Skyline Champion Corp. (SKY) – an interesting setup in manufactured housing
Skyline Champion Corp. (SKY) is a manufactured home builder.
The current public company was formed June 1st, 2018 as the result of the combination of Skyline Corporation and Champion Enterprises Holdings, LLC. In the company’s words, SKY employs over 6,800 people and is one of the largest homebuilders in North America. With over 65 years of homebuilding experience and 36 manufacturing facilities throughout the United States and western Canada, Skyline Champion is well positioned to build a wide variety of manufactured and modular homes, park-model RVs and modular buildings for the multi-family, hospitality, senior and workforce housing sectors.
In addition to its core home building business, Skyline Champion operates a factory-direct retail business, Titan Factory Direct, with 21 retail locations spanning the southern United States, and Star Fleet Trucking, providing transportation services to the manufactured housing and RV industries from 10 dispatch locations across the United States.
SKY is currently trading near it’s 52-week low, despite the combined business having a solid #2 position in the market, a long runway for growth, opportunities for margin expansion, a clean balance sheet, aligned management team, and potential generate a high free cash flow yield, with no risky consumer lending segment. The opportunity is available thanks to fears surrounding interest rates, the overall share price decimation of all publicly traded home builders, a short operating history for the combined companies, and the fact that the company won’t screen well – currently showing operating losses. SKY certainly isn’t alone in seeing it’s market value erode, as the stocks of most publicly traded site and manufactured home builders have been hit hard during the past year.
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). 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 a favorable regulatory environment should provide a nice tailwind for SKY to moving forward.
SKY operates in an industry with steady demand, among competitors such as Cavco (CVCO), the smaller Nobility Homes (NOBH) and The New Home Company (NWHM). Sun Communities (SUI) is a manufactured housing community REIT, and there are also manufactured home parts and material suppliers such as Patrick Industries (PATK). The 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 for the now 22 million Americans who live in manufactured homes. In addition, advances in product design and engineering have laid to rest the stigma of moving into a ‘trailer’ or ‘mobile home’.
SKY is now among the largest manufactured home builders in the US, with an estimated 14% market share (measured by new home shipments), and as mentioned above, second only to Berkshire Hathaway’s Clayton Homes. This is an industry where size advantages become significant over time, as manufactured homes 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. In addition, size and scale advantages provide the largest players with the options to make small acquisitions, achieve operating efficiencies and procure cost advantages in the areas of labor and materials. Of note, SKY currently trades at discount to peer median multiples, before taking into account margin improvements, growth runway, returns on invested capital and potential to capture additional market share.
Given the combined company’s short operating history and uncertainty surrounding pro forma projections, I believe that SKY possesses a large amount of underappreciated growth that the market has yet to value. I see SKY being able to earn somewhere in the neighborhood of $80-$100mm in free cash flow by 2020, against a total EV just north of $800mm. At a current price of around $15, the potential for SKY to achieve cost synergies and economies of scale, improve margins, and solidify it’s spot as the #2 player in manufactured housing has yet to be priced in.
In order for the thesis to play out, a few things need to take place:
1. Demand for manufactured housing needs to continue to grow
2. Affordable options for consumers have to be available, including financing
3. Macro tailwinds have to exist; the government has to be on board
4. SKY has to realize synergies/efficiencies from its merger with Champion
5. Investors have to be purchasing shares at a fair price
1. Demand for manufactured housing will continue to grow
80% of new homes sold in 2017 under $150k were manufactured homes
Labor costs and shortages of available sub-contractors for site-built homes have put pressure on the margins of some home builders
Manufactured homes are cheaper to build from a labor and materials standpoint, given controlled environments for building (no weather delays), bulk buying and shipping advantages and standardization of processes
Downturns in the manufactured home industry have typically been related to lack of financing and lack of secondary markets – this is about to change
There is currently an affordable, site-built housing shortage in the US as younger generations struggle to purchase new homes given low wages, high levels of debt and large cash outlays upfront
We are currently well below historical averages for shipments of manufactured homes, which bottomed in 2009. In 2017, 93,000 manufactured homes were shipped. The long term yearly average dating back to 1960 is around 225,000. This suggests plenty of room for a growth in new home shipments
Significant capital has been raised to expand and develop manufactured housing communities by Sun Communities and Equity Lifestyle Properties, two manufactured housing REITs – a sign of growing demand
2. Affordable options for consumers have to be available, including financing
Manufactured homes cost one third or less per square foot compared to site-built homes
The average spread of new site built homes versus manufactured homes is now above $100k.
From 2013-2017, shipments of manufactured homes have grown at a 12% CAGR, compared to just 8% for single family starts
New government loan programs will pump needed capital into the industry, helping to finance the initial purchase of manufactured homes
With 75% of the US earning $100k or less, and millennials serving as the fastest growing segment of the population, 41% of manufactured homes are now being purchased by the millennial population
The median net worth, income and assets needed to purchase a manufactured home is significantly less than typical site-built home buyers
3. The government has to be on board – macro tailwinds
Historically, limited financing options existed for manufactured homes – banks exited the market in the early 2000’s
The historical lending environment for manufactured housing has been characterized by restrictive lending with higher interest rates relative to site-built borrowers
Fannie and Freddie want to revitalize the manufactured home secondary market
Fannie Mae and Freddie Mac will be implementing a new test program to make the mobile home market more active, consisting of purchasing mobile home loans over the course of the next three years
In December 2016, HUD announced that it would review regulations surrounding the construction and financing of manufactured homes. As a result, the Federal Housing Finance Agency issued a ‘duty to serve under-served markets’ to Fannie and Freddie.
