Buying Low and Selling High Works for Both Investors and Companies
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Everyone knows that the winning formula for success in both equity and property markets is to buy low and sell high. But this is often easier said than done. Timing is of the essence here. Anyone who bought a basket of diversified stocks in mid-2009, would have most probably more than doubled his money, notwithstanding his stock picking skills.
The same applies for homebuilders established after the Global Financial Crisis. Founded right after the Global Financial Crisis in April 2009 and listed in January 2013, Tri Pointe Homes (NYSE: TPH) is a regional merchant homebuilder focused on single-family homes in Southern and Northern California and Colorado.
Good timing is key to success
Tri Pointe has timed itself well to capitalize on the housing market recovery in two aspects.
The first aspect relates to the timing of Tri Pointe’s incorporation in April 2009 and commencement of merchant homebuilding operations in November 2010, after the global financial crisis and the domestic housing downturn. As a result, it does not carry any burden from legacy assets or liabilities, unlike its publicly listed peers. Instead, Tri Pointe is well-positioned in growth markets such as California and Colorado.
The second aspect pertains to Tri Pointe’s timing in land acquisitions. It acquired 353 lots and 511 lots in 2011 and 2012, respectively, at or near the bottom of the housing cycle. According to median price data for homes from the California Association of Realtors, the California housing market reached a trough in 2011 before rebounding strongly in the second half of 2012.
These well-timed low cost lot acquisitions form the bulk of Tri Pointe’s 1,028 owned lots as of the end of the first quarter of fiscal 2013, and will be a key driver of Tri Pointe’s margins going forward. The results speak from themselves, as Tri Pointe increased its homebuilding gross margin to 18.5% in the first quarter of 2012 from 11.2% a year ago.
Betting on the jockey
The jockey and horse analogy is often used to illustrate the importance of management relative to company quality and vice-versa. The simple rule of thumb is that management matters more for businesses in competitive and cyclical industries. This is the case for Tri Pointe in the home building business.
Tri Pointe’s top three guys at the helm, CEO Douglas Bauer, COO Thomas Mitchell and CFO Michael Grubbs, were all former colleagues at William Lyon Homes. Douglas and Mitchell led William Lyon’s California operations, and bring with them a combined real estate related experience of close to half a century.
Given that property markets are essentially all about relationships and deal making, the top executives at Tri Pointe have an edge over competitors in terms of accessing development and investment opportunities. This is evidenced by Tri Pointe’s success in land acquisitions, almost doubling owned lots from 552 lots to 1,028 lots in a span of nine months from October 2012 to March 2013.
Net cash financial position to offset cyclicality effects
A combination of financial leverage and cyclicality is a recipe for disaster. Many companies in cyclical industries go out of business, but not because they incur losses in a downturn. Instead, they become bankrupt as a result of their failure to pay creditors.
In Tri Pointe’s case, it has a low gross debt-to-equity ratio of 20% and is in a net cash financial position. Tri Pointe’s policy of a debt-to-capitalization ratio of less than 50% for financing land acquisitions and home construction is a key contributor to its strong balance sheet.
In the first quarter, Tri Pointe achieved a record backlog of 143 homes valued at $77.0 million with new home orders per average selling community at 16.8 orders, representing a 57% quarter-on-quarter increase. Management guided that Tri Pointe will deliver approximately 55%-60% of its 143 units in backlog in the second quarter, with full year 2013 revenue expected to grow 271% year-on-year from 2012.
Toll Brothers is the market leader in the domestic luxury home building market. In the second quarter of fiscal 2013, it grew revenue and net income by 38% and 46% year-on-year, and its current backlog stands at 3,655 units valued at $2.5 billion.
In recent years, Tri Pointe has diversified its operations through initiatives such as increasing the diversity of its customer types such as move-up, empty-nester and active-adult buyers, investment in apartment and campus living programs, and the establishment of Gibraltar Capital, a distressed real estate investment firm. While it is generally positive to use diversification as a means of risk reduction, it also suggests that Toll Brothers will not be able to capitalize fully on the housing market recovery.
PulteGroup is one of the largest domestic home builders, with a presence in 55 markets targeting entry level buyers, move-up buyers and active adults with its different brands. It registered net income of $82 million in the first quarter of fiscal 2013, compared with a net loss of $12 million a year ago, as a result of stronger housing demand. It has a current backlog of 7,825 homes valued at $2.4 billion, and increased its authorized investment in land and development to $1.4 billion per year for 2013 and 2014.
Nevertheless, PulteGroup is the most leveraged of the three with a gearing of 114%, making it vulnerable to the cyclicality of the housing market. In addition, it is also priced at a premium to Tri Pointe with a price-to-book ratio of 3.3.
I like Tri Pointe for its well-timed land acquisitions, experienced management team and strong balance sheet. Tri Pointe’s share price is down 20% from its March 2013 high of $20, and it is now attractively valued at 1.66 times its book value, taking into account its strong growth prospects.
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