about: BZH (Beazer Homes USA, Inc.) Editor's notes: Strong growth potential at BZH should lead to multiple expansion and improving earnings. With the help of deferred tax assets, shares could see 90% upside by the end of FY14. Alpha-Rich ideas are our best money-making long and short investment ideas. They are released exclusively to Seeking Alpha Pro users 24 hours before publication. Learn more about Seeking Alpha Pro. Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More...)
Beazer Homes USA (BZH), the once $3.5 billion market cap homebuilder, is not afraid to show its hand. While the memory of overbuilding real estate remains etched in the minds of many CEOs, the significantly smaller Beazer Homes (current market cap now just over $400 million) has decided to go all in. With the housing recovery in this country still estimated to be in the early innings, the move appears well timed and could provide significant upside potential for equity holders. Beazer CEO Allan Merrill is enthusiastic about the company poised to report full-year profitability for the first time in nearly a decade during FY14.
The stock price has significantly lagged the rest of the industry over the past decade (see chart below) and many analysts and Wall Street research firms have discontinued coverage due to the asset class change from small-cap to micro-cap. But like any poker player will tell you, the longer you keep playing the game, the greater your odds of winning become. Beazer has made it through the roughest housing downturn in the company's history and been severely beaten down, but not knocked out. The housing game is still being played and with a growing backlog, massive inventory purchase program and significant deferred tax asset, Beazer Homes is extremely well positioned to impress shareholders over the next few years.
BZH data by YCharts
Brief Overview
Atlanta, Georgia based Beazer Homes has been building homes across the United States for over 35 years. Operating in 16 states across three geographic regions, the company caters towards entry level, move-up (both first and second time), and retirement oriented consumers. With a marketing pitch towards energy efficient homes, the company differentiates itself from many competitors.
Unlike many publicly traded homebuilders, Beazer does not have a captive mortgage agency. The company works with a small number of preferred lenders to offer multiple competitive rates to would be home buyers. This process actually causes the lenders to compete against one another for the business, ultimately benefiting the borrower.
Similar to many builders in the industry, Beazer overbuilt during the housing boom and has taken significant inventory writedowns in the past few years. The company has since re-emerged and is much more financially sound. Investors looking at the company today have upside potential via the rising tide of a housing market coupled with significant net operating losses from prior years to offset most taxable income moving forward. Beazer Homes is positioning itself to take advantage of this housing recovery and making bold moves to accomplish this.
Leverage
With almost every publicly traded homebuilder borrowing in this extremely low interest rate environment, leverage in this industry is a common practice. While the offering size and type of debt vary by the issuing company's credit quality, we rarely see debt-to-capital (debt-to-total assets) cross above 50%. Beazer Homes is clearly a believer in this housing market and currently pushing the limits at 77%. However, in spite of tipping the liability side of the balance sheet, in January 2013, Moody's increased the company's long-term debt rating to Caa1, S&P reaffirmed B- in December 2012, and Fitch upgraded the debt one notch to B- in September 2012. The strengthening housing market is giving Beazer some help, exactly what you are looking for when taking on such high levels of debt. Given the following statement from Beazer Homes' recent 10-Q filing, the company is truly all in, "As of June 30, 2013, we were not able to incur additional indebtedness, except refinancing and non-recourse indebtedness."
BZH Debt to Total Assets data by YCharts
Keep in mind that Beazer still has access to $150 million of additional borrowings under a secured revolving credit facility if necessary. Additionally, with just under $300 million in cash on the balance sheet as of 6/30/13, they have ample liquidity if unexpected expenditures were to arise. Regardless of the high debt, cash flow problems do not appear evident for the company.
Below is a snapshot of the current debt profile. While the next maturity date is not for another three years, the June 2016 bonds are callable beginning next year and refinancing may be in line. While management has not given any explicit comments towards calling the bonds, lengthening the maturity and lowering the interest payments would be very beneficial for equity holders. Note: the TEU (tangible equity units) Senior Amortizing Notes, maturing in August '13 and '15 will be settled in stock, not cash.
(click to enlarge)
Source: Beazer Homes SEC Filings
Before you immediately pass on Beazer Homes given their substantial leverage, consider the environment they are operating in. With new home sales roughly half of pre-crisis levels, demand for new homes far outpacing supply, home prices growing at double digit rates year-over-year, and home price affordability at record levels (even with higher interest rates), the homebuilding space offers substantial growth potential. If Beazer is correct in leveraging up during this growth phase, the long-term results could be significant.
New Orders and Backlog
If you were to evaluate Beazer based upon new orders alone, the recent quarterly and full-year results would be disappointing. New homes ordered fell to 1,381 from 1,555 in the same quarter a year prior and are expected to show no gain for the full year. At first glance, this would appear to be negative, but impressively, the company was able to increase revenue and profit margins substantially as a result of selling higher priced homes from a smaller base of communities. As you can see in the table below, the community count has dropped significantly over the past five quarters. This was expected and clearly communicated by management a few quarters earlier; 2013 was anticipated to be a year of strengthening the income statement and controlling costs before bringing the number of communities back up to 170 by FY14 end.
