Description

Description

I recommend buying shares of Cavco Industries Inc., a leading designer and builder of factory-built structures including manufactured homes, modular homes, commercial buildings, park model RVs and vacation cabins. Cavco has a pristine balance sheet and long history of profitability and has been a long-term compounder in a cyclical industry. Lordbeaverbrook wrote them up in 2003 with a mkt cap of $72 mil – a 20+ bagger.

Thesis

Cavco is a wide-moat company with a long runway at compelling values benefitting from the housing affordability crisis and deregulation trends.

·         Growth

o   Assured revenue - larger community REITs will buy every home they can produce plus 34 week order backlog

o   More than doubled revenue in past 5 years

o   2022 growth of 46.85%

o   2023 rev forecast of 17% - we believe this is too low

§  13 consecutive quarters of beating estimates

·         EV/EBIT: 8.14X with a 10 year median of 16.37X

·         Strong margin improvement

o   Streamlining production

o   Efficiency enhancement for recent acquisitions

o   Falling input prices like lumber

·         Excellent management

o   Commodore acquisition increases production capacity by 25% ($153 million purchase price for $258 million in TTM revenue) and immediately accretive

o   No debt

o   Stock buy-back for another $100 million

Wide Moat Industry is Rebounding

·         Regional Industry

o   Manufactured homes cannot be economically shipped beyond 350 miles

o   Most revenues sourced through local, independent distributors. Local relationships essential to driving sales

o   Barriers to entry generally force companies to expand to new markets via acquisition

·         Top three companies have 80% market share and growing (CVCO 17%)

o   Clayton, the largest at 49% share, has limitations on acquisitions due to FTC.

o   Scale is critical to cover regions as shipping costs require local presence

·         350,000 manufacture homes shipped annually during 1990s plummeted to 50,000 by GFC

·         Steady growth to over 100,000 shipped annually and accelerating since GFC

Manufactured housing costs 40% of a site-built home and benefits from the Housing Affordability Crisis

·         Exacerbating Factors (Current)

o   Case Shiller National Home Price is up 20% in TTM (April)

§  Mortgage rates have roughly doubled in past 6 month

o   US Nation Median Rent is up 16.7% in past year to $1,827 per Realtor.com (April)

·         Longer Term Issues

o   US National Home Price Index has risen 8% annually for the past decade ($301K for avg home)

o   Housing Starts have been below replacement rate for years

o   Demographics support rising demand

§  75% of 55+ y.o. are home-owners and this is the fastest growing population segment (expected to grow by 9 million by 2027)

§  Gen Y (25-40 y.o.) is the largest population group are in peak household formation age

Deregulation will accelerate growth by removing impediments

·         FNMA & Freddie Mac both looking to increase access to loans to help manufactured home market

·         Biden Administration expected to deregulate chassis rule and other obstacles designed to favor site builders

·         Alternative Dwelling Units (ADUs) rapidly becoming significant as zoning regulations are being reduced in states

Industry Overview

The industry was impacted by HUD rules designed to favor stick builders in the 70s. The late 90s saw easier lending standards accelerate buying only to set up for the 00s results to fall as bad lending and repos flooded the market which harmed new sales. Later, easier underwriting and low interest rates helped numerous home buyers shift to single family homes and away from manufactured homes as sub-prime mortgages favored site-built homes.

Today we have a housing shortage and dramatically higher mortgage rates which are blocking some buyers from achieving their dreams of home ownership. This effectively pushes home buyers into considering manufactured homes as a more affordable alternative especially with ever increasing rents. While there may be some cancelations at the low end due to rates more qualified buyers are added often purchasing higher margins selections for manufactured homes instead of site-built homes. We should see a rising percentage of manufactured home shipments for some time.

Housing shortages are making homeownership unaffordable across the U.S. : NPR

Freddie Mac and Fannie Mae are interested in supporting this market including purchasing more loans which could have a sizeable impact on the availability of financing.

California and other states have created legislation that helps Alternative Dwelling Unites (ADUs) and other lower costs housing strategies. ((AB) 345 – 9/28/2021)

https://www.hcd.ca.gov/policy-research/accessorydwellingunits.shtml

https://www.hcd.ca.gov/policy-research/docs/adu_december_2020_handbook.pdf

The Biden Administration is interested in helping.

https://www.bloomberg.com/news/articles/2022-05-20/mobile-homes-might-make-biden-s-housing-plan-work?sref=ACyoLiuv

Competition

The industry is an oligopoly dominated by the top 3 competitors.

Competitors

Clayton Homes ~50% market share (owned by Berkshire)

Skyline ~17%

Cavco ~17%

Sub 5% for everyone else – Roughly 30 manufacturers 

We believe that the rising price of the ASP shows pricing power that is growing along with the perception of quality. In addition, the pricing gap between manufactured homes and site-built homes provides an umbrella for the manufactured home builders.

There are significant barriers to entry. Opening a new manufacturing facility costs approximately $25 million. Perhaps more important is establishing relationships with local distributors and retail outlets. These sellers yield tremendous influence on customer acquisition and are essential for achieving local economies of scale. Finally, bottlenecks in staffing and supply chains will provide an opportunity for superior operators to gain local market share from inferior suppliers.

