When we think of industries that have always been hot & continue to be hot, we think of real estate. However, what we might overlook is that many companies purchase land & build homes, selling them to customers and generating very strong margins & free cash flow along the way.
DrHorton has been the largest homebuilder in the states for almost 20 years. And along with the growth in suburban lifestyle and the need for new homes, and increasing prices/shrinking available land, DrHorton has been able to offer a serious value proposition. Additionally, with rising home prices, homebuilding incentives have been going through the roof & the government just added new tax-sheltered incentives to buying a first home, something that is accretive to homebuilders.
We can also remark that current market trends seem to point to a supercycle within the homebuilding industry (which is at the center of construction & real estate). After many years of a slump, construction is poised for a boom - and the real estate industry is being seriously bolstered by interest rates near zero (something that seems unlikely to change until 2024).
This trend is unfortunately being undermined by serious supply chain constraints - something that recently led to DrHorton lowering home delivery & revenue numbers, though they still expect the same profitability. Luckily, this is likely to be a transitory effect, with supply chains hopefully cooling down within the next year. Additionally, this cost is mostly being passed onto the consumer, which is why earnings aren’t likely to be affected (something which is sustainable due to the interest rates). Finally, these supply chain costs lead to pent-up demand, since people that need homes will still want & need homes a year from now, so any restraints should mostly be realized over the coming years, leading to more sustainable growth.
This phenomenon is apparent across the homebuilding industry, and leads to a general undervaluation - with most stocks trading for around 7 f p/e with growth above 15% expected - something that is unheard of. Within the industry however, DrHorton seems to provide the best risk-return profile. For example, the company’s closest competitor is Lennar - a company with a f p/e over 7, and growth of 10% expected as opposed to DrHorton’s below 7 f p/e & 15% expected sales growth.
This undervaluation is best exemplified in the dcf valuations:
If we take 2022 average earnings projections (to allow for normalization of annual growth rate)
With a 10% expected growth rate for the next 3 years (which is very realistic considering that current expectation are 15%)
And a 2% perpetual growth rate (which is very acceptable considering that the real estate industry should grow at least that much, and as a leader in the industry, DrHorton should be able to realize that growth)
We then arrive at an expected share price of $101 for an annual 18% needed share appreciation rate. This is well above market & provides an adequate 15% margin of safety
In conclusion, the long-term trends of the industry along with the relative undervaluation of the company leads to a market-leading dcf valuation & a great risk-reward profile, that is sure to lead to share appreciation & capital preservation (especially considering that we haven’t even mentioned the almost 1% dividend yield that is being grown modestly every year).
By: Mateo Gjinali
Comments