To say that Wall Street didn't like NVR's (NVR -0.69%) most recent earnings release seems like a bit of an understatement. The company's stock dropped more than 11% last week when the company reported fourth-quarter earnings that didn't quite meet expectations.
After such a strong performance in 2017 and signs that the housing market is still going strong, one has to wonder what is going on with this stock. Is this just the market overreacting to some one-time blips, or are there some other things at play here that investors should worry about long term? Let's dig into what caused NVR to miss its earnings estimates for the fourth quarter -- and what investors should keep an eye on in 2018.
By the numbers
|Metric||Q4 2017||Q3 2017||Q4 2016|
|Revenue||$1.78 billion||$1.63 billion||$1.71 billion|
|Net income||$124.7 million||$162.1 million||$150.9 million|
This past quarter has been a funky one for every company as they try to assess the impacts of the recent changes to the U.S. tax code. For NVR, that meant taking a $62.7 million charge to the bottom line to reassess its deferred tax assets, which are now less valuable because of lower tax rates. At the same time, though, that charge was offset by a one-time gain related to how its stock option exercises are taxes.
For the fourth quarter, this was a $13.9 million gain, so the overall impact was an additional $48 million in income taxes for the quