Nobility Homes (NOBH) – Illiquid, under-followed, cash generative home builder
Shares Out: 3.9mm
Market Cap: $73.3mm
Enterprise Value: $38.3mm
TTM Earnings: $5mm
TTM P/E: 14.6x
Avg. Volume: 118 (not thousand, just 118 shares)
I’ve been doing some work in the home building industry, particularly as it relates to manufactured home builders. During my research into SKY and CVCO, I came across a small microcap company manufacturing homes in Florida, with an interesting financial profile and solid operational history. The company is Nobility Homes (NOBH).
NOBH is a manufactured and modular home builder located in Ocala, FL. The company has been operating since the 1960s, and has shown plenty of resiliency (as have most MH homebuilders) having recovered very nicely following the great recession, and experiencing only a few years of modest operating losses without increasing the share count or taking on new debt. NOBH has less than 1% share of the MH market, estimated by the 591 homes they sold in 2018 against 90,000 industry wide shipments.
NOBH sells homes via retail to customers and wholesale to independent dealers. Their prices typically range from $30,000 – $130,000, considered to be within the low to medium price range of the industry. Both sales channels have the same gross margins (17-18%), but the retail channel commands an average sale price of nearly 2x higher than the wholesale channel. The retail sales are conducted through Nobility’s subsidiary, Prestige Home Centers Inc., which accounted for 76% of sales in 2018. Retail channel sales through Prestige are generally to purchasers living within 100 miles from the retail store, where internet based marketing leads drive traffic to the sales centers where a deal can be made in person. The wholesale channel operates through two salespeople with a customer base of both independent dealers and 35 manufactured home communities.
The model is interesting and unlike other manufactured home builders in that Nobility ‘builds to order’ homes as opposed to building models, storing/displaying them at their retail centers, and paying to store the associated inventory. Customers can visit the retail sales centers, look at sample homes (that the independent retailers pay NOBH wholesale to display at their stores) and are then required to put down a deposit ranging from $500 to 35% of the retail contract price.
NOBH doesn’t offer consigned inventory to dealers or other credit terms, and generally receives payments for the homes within 15-30 days of delivery. As a result of this and customer deposits, non-cash working capital is relatively low, and the ‘build to order’ model allows NOBH to keep a tight control on costs.
In addition, NOBH has been able to build up a resilient and growing business by aggressively pursuing the retirement and manufactured home community markets. They’ve been able to accomplish this near $50mm run rate revenue business without establishing major scale, making it that much more impressive. NOBH has one manufacturing facility in Ocala, Florida (Clayton has 40, SKY has 10, Cavco has 19), with the company estimating it can compete effectively in its markets within a range of 350 miles from the manufacturing facility. This is a small company with a small piece of the market, with a simple business model that does one thing, and focuses on doing that one thing well.
The manufactured home industry is fragmented, with the top three players – Clayton Homes, Skyline Champion (SKY) and Cavco (CVCO) controlling the bulk of shipments with market shares of 49%, 17% and 13%. Size and scale matter greatly in the industry for distribution, manufacturing and purchasing advantages.
Source: Skyline Champion Investor Presentation
While both manufactured and site-built home builders can be cyclical, the best companies in the industry are durable, with long operating histories (Clayton was founded in 1934, Champion Homes in the 1950s, Nobility in 1967). Clayton, Champion, Nobility and Cavco all experienced tough years during both the early 1990s and the financial crisis, but have since bounced back in a strong way. Growth was tough during those periods, and hasn’t quite recovered back to historical averages (it’s possible that many manufactured home builders traditional customers were purchasing site-built homes given the prevalence of loose lending standards leading up to 2009), but solid balance sheets, conservative lending and cost cutting allowed the businesses to emerge strong from a recession that was tied to residential real estate. Despite Clayton Homes (a Berkshire Hathaway subsidiary) holding the strong number one spot in terms of market share (50%), the industry is big enough for multiple companies, and NOBH’s sub-1% market share isn’t getting in the way of any of the bigger players.