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Source: Beazer Homes Investor Presentations
Even though the community count is dropping, the backlog value continues to grow at very impressive rates. Homebuilding is seasonal in nature with the fall and winter (Beazer FQ1 and FQ4) quarters exhibiting much less order flow. When you smooth out the backlog (below) you can see a clear upward trend in the backlog order value. As of the recent quarter end, the backlog has increased to $646 million. Keep in mind that we have seen this rise come in the presence of a lower community count.
(click to enlarge)
Source: Beazer Homes SEC Filings
During the recent quarterly earnings call, CFO Robert Saloman provided guidance as to what the community count will look like moving forward, "In addition to the 144 active communities at June 30, we had 50 communities in various stages of development that were not yet opened and 21 communities that have been approved, but whose transactions had not yet closed. During July, we approved another 11 communities for acquisition, several of which should contribute their first sales in fiscal 2014." When Beazer begins opening more communities over the next few quarters we are likely to see the backlog exhibit substantial growth rates. Couple this with an increase in the average selling price (see chart below), and profitability for Beazer Homes is not far off.
(click to enlarge)
Source: Beazer Homes SEC Filings
Inventory
Beazer Homes is not just hording cash, they are actively putting their borrowings to work. Over the recent quarter, the company spent $162 million on land and land development, bringing the year-to-date total to $314 million (compared to $141 million over the first three quarters of last year). Expectations for the final quarter of FY13 are $170-$190 million, bringing the full year total to roughly $500 million. This money is not being spent in speculative markets, however, the lion's share of this investment is being spent in some of the hottest growing markets in the country; California, Florida, Texas, and the Mid-Atlantic.
The company is also looking to build more condominium and multi-family properties rather than free standing single family homes. This shift to what the market is currently demanding shows a management team which is capable of adjusting to consumer preferences and not getting stuck in their old ways. Below is a table showing the breakdown of Beazer Homes' current inventory. Note that the company (like all others in the industry) capitalizes interest costs, I have subtracted this from total inventory on the balance sheet to provide an adjusted inventory level to measure tangible assets.
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Source: Beazer Homes SEC Filings
West: Arizona, California, Nevada, Texas East: Indiana, Maryland, Delaware, New Jersey, Pennsylvania, New York, Tennessee, Virginia Southeast: Florida, Georgia, North Carolina, South Carolina Valuation
If Beazer Homes is correct in their robust land purchases funded with borrowed dollars, the company is poised to deliver substantial profits in the years to come. Additionally, if the best case scenario plays out, shares offer some of the most attractive valuations in the industry. Since we cannot evaluate earnings quite yet (Beazer still has negative earnings), and use of the deferred tax asset (to be described later) will significantly alter earnings per share among competitors, I prefer to evaluate this industry utilizing a price-to-sales and price-to-book value ratio. As you can see in the first chart below, shares of Beazer Homes trade significantly below the industry utilizing a P/S ratio. I believe this stock is mis-priced given the limited coverage amongst analysts and a very small market cap.
BZH Price / Sales Ratio TTM data by YCharts
When looking at a price-to-book value ratio, it appears Beazer Homes is fairly priced within the industry. This is somewhat misleading; however, Beazer homes has been recording declining shareholders equity for the past few quarters while their share price has been range bound with an average of roughly $16. Given that many competitors have much less debt and have been utilizing their deferred tax assets to increase profitability (i.e. growing shareholder equity), if Beazer were to run similar financial statements as the rest of the industry, one could argue they should have a significantly higher P/BV multiple. Given that they trade in line with the industry today and have the potential to outperform the industry on both equity growth and share price appreciation over the next twelve months, we are likely to see the market award shares of BZH with a higher multiple moving forward.
BZH Price / Book Value data by YCharts
Given the combination of a depressed share price compared to the industry, significantly lower P/S ratio and artificially low P/BV ratio, shares of BZH are extremely undervalued. If the company is successful in implementing its growth strategies moving forward, shares could see the $30 range before FY14 comes to an end.
Concluding Remarks
While we are likely to see continued volatility in the homebuilding space due to interest rate fears and differing results in the multitude of housing reports released each month, the overall trend of housing continues to remains strong. If you remove the "noise" which the media bombards us with, you see an industry that currently has the ability to increase home prices without affecting demand. In fact, demand has actually proven stronger when average selling prices are raised (over the past few years). I also recommend investors keep a close eye on the monthly employment data released from the Bureau of Labor Statistics to see how construction hiring is trending. Below is a chart of residential building jobs created each month since January 2011, when the housing market unofficially bottomed and began recovering.
Source: Bureau of Labor Statistics
Investors looking to acquire homebuilders in today's market have another valuable incentive, deferred tax assets. The massive inventory impairments over the past few years have turned into substantial net operating losses which can be used to offset most taxable gains moving forward. Beazer Homes has a current valuation allowance of $505 million which if converted into a deferred tax asset is estimated to be worth $454 million, roughly $13 a share. Without getting into the intricate details of what a deferred tax asset and valuation allowance are, to simplify my point, profitability from Beazer in the future is highly unlikely to have taxable consequences at the corporate level.
Consider your investment goals and objectives before initiating a position in Beazer Homes and remember that the value of investments in equity securities, like BZH, will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy. Given what appears to be a sustainable recovery in housing and a company levering up to take advantage of this, if management is correct in their bets, the share price has significant upside potential.
Note: All data reported and graphed is pulled directly from Beazer Homes SEC Filings, Press Releases, and Investor Presentations.
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