost from radio, TV, etc., but it also could be a very large hole to fill.

Is it Time to Buy Stocks? Here are Data Points Worth Considering. $SPY

The market is clearly in panic. Americans and other global citizens in quarantine will clearly not help most businesses (and therefore it doesn’t help stocks). Is it time to buy stocks now?

One piece of data I came across this weekend was Open Table’s data on restaurant reservations, found here.  As shown below, the US saw a ~42% decline in reservations Y/Y and globally they are down 40%.

Update: this data has only gotten more ugly

Not to mention, we have many public school closures, work travel has been postponed, cruises are putting up ships, and restaurants and bars are limited to take-out meals only. Heck, I can’t even go to the gym anymore. This will clearly crimp many businesses and could pressure liquidity.

This feels like SARS and 9/11 rolled into one. After 9/11, business confidence was hammered and many consumers were fearful and did not want to travel or go out to eat as much. United’s CEO said that this experience has been worse than 9/11 –

After 9/11, revenue was down 40% for two months and then began a gradual recovery… Our gross bookings in the Pacific are down about 70%, so there are still some bookings occurring even in the Pacific region. In Europe, our gross bookings are now down about 50%. Domestically, we’re currently seeing net bookings down about 70% and gross bookings down about 25%. While those numbers are encouraging compared to international, we’re planning for the public concern about the virus to get worse before it gets better.”

After 9/11, we had a tremendous shock to the system and it took some time to recover. Peak to trough, the S&P declined ~30% but within time, we recovered relatively quickly. Recall at this time, we entered a recession and also had a lot of air coming out of the tech bubble as well.

So on one hand, we have an extreme scenario. Short-term funding for a wide array of industries will need to be provided and I personally think we will need to see the US government step in meaningfully.

On the other hand, let’s look at the positives to see if it can help us answer if it is time to buy stocks:

  • Short-term pain, long-term gain. It appears the US is now taking the virus more seriously. While there will be short-term pain from a quasi-quarantine, this will help damped the rapid spread of the virus. This will also prevent a overrun of our hospitals and healthcare system
  • Authorities acting relatively quickly. The fed has now cut rates 2x and initiated bond buying (QE5). Although this won’t cure the virus, it could help calm financial markets which will then allow for liquidity to flow through to businesses who need it now. While not established yet, I bet we will see a cut to banks’ reserve requirements to also help the system
  • Not a financial crisis. While there are financial aspects to this (i.e. liquidity, companies drawing on revolvers) this is not like the 2008 mortgage crisis. Although banks are now cutting GDP estimates for Q2 and Q3 2020, many expect that demand will rebound meaningfully.
  • The US is behind the curve, and that is a good thing. Although the outbreak is hitting US shores later than Europe and China, it also means we can look at their data to when cases tend to peak and level out. The US now is essentially in quarantine and that will help fight the spread. (Note, I thoroughly enjoyed the charts posted in this WaPo article for how social distancing actually does work). I think the market will move up even if cases in the US are rising once we see Italy, South Korea and China under control.
  • The biggest companies in the world are flush with cash. Add up the cash held by Apple, Microsoft, Google, Berkshire Hathaway, and Facebook. These businesses fortunately will not be facing liquidity needs, represent large proportions of the S&P, and have longer time horizons than most investors today.

With many stocks I look at down 50-60%, this could be an opportunity of a lifetime given they are pricing in a long-term pronounced downturn. As discussed previously, a one-year impact to earnings that everyone largely expects will be temporary has little impact on the intrinsic value of businesses.

In sum, do I think stocks can continue to go down? Yes. They have historically over shot in both directions. But we can’t time it. I personally am looking at a collection of businesses that will continue to compound earnings at extremely attractive rates.

In this case, I think the situation will be written about extensively. There will be things we don’t even know about yet that books will be published on. 

But as you think about the past and uncertainty, realize that those times are actually the best in terms of investing. Buying when everything looks amazing and nothing can go wrong typically turn out to be poor outcomes (e.g. peak of tech bubble, the calm before the 2008 storm). Everyone knows in hindsight to buy when others are fearful. I’d also add the richest people in the US are typically perma-optimists, not perma-bears.

Is it time to buy stocks? Up to you, but you should have a plan for when you will. 

Should you buy Homebuilder stocks?

Given the market selloff, I’ve seen a lot of doom and gloom articles on buyers’ appetites for homebuilding. Will buyers still show up to buy a home with COVID-19 going around? What will the impact on interest rates have?? All of this makes me wonder if Homebuilder stocks have reached attractive levels…

I personally like to buy when people are fearful…

Check out these headlines:

All these headlines essentially result in one thing… Agh! Panic!

Panic

Since most people hold a majority of their net worth in a home, these headlines draw eyeballs.

But let’s think about this for a moment. Yes, the coronavirus may impact my willingness to go out to eat. To ride the subway. To cheer on my favorite team at a sports bar (looking at you March Madness).

But is it going to cause me to stop buying a house? Especially when credit is readily available and interest rates just hit all time lows for a mortgage?

I personally have trouble seeing it. And so far, we aren’t in quarantine and the data has been supportive:

  • Redfin noted in early March, “Demand is still growing at surprisingly healthy levels. And growth in the number of people submitting offers is much higher.”
  • Even at ground zero for coronavirus in the US, Seattle, they noted, “Now coronavirus fears have spread from Seattle to other parts of the country, but we haven’t seen a big impact on home-buying demand yet.”
  • Hovnian, a national builder, had a lot of positive things on its results call:
    • Talking about reported results:

“Some may say that the strong increase was against an easy comparison last year. I’m pleased to say we were also up 33% compared to the first quarter of 2018. Additionally, our sales pace was the highest level of contracts per community for any first quarter since 2005. It’s clear that the housing market is rebounding and demand for our homes continues to gain momentum.”

    • Regarding the virus impact specifically:  “Sales feel particularly and perhaps surprisingly steady and solid”

It makes sense. The 30 year mortgage rate has made it super compelling to buy a home. This will obviously help the homebuilder stocks.
30 Year Mortgage Rate Chart

30 Year Mortgage Rate data by YCharts

At the very least, those that own a home can refinance and keep some more cash in their pocket each month.

At the same time, we’ve been underbuilding in this country since the downturn. While we overbuilt in the last downturn, we’ve been growing as a country (creating new households) but new starts haven’t kept up. We were just now getting to mid-cycle levels before coronavirus caused a drop off.

I think this will lead to pent up demand when we come out of this which will support Homebuilder stocks

I personally am looking at the homebuilder equities. Toll brothers and Lennar are trading just above 1.1x BV. These are companies that have cleaned up their balance sheets and are generating ~13% ROEs. That seems cheap to me. Toll has also been buying back stock like its nobody’s business. This could even be a shot to buy NVR, a great blue-chip.

Could we see a pause? Sure. But I think the longer-term fundamentals are strong and that this virus won’t impact their intrinsic value.