Value Investors Club / CAVCO INDUSTRIES INC (CVCO)

Description

Company Summary

Cavco Industries, Inc. (NASDAQ: CVCO) is a producer of factory-built homes in the US. CVCO produces (1) manufactured homes (aka. mobile homes, usually one story without basement, fully built in factories, then shipped on trucks and sit on buyer land), (2) modular homes (mostly built in factories, but has basement, partially built on land); (3) park model RVs (<400 sqft mobile cabins, fully built in factory and shipped to land site) , (4) vacation cabins, and (5) factory-built commercial structures.

Additionally, the company owns 1) a financing arm (CountryPlace) providing loans to manufactured homes buyers; and 2) an insurance arm (Standard Casualty) providing property and casualty insurance primarily to owners of manufactured homes.

Manufactured homes are factory built instead of built on site. CVCO produces its manufactured homes in a factory style assembly-line process in which each module or floor section is completed in stages. CVCO operates 29 homebuilding production lines located in US and 2 in Mexico. The homes are sold via a network of independent distribution points in 48 US and Canada plus 64 company-owned retail stores, of which 50 are in Texas. Roughly 65% of homes are sold via company owned retail outlets; 28% to manufactured housing communities; and 7% to independent retailers.

CVCO's primary customers are entry-level and move-up buyers and person over 55. It also sells homes to manufactured housing communities, and subdivision developer and 2nd home or vacation home buyers.

The residential homes produced are generally single story and between 500 to 3,300 sqft, though larger homes and multi-levels are available for modular homes (with basement/embedded in foundation). Once a home is built at the CVCO's company facilities, it is transported via independent or CVCO owned trucking to retail centers, planned communities, work site or a home buyer's site. Shipping is usually cost effective within a 350 miles radius. Installation of homes on site are performed by distributors or independent installers.

Manufactured Housing Industry

According to Cavco presentation as of May 2023, the US manufactured housing industry comprise of 35 companies with 146 homebuilding factories. 97% of new homes sold under $200k were manufactured housing. Manufactured housing represents 6% of occupied housing. That's 22 million residents.

The manufactured housing was birthed post WW-II to address housing affordability. The initial iterations of manufactured homes were spurred by travel trailer, RV, and mobile homes. Because of sub-standard quality in the 50s and 60s, the need for regulation of mobile homes came into being and the 1976 HUD code for the manufactured houses was established, still used today. The quality of manufactured homes are now of a reliable quality, in some cases arguably better than stick built homes. this is a highly competitive business, cost of shipping home itself is also meaningful. the location between where the house is shipped and where the factory builds the house is important. top dog is Clayton. Clayton is integrated and has financing abilities. very powerful

Modular homes and manufactured homes have slight variations. both are factory built, manufactured home is built on a frame. Modular homes is perimeter supported and cannot be transported by wheels. If you want a basement, get a modular home, for these are build a foundation. Modular homes are built to local building codes while manufactured homes are build to HUD code. Manufactured home makers can also build park models, under 400 sqft. also built on a frame.Modular homes looks just like site build homes but very few communities have modular homes because title to that home merges into real estate and becomes the deed, complicating the manufactred home community model. no cost advantage except in bad weather environments and get the roof in place. the more upscale the modular homes, less pricing advantage is preserved. generally savings is 20-30% from site build homes. Modular homes are generally one-offs, small portion of the manufactured housing segment. modular homes are built generally where site build home crew cannot realistic show up... nice lakefront properties

The key actors in the manufactured homes industry are

Dealers - they buy homes at wholesale and sell to customers that walk into their stores. Dealers are powerful because they control the financing. Dealer decides the financing, steer people to Clayton, skyline, to Fleetwood homes. Having a dealer pushing your product is very important for the manufacturer. Dealer also pick the site, help the buyer pick the site where the homes will be sited. Dealer engage the contractors to do the site work. Dealer used to be indispensable link within the indutry, placing homes into manufactured housing communities. Also were paid a finder's fee by that community owner. When financial crisis happened 09, the abliity to get marginal owner financed was severely restricted; owner provided financing to marginal owners with bad credit to reduce home vacancies; dealer lost significant portion of business. Dealers used to be more prevalent, still relevant now though not as much; dealer can get larger gross profit based on the financial position of the buyer. better financial position, better profit margin

Retail lender and the retail lending community... very little institutional consumer financing for manufactured housing because data on the industry is hard to get. Lowest default rate was manufactured housing community. counter-cyclical and resilient biggest lender in the industry is 21st mortage (berkshire) and Vanderbilt homes. Heavily populated with Fannie and Freddie lending as well

Consumer. Two big segments are newly wed or retirees.

Manufactured housing Communities. charge site rent. Manufactured housing communities used to be situated in non-ideal places, but placements have improved over time, becoming better investment. difficult to build new manufactured housing communities for political and geographic reasons. Existing populations of communities are oftentimes trophy-type assets. Newer manufactured homes in communities can be rented. there is a market for these. This leaves smaller community owner at disadvantage because there isn't capital sources willing to provide the financing for community owner to purchase highly levered houses. Community purchase the homes from owners at favorable price or deal with the lenders to purchase homes at a good price from default owners. Community owners used to sell the manufactuered home and off load that liability. Now on a renting model, still responsible for the houses and maintenances. Larger national owners are ELS, Sun, Yes!, Hometown.