There are 140 home building factories and 4,000 Home Sales Centers and 43,000 Land-Lease Communities.

We are convinced that the market sell-off in the sector due to higher mortgage rates and general market conditions offers an opportunity to buy into an exceptional company in an exceptional industry at the right time. Furthermore, the natural barriers to entry and strong positioning convince us that the dominant players will continue to consolidate the industry. We believe the consolidation in the industry will continue.

The Company

Cavco completed their twelfth consecutive year in a row of revenue and earnings growth. In the past 5 years net revenue and earnings grew at an annualized rate of 16% and 31%, respectively. They have made strategic and opportunistic acquisitions, bought back $100 million in shares and just approved a new $100 million stock repurchase program  - all while maintaining essentially no debt.

CVCO’s model is similar to the auto dealer model with Cavco owned stores and independent dealer stores. Operations are decentralized with some guidance from HQ. They build manufactured homes, mobile homes and RVs, offer P&C insurance and lending as well 20 production lines in Northwest, Southwest, South/Southeast, Midwest, and Mid Atlantic and distribute through 45 company owned retail stores, 32 of which are located in Texas, and a network of independent dealers (one stop shopping). CVCO is indifferent to owning stores as margins (20% markup at non-owned) effectively are similar. Insurance renewal rates were 93% last year.

Acquisitions

CVCO has grown organically and with solid acquisitions. In 2015 they acquired Fairmont Homes and in 2017 they acquired Lexington Homes. More recently they completed their largest acquisition ever by purchasing Commodore for $153 million which is immediately accretive. Commodore have revenues over ¼ billion in the previous year and this acquisition increases their manufacturing capacity by 25%. On April 21, 2022 they announced another acquisition of 184,000 sq ft manufacturing facility in North Carolina. Total manufacturing sq footage is about 4,400,000 sq ft.

https://seekingalpha.com/news/3718912-cavco-industries-to-buy-the-commodore-corporation-for-153-million-in-cash

Margins vs history and competitors

Cavco has been consistently strong in ROIC and EBITDA margins and has been improving in measurable ways. Skyline Champion is performing well but has a much more erratic history. Additionally, they are more focused on FEMA units at present.

The typical home is completed in ~6 days. Effective shipping radius is 350 miles from a cost-effective perspective so having geographically spaced manufacturing facilities is critical to compete on a national scale. Numerous options are available but there has been some streamlining of models to speed up production. Factory utilization rates have been on the rise to 80%. According to CEO Bill Boor, factory utilization should continue climbing as they focus on throughput. Improving EBITDA margins and higher ROICs in the past 6 years tell the longer-term story of a company performing well.

Higher mortgage rates in many ways help margins as input costs such as lumber fall.

Softer Housing Sales Are Hammering Demand for Lumber | Barron's (barrons.com)

Low end buyers have been hurt most with inflation and ironically these are the lowest margin homes. The site-built home buyer that is priced out is more willing to pay for a higher end manufacture home and this should help with margins.

The acquisition of Commodore temporarily hurt margins by about 200 bps due to mark up of inventory. This will take a couple of quarters to work through, but management believes there continue to be ways to improve margins using best practices.

Management

Bill Boor became president in 2019 and has industry experience and has been on their board since 2008. He replaced long-time CEO Joseph Stegmayer. One odd thing to note is their previous CEO was involved in alleged insider trading issues which are in dispute. I believe this is a minor issue as the CEO has since retired but the litigation with the SEC continues.

https://seekingalpha.com/news/3737245-cavco-will-vigorously-defend-itself-against-sec-accounting-violation-complaint

We believe Boor has shown signs of being an excellent executive including previously mentioned smart acquisitions, manufacturing efficiency increases and multiple stock buybacks while maintaining a strong balance sheet.

Valuation

We think the limiting factor for CVCO has been adequate manufacturing capacity. They have aggressively addressed this shortfall and are poised to continue topline growth. The response below in part supports our view that growth will continue (Q4-2022 call 5/26/2022):

Analyst forecasts (3 analysts)

Last quarter Cavco had $505 million in revenue. Consensus forecast for the next quarter is for a 7.5% decline in revenue and only $1.9 billion in the next fiscal year. We believe that, despite a drop in demand due to mortgage rates, they will be able to exceed these forecasts due to mix shifts to lower cost housing, their existing backlog, demand from REITS, and better production efficiency. Additionally, as seen below, Wall Street (currently only 3 analysts maintain coverage) has a spotty track record at forecasting Cavco revenues.

CVCO trades at very low multiples.

·         On consensus estimates for FY 2023 CVCO trades at 10.5x earnings, 6.7x EBIT

·         On consensus estimates for FY 2024 CVCO trades at 9.6x earnings, 6.1x EBIT

Risks

 Margin compression

·         Deep recession

·         Poor integration of Commodore acquisition

·         Bad future acquisitions

Catalyst

·         Fannie Mae / Freddie Mac creating financing solutions for low income buyers

·         HUD de-regulations (chassis rule)

·         Continued high home prices / rents fueling demand

·         Biden Administration industry support

·         Commodore acquisition

·         Stock buybacks