NVR, Inc. (NVR) constructs and sells real estate properties. It deals with single-family detached homes, townhomes, and condominium buildings. It operates in two segments: Homebuilding and Mortgage Banking.
The Homebuilding segment sells and builds homes under the Ryan Homes, NVHomes, Fox Ridge Homes, and Heartland Homes trade names. The Mortgage Banking segment originates mortgages, mostly for its own homebuyers, although this segment is much smaller.
We are bullish on the stock due to its excellent track record and relatively low valuation.
NVR: An Excellent Track Record
NVR stock has performed very well in the past and has outperformed the SPDR S&P Homebuilders ETF (XHB) by a large margin in the past five and 10 years due to its strong fundamentals and growth. Its five-year returns (including dividends) are 113% compared to 75% for the Homebuilders ETF. Its 10-year returns are more impressive, coming in at over 460% vs. 211% for the ETF.
This great performance can be attributed to a few factors: consistent growth in revenue, earnings, and free cash flow, as well as high returns on capital, growing profit margins, and a strong balance sheet. Let’s discuss these factors below.
Consistent Revenue, Earnings, and Free Cash Flow Growth
Starting with revenue, it has grown consistently every year for at least the past 10 years. In 2012, revenue was $3.19 billion, and in the past 12 months, it recorded revenue of $9.3 billion. This is pretty impressive growth for a relatively boring company. When looking at diluted earnings per share, this figure has grown at a 25.3% CAGR in the past five years.
Similarly, from December 31, 2012, to December 31, 2021, free cash flow grew from $252 million to about $1.23 billion. Another thing that separates NVR from its peers is that its free cash flow was positive in each of the past 10 years.
Many of its peers have volatile cash flows, making the business much harder to predict. This is likely because the company does not actually develop land, generally.
Instead, NVR mostly acquires finished building lots from other developers in the form of fixed-price Lot Purchase Agreements, known as LPAs. The company generally puts down a deposit of up to 10% of the purchase price for these LPAs. This seems to be a more stable business model as far as cash flows are concerned.
High Returns on Capital
Regarding NVR’s cash return on invested capital (CROIC), which is measured as free cash flow divided by invested capital, its five-year average comes in at 27.7%. It has consistently been above 20% for the past five years.
Since its return on invested capital is higher than its weighted average cost of capital (its cost of doing business) of 7.5%, it is considered to be a value creator. This is known as the economic spread, and it is calculated as ROIC minus WACC.
Growing Profit Margins
Other things that investors love to see are growing or steady profit margins. NVR’s gross profit margin was relatively steady from 2017 to 2020, hovering around 20%. However, in the past 12 months, this figure has ticked up to 25.6%, and the most recent quarter experienced a gross margin of 28.5%.
Here’s what the company’s most recent earnings report, released earlier this week, said about its gross profit margin: “Gross profit margins were favorably impacted by the aforementioned increase in the average price of settlements in the first quarter of 2022, coupled with lower lumber prices quarter over quarter.”
It will be interesting to see if it can maintain these margins, as home prices could drop due to rising interest rates, and lumber prices are volatile. However, lumber prices have been relatively stable since the start of Q2.
Nonetheless, its profit margins, including net income and FCF margins, have been on multi-year uptrends. For example, NVR’s net income margin has grown from 5.7% in 2012 to over 15% for the trailing 12 months.
Strong Balance Sheet
NVR has a strong balance sheet, especially for a homebuilder stock. This is likely because, as mentioned above, the company generally does not develop any land. Because of this, it requires less capital to operate compared to other companies (which also explains the high returns on capital).
NVR has cash & equivalents of $2.14 billion and debt of $1.52 billion. Therefore, it has a net cash position of about $620 million. The company can use its cash and free cash flow to buy back shares, which it has been doing. Its TTM buyback yield is 9.4%.
Also, in the last 12 months, its earnings before interest and tax (EBIT) were about 37x greater than its interest payments. Overall, the company is financially sound.
Risks: Rising Interest Rates, Real Estate Slowdown
The most obvious risks for a homebuilding company like NVR are rising interest rates and a possible recession on the horizon. Rising interest rates dry up housing demand, as they increase the cost of borrowing.
Real estate company Redfin (RDFN) has already seen signs of a housing market cooldown. Redfin Chief Economist Daryl Fairweather stated, “Most homebuyers are still encountering bidding wars, but competition is beginning to cool because surging mortgage rates and home prices are prompting some Americans to back out or put their buying plans on hold.”
He continued, “We expect bidding wars to ease further in the coming months as rising mortgage rates price more buyers out of the market.” Some people may still be scarred from the Great Recession of 2007 to 2009 – when real estate prices plummeted. Although prices can fall, it is unlikely that we will see a Great-Recession-style type of decline in the housing market, as back then, banks were lending money much more recklessly.
Also, according to TipRanks’ Risk Analysis tool, NVR has disclosed 21 risks in its most recent filings. Most of the risks come from the Production category.
Regardless, we feel that the company’s risks have been priced in, to an extent, as NVR stock is ~25% off its highs and is trading at a relatively cheap valuation; we discuss this below. In addition, because of its strong balance sheet mentioned above, NVR should be able to weather a housing slowdown easily, as it has done in the past.
On a price-to-forward-earnings basis, NVR is trading at a much cheaper valuation than it has in the past five years. Its forward P/E ratio is 8.8x compared to its five-year average forward P/E ratio of 15.7x. Using the same metric, it’s even below its March 2020 low of 9.6x.
It is most likely trading at a discount because of the rising interest rate environment discussed above. However, we think this discount is a bit too much, and analysts seem to agree as well.
Wall Street’s Take
Turning to Wall Street, NVR stock comes in as a Moderate Buy based on two Buys and three Hold ratings assigned in the past three months. The average NVR price target of $5,800 implies 29.1% upside potential.
We generally don’t invest in homebuilders because they often have volatile cash flows. However, NVR has been an outlier in this sense. It also has a strong balance sheet and high returns on capital. Because of its strength, it has been a long-term outperformer in its industry.
At its current valuation, we are bullish on the stock for the long term despite potential headwinds.
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