The manufactured housing industry is somewhere around $5B in size, and increased access to credit, low interest rates and rising prices of site built homes have contributed to rising demand over the past five years. There are now 22 million Americans living in manufactured homes, and advances in product design and engineering have laid to rest the stigma of moving into a ‘trailer’ or ‘mobile home’.
As mentioned above, size advantages can become significant over time, as large manufactured home builders benefit from the economies of scale resulting from purchasing large quantities of materials, products and appliances. Home builders can then negotiate substantial savings on many components used in the building process, with these savings passed on to the buyer. This stands in sharp contrast to site built homes, where higher costs in the form of labor or materials are passed on to the buyer as well….in the form of higher prices. As a result of these dynamics, the average spread between a site built and manufactured home is now above $100k.
None of the businesses trade at premium multiples – cyclicality combined with industry gross margins in the 17-20% range and operating margins in the 6-9% range sees to that – but the best run manufactured home builders have steady sales growth, limited capital needs and high free cash flow conversion. NOBH actually has some of the highest margins in the industry (gross margins in the 21-25% range over the past five years, with 12-13% operating margins), with a strict focus on costs and conservative growth.
I don’t necessarily see NOBH being concerned with achieving additional scale/size (they have one manufacturing facility), but I’m interested in asking management about future uses for their large cash balance (I’m scheduled to speak with CEO and President Terry Trexler soon and will post any updates).
I make somewhat rosy projections in the valuation section, but if NOBH can increase their retail sales around 12% through 2021 (new home growth has been in the mid-teens over the past few years), with 5% average home price increases (growth has been in the 6-10% range the past few years), I see them being able to generate somewhere around $6mm in earnings by 2021, and around $5mm in free cash flow. With continued cash build, and the benefit of share buybacks, NOBH could be trading at less than 12x 2021 earnings, with nearly $43mm cash on the balance sheet.
Management and Compensation
Nobility is run by the father and son team of Terry and Tom Trexler. Terry founded the business and owns 53% of the shares in addition to Tom’s 10%. Gabelli’s small cap fund owns another 14% of the shares, with their proportion increasing over time. Hopefully they also see some uses for the cash and will nudge management in the right direction.
Both Terry and Tom make $300k in total comp. ($93k in salary, $200k bonus and the rest in stock) which isn’t peanuts, but in my view nothing to get upset about. The business carries no debt, has managed for conservative growth, rebounded very nicely from the great recession, and has issued virtually no stock in the last decade plus. In addition, there are only 5,000 options outstanding as of YE 2018.
I have some questions regarding capital allocation, increasing manufacturing capacity, and dividends/buybacks in addition to some other things. My biggest worry is that management just isn’t that concerned with doing much to expand/grow the business or allocate capital, and father and son are happy to sit back and collect their salary (although there has been no egregious value destruction from what I can see). Terry is 74, and when I emailed him asking to chat (management does not do conference calls or put out guidance) he said that he’s free on Fridays and “aside from eating lunch, I have nothing to do that day.” I thought that was funny.
I’m scheduled to speak with them soon, and will post any updates.
Joint Venture and Other Investments
Nobility formed a JV called Majestic 21 which is an investment with a 21st Mortgage Corporation. NOBH holds a 50% interest in Majestic 21. NOBH isn’t required to consolidate the investment due to lack of influence over economic decisions (and only a 50/50 partner allocated a profit/loss). Under the agreement, NOBH repurchases homes from 21st Mortgage including foreclosed/repossessed units for resale through the company’s retail centers as a remarketing agent. Nobility earns commissions from resales and small cost of carry when holding repurchased units in inventory. In FY 2018, NOBH reported $100k in undistributed earnings from the JV. Nothing material.
NOBH also has a 31.3% interest in a South Florida manufactured home retirement community called Walden Woods South. The majority owner of Walden Woods South is the company’s President. The investment is fully impaired. However, since the President is the majority owner, and has no obligation to fund future operating losses of Walden Woods South, the carrying value of the investment hasn’t been reduced to less than zero.
The President of the company also owns a 51% interest in the stock of a company called TLT Inc., which is the general partner of limited partnerships which are developing manufactured housing communities in Central Florida, and has purchased manufactured homes exclusively from NOBH since 1990.
There doesn’t appear to be any impropriety here, especially within regards to kick backs or excessively high compensation. The buyback issue is one I’m going to press with management, as I’ve seen too many small businesses hoard cash and put off investing or wise capital allocation moves to sit back and continue to collect a salary.
Here are some interesting back of the napkin numbers:
Inventory – $1.56/share
PP&E (manufacturing facility + land) – $1.41/share
Add up the above numbers, and you get $12.3/share in assets measured against an $18.8 share price. Of course we wouldn’t get full value for any of those things aside from the cash in a liquidation scenario, but there appears to be plenty of downside protection here especially as NOBH has no debt and is still growing the top line quite significantly. The operating business remains strong.
As mentioned above, I assume that NOBH will be able to grow their higher margin retail sales by 12% over the next few years, while wholesale sales decline, and will experience a 5% increase in the ASP of their homes. These projections are conservatively below recent trends in the growth of sales and price increases. Should they be able to achieve this, I see the company being able to sell around 700 homes by 2021.
If NOBH can reach somewhere near the above numbers, I estimate they can do just below $60mm in sales by 2021. With margins remaining flat during the period and below historical averages, NOBH may be able to generate around $6mm in earnings by 2021, putting them at a P/E of less than 12x. This is cheap for a quality, resilient, well-run business with a huge cash balance and levers to pull to generate additional value. Peers trade at mid-teens multiples. In addition, NOBH started paying a dividend again in 2017 for the first time since cutting it in 2010. It’s a 1% yield, but there is plenty of room for this to grow over time.
I don’t love to do this, especially with a homebuilder as NOBH needs cash for working capital purposes, but just for fun, on the below 2021 estimates we have an ex-cash P/E of 4.4x, and an EV/free cash flow multiple of 5.6x.
I’m assuming slight benefits from buybacks and an increased dividend, but nothing major.
There is additional value creation to be had. It would be nice to see a significant buyback program announced/take place, or a special dividend issued. In February, NOBH repurchased 100k shares from President Terry Trexler. Not exactly what I want to see in terms of buybacks, but its a start. The board has authorized a 200k share buyback program per year, indefinitely. If NOBH were to follow through with this, the value creation would be quite high. Repurchasing 600k shares over the next three years would represent around 15% of the business. In addition, given the business quality and customer base, NOBH would make for a nice tuck-in acquisition for a larger player looking to strengthen their Florida offerings. I’m not betting on that outcome though, and there is no indication of a deal on the table or that management would be willing to sell.
The recent stock price drop of around 13% based on seemingly no news has opened up an opportunity to purchase shares at what I believe to be a favorable price.
I own some NOBH.
Recession – generally causes downturns in new home purchases
Stock market downturn – would affect retirees/those that depend on fixed income or securities to pay monthly expenses
Cyclical business – where are we in the cycle?
Top of the cycle – I’m noticing the first decrease in MH shipments by state as of 2018
Family controlled ownership – may not always have shareholders interests in mind
Lack of guidance/transparency – why no conference calls or guidance?
Low IR efforts – would be nice to drum up interest in the stock
Thesis dependent on Florida population growth
Heavy concentration in one state – 100% of business takes place in Florida
Weather and natural disaster related events
Potential for mark to market losses during another downturn – while the business is certainly resilient and the margin of safety large given the cash, inventory and manufacturing facility, housing related stocks are not immune to large drops during tough economic times