Manufactured homebuilders - There are about 25 manufactured homes builders. The big three are Berkshire/Clayton Homes, Skyline Champion, and number 3 Cavco. Clayton lending has two advantage

Investment Thesis

Growing demand on the backdrop of key consumer demographical growth. Historically, given the affordability of manufactured homes, the two largest consumer demography purchasing manufactured homes are young adults (often moving into their first homes) and retirees / older than 55 on limited income. The two groups are euphemistically referred to in the industry as the "newly wed and the nearly dead". Both demographics are growing in the US. Gen Z and Millennials have some of the lowest home ownership rates compared to previous generations at this age and this segment is expected to become first time home owners over the next decade. Many of them may consider manufactured homes to address this generation's struggle with housing affordability. Concurrently, it's well known that baby boomer generation is well on their way to retirement. The retirees group is the fastest growing segment in the US. Many in this group - on limited income - may downsize to manufactured homes. Thus, the preconditions to robust manufactured housing demand is building as the industry's two key consumer demographics are primed to grow steadily over the coming decade.

Evidently, manufactured housing already making a comeback. In addition to the demographics factor, what also drives manufacturing homes sales is financing costs relative to that of regular stick-built homes. The history of manufactured housing indicate that an important variable to demand of manufactured housing is cost relative to regular/higher prized housing. Over the past decade, manufactured housing sales have steadily climbed - along with growth in average selling price - while holding constant as ~15% of new one family home sold. This growth in manufactured housing sales came in a 0% fed rate environment in which financing of regular / more expensive homes had become relatively more affordable. As the US enters a new environment of no longer 0% fed interest rates, financing has become more expensive. Hence, payment of regularly homes have become more expensive relative to manufactured homes. In a rising rates environment, manufactured housing demand should climb relative to regular homes demand. In my findings, this relationship is empirically substantiated as the relative sales of manufactured homes sales tend to increase in tandem with fed hikes. So in addition to the demographical context, the financing context is also constructive for more demand for manufactured housing sales.

Cavco is one of the 3 oligopolies in the space, thus in prime position to capture demand growth. Berkshire Hathaway's Clayton Homes occupies ~50% market share. Followed by Skyline Champion (SKY) (not as profitable) at 21%. Cavco is #3 at ~17%, with much better profit margin than does Skyline Champion. CVCO has demonstrated by company's outperformance over the two decade, reflected on financial metrics and stock performance. This should be sustainable going forward because the company bear moat in quality of product, large distribution systems, and brand recognition. I see nothing thus far on the horizon indicating that its competitiveness in the industry is eroding.

Current valuation at decade low creates an attractive opportunity for entry. Cavco historically trades at a premium to peers, but valuation has dipped to decade low since 2020.

Though this is predominantly a function of skyrocketing EBITDA due to higher sales since 2020, consensus forward EBITDA continue to be strong - and should be - because of demand growth. Yet CVCO stock price has not appreciated to commensurate better fundamental outlook because consensus have nonetheless been revised lower over the past 3 quarters earnings. For instance, fiscal 2024 revenue consensus has been revised lower by 16% from 3 quarters ago as CVCO reported declining backlogs. Yet, Aug 2023, CVCO noted that the decline appeared to be decelerating per both SKY and CVCO's earnings call in August 2023.

At best, if these observations hold, manufacturing housing demand is reaching a inflection point that should soon translate into better guidance from management, ergo upward consensus revisions that would be positive for the stock. At worse, even if manufacturing housing demand this year continues to drop, by another 10-20% drop on consensus revenue, current implied valuation would still be <11x EV/EBITDA, still 4x below than the 15x EV/EBITDA where CVCO had historically traded at --- and that was in a 0% fed rate environment in which manufactured homes were relatively less attractive to regular homes because financing was cheap.

Even assuming worsening conditions, CVCO is still cheap at the moment.

What could go wrong

Recession would of course ruin things. If there is a recession next year, demand for all manufactured housing and backlogs at companies could decline quite precipitously still. The sentiment could further plummet CVCO. The ameliorating factor is that manufactured housing has historically the lowest default rates in lending. People are highly motivated to keep their mobile homes and manufactured housing is actually counter-cyclical. In any event, if recession looms next year, I would digest new datapoints and reassess on the thesis. manufactured homes have boom and bust cycles because cycle time is low and backlog can clear very quickly and you don't have visibility with backlog clearing quickly. Over the past few years with all the pandemic demand, their return on capital weren't great.

Further decline in manufactured housing demand over the short term. Historically, a rise in raise is immediately followed or generally occurs nearly in unison with a temporary decline in demand for manufactured housing. If rates unexpectedly go up higher, manufactured homes demand may temporarily decline further. Keep in mind that the buyers of manufactured homes have less income and are more sensitive to rate increase in the short term, so I believe a change in rates translates the most quickly in the behaviors of manufactured home buyers, who would be much more prone to put off purchasing a home... but over longer term, rates and the manufactured homes demand relative to regular homes are from what I observe negatively correlated.

Longer term growth prospect may be constrained by of lack of manufactured housing land. Manufactured housing is only permitted in certain communities, on land that are specifically approved for manufactured housing. These zoning requirements along with lingering stigma of manufactured housing continues to throttle addition of new approved land (manufactured housing communities) that over time has to keep pace with any potential increase in demand for manufactured housing. However, advocacy for manufactured homes and even government support has been growing, so I'm rather optimistic that manufactured housing communities supply wouldn't dry up anytime soon. Though again, in terms of risks, this one is worth monitoring.

Valuation

I see base case return of 30% to $345/sh based on a 11x EV/EBITDA; Downside is similar, though less likely as CVCO backlog appears to be nearer to the trough than nearer to 2022 peak from the drop.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst

Turn around in backlog and demand for manufactured housing.

Improvement in economic conditions.

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			2023	2024
Price:	265.66	EPS	26.95	20.66
Shares Out. (in M):	9	P/E	9.9	12.9
Market Cap (in $M):	2,305	P/FCF	0	0
Net Debt (in $M):	-357	EBIT	0	0
TEV (in $M):	1,950	TEV/EBIT	0	0