Investors who picked up shares of NVR Inc. (NYSE:NVR) after the 2008 financial crisis and held them until early 2020 would have been pleased: Between March of 2009, when the last big market recovery started, and February 2020, the stock rose from about $320 to $4,037. That's a 12.6-fold increase in 11 years.
But that's only part of the story.
NVR builds and sells single-family detached homes, townhomes and condominium buildings, and almost all of them are built on a pre-sold basis. In addition, it operates a mortgage banking and title services business.
Based in Reston, Virginia, it operates in 14 states, mostly on the east coast, and its busiest operations are in the Washington D.C. and Baltimore, Maryland metropolitan areas. It operates under three brand names:
- Ryan Homes: Targets first-time and first-time move-up buyers.
- NVHomes: Marketed to move-up and luxury buyers in Delaware, Washington D.C., Baltimore and Philadelphia.
- Heartland Homes operates in the Pittsburgh region.
An important key in its business model is that it usually buys finished building lots, rather than developing the land itself. In its 10-K for 2019, the company argued: "We believe that our lot acquisition strategy avoids the financial requirements and risks associated with direct land ownership and land development."
Writing in Forbes, risk analyst Stephen McBride agreed:
"NVR never buys raw land. It only buys developed land."
"This is unique among homebuilders. It means NVR avoids the riskiest part of the business."
"It's why NVR was the only homebuilder to turn a profit every year from 2006 to 2011."
In addition, NVR focuses on developing a leading market position in each market it serves, pointing out in its 10-K: "This strategy allows us to gain valuable efficiencies and competitive advantages in our markets, which we believe contributes to minimizing the adverse effects of regional economic cycles and provides growth opportunities within these markets."
To summarize the NVR business model:
- Builds and sells three types of residential housing.
- Most of its homes are pre-sold.
- Targets a range of buyers, from first-time to luxury.
- Reduces risk by purchasing finished lots, rather than developing its own.
- Tries to become the market leader in each market it serves.
In 2019, its revenue from homebuilding was $7.22 billion while revenue from the mortgage arm totaled $167.82 million.
NVR is one of 20 companies currently on the Buffett-Munger Screener list, companies that are quantitatively judged to be of high-quality and reasonably priced.
To successfully get through the Buffett-Munger screener, a company must meet four criteria:
- A high predictability rank.
- A competitive advantage or a moat.
- Little or no debt.
- Fair or undervaluation, based on the PEPG indicator (the price-earnings ratio divided by the average growth rate of Ebitda over the past five years - also known as PEG).
We'll examine those criteria to further analyze NVR's attractiveness to value investors.
This refers to a company's ability to consistently grow its revenue and earnings, and is based on the stock's history. This 10-year chart of revenue and diluted earnings per share shows that NVR has easily met this criterion:
It's not surprising, then, that NVR receives a full five out five-star rating for predictability.
When GuruFocus contributor Margaret Moran wrote about homebuilders in an April article, reader BEL-AIR objected to the idea that a moat was possible in the industry, saying, "I have owned a real estate development company for 25 years, and I am afraid your analogy that home building stocks being 'well moated' is totally off the mark." His objection was based on his belief that housing was a commodity business and most homebuyers will simply go the builder with the cheapest products.
I would recommend that you read Moran's response. But I will take up the challenge from BEL-AIR as well, with three points:
- First, anecdotally; I live in a city that has experienced rapid growth for several decades now and witnessed homebuilders spending millions of dollars per year promoting their brands (and, I used to lead a non-profit organization that solicited their advertising). It's also a prosperous city, so there is strong demand for higher-end housing as well as lower-priced housing.
- Second, the Macpherson model gives us a tool for quantitatively assessing a competitive advantage, based on return on capital and return on tangible equity; both measures confirm NVR has a moat.
- Warren Buffett (Trades, Portfolio) assesses a company's competitiveness by examining its return on equity. Since fiscal 2013, NVR's ROE has been above 20%, and in 2019 it was 42.34%, again confirming the existence of a moat.
Companies with little or no debt have two important advantages: First, they are in no danger of going bankrupt and destroying shareholder value. Second, they do not need to use cash flow to service their debt, making more funds available for expansion or distribution to shareholders.
Looking at NVR's financial strength rating, 8 out of 10, and the metrics in the table, we can be confident the company does not have a debt problem:
Starting with the cash-to-debt ratio, we see it is more than 1.0, meaning it could pay off its debt with cash, cash equivalents and marketable securities if required.
Interest coverage is more than 40 to one. For the first quarter of 2020, it had $160 million in operating income (Ebit, or earnings before interest and taxes) versus $6 million in interest expenses.
That's backed up by the WACC vs. ROIC ratio, where return on invested capital is 43.3% versus its weighted average cost of capital at 7.28%.
For this criterion, the stock must by fairly or undervalued, as measured by the PEPG or PEG ratio. These ratios, developed by mutual fund legend Peter Lynch, refer to the price-earnings ratio divided by the five-year Ebitda growth rate.
GuruFocus shows a PEG ratio of 0.82, which qualifies NVR as undervalued. A stock with a PEG ratio of less than 1.0 is considered undervalued, while stocks with a ratio of greater than 1.0 are considered overvalued.
That is backed up by the discounted cash flow calculator, which shows the stock trading with a significant margin of safety:
Overall, I believe that NVR easily meets all four criteria specified by the Buffett-Munger screener.
Thanks to its business model, which appears to be unique in the homebuilding industry, it also has derisked itself in several important ways. By building only pre-sold units, it avoids the financial risk and uncertainty involved in building spec homes. By sticking with finished lots, it avoids the risk and uncertainty inherent in land development. And by focusing its efforts in specific markets, it avoids the risk and uncertainty of being a minor player in many markets.
NVR deserves the attention of value investors. It is financially strong with little debt, offers above-average profitability, is currently undervalued and has eliminated much of the risk and uncertainty involved in the homebuilding industry.
In the short term, there will undoubtedly be share price fluctuations, but as economic conditions stabilize, it should provide medium- and long-term results that satisfy.
Disclosure: I do not own shares in any companies named in this article and do not expect to buy any in the next 72 hours.
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This article first appeared on GuruFocus.