By purchasing manufactured home loans at scale, the GSE’s will generate a secondary market that has never before existed, that should have the side effects of generating more demand for the production of manufactured homes
Fannie has plans to purchase around 30,000 loans by 2020
New Chattel Loan program will see entities acquire another 5,000 loans
4. SKY has to realize synergies/efficiencies
The company is guiding for expected synergies in the range of $16-18mm within 18 months (not incredibly significant for a company with an enterprise value of $800mm, but still something)
SKY may realize bulk buying and shipping advantages with increased scale
They now possess economies of scale advantages
SKY has the balance sheet to do perform small acquisitions given the highly fragmented nature of the industry
There may be opportunities to expand product offerings and enter new geographies
There is the potential to optimize manufacturing output by streamlining overlapping functions, and converting plants to more efficient layout
Sky could optimize fixed costs by rerouting demand to plants with spare capacity for specific SKUs, as well as eliminate under-performing or lower margin products – improve the product line
5. Investors have to pay a fair price
Given the cyclicality, lower growth rates, credit risk and competitive nature of the industry, manufactured home builders have typically traded around 15-20x earnings and 10-12x EBITDA.
As mentioned above, SKY isn’t going to screen well, and currently shows a loss of $78mm or -$1.53/share for the six months ended 2018 due to bloated merger expenses pushed through the income statement in the form of increased SG&A. These expenses are non-recurring, and with increased sales moving forward, SKY should be able to demonstrate some operating leverage as well as continued free cash flow generation.
Annualizing the six months ended 2019 revenues of $723mm (assuming no growth) would put SKY at around $1.4B in revenues. Assuming 7% EBITDA margins, SKY should deliver somewhere in the range of $100mm in EBITDA for the FY 2019. At current prices, this equates to an EV/EBITDA of 8.3x, lower than peers and in my opinion failing to price in the company’s market share, growth profile, potential scale advantages and long runway for continued growth.
Taking a look at industry data in terms of total manufactured housing shipments moving forward, and factoring in SKY’s market share as well as small increases in ASP gets us to what looks like a fair projection for 2020-2021 in terms of where SKY will stand as a builder. I’m assuming conservative 6.4% growth in new MH shipments per year (industry CAGR of 12% ’13-’17).
Back of the napkin math shows that SKY will get cheaper over time following increased housing shipments, small increases in new home prices, and assuming very slight increases in operating margins. My math doesn’t give credit for operational efficiencies, higher growth rates or high increases in the prices of new manufactured homes. I also don’t take into account many balance sheet assumptions other than a few percentage points of annual dilution.
SKY growing their MH market share from 14% to 17% by 2021 (reaching 20K new home shipments by 2021 up from around 15K today)
15% growth in revenues moving forward (SKY did north of 48% revenue growth YoY through the latest quarter, 35%+ the previous quarter)
New MH shipments grow at a CAGR of 6.5% through 2021 (SKY has historically grown new home sales in the 20% range)
4-6% average sale price increases (SKY is seeing 15%+ price increases since the merger)
*Of note, fiscal year ended March 31, 2018 for Champion and fiscal year ended March 4, 2018 for Skyline. I included 2018 year pro forma as outlined by mgmt.
**EBIT is good proxy for free cash flow given the minimal capex needs. SKY is guiding for $11mm in total Capex for the YE 2018.
At 12.5x 2021 EBIT assumptions, SKY would trade at a share price of around $24.
It’s not difficult to see a positive return profile here, with SKY eventually generating gobs of free cash flow to repurchase shares, pay dividends or reinvest into increasing capacity. In addition, downside appears to be limited given the clean balance sheet, $100mm in liquidity, and aligned management team. CEO Keith Anderson has spent his career in various facets of manufactured housing, and owns nearly $20mm in stock (2.4%).
I own shares of SKY and NOBH.
Dilution- additional capital raises seem unlikely, there are some moving parts within the cap structure
Growth stalls – SKY should be able to grow new MH shipments as wells as increase prices faster than the industry
Economic downturn/recession – a hindrance on all homebuilding activity, especially if credit were to dry up and affordable financing were to disappear for a period of time
Synergies are never realized – management’s guide of $12-16mm in synergies isn’t significant given the size of the business, but SKY should be able to achieve material, labor and manufacturing efficiencies moving forward
Interest rate increases – I don’t believe these will be significant enough to deter demand, especially with Fannie and Freddie stepping in to help boost liquidity and availability of affordable financing
Regulation surrounding the development of communities or sites for manufactured housing – plenty of capital has entered this space as of late indicating now slowdown in demand, affordable housing communities should be last on the list of things to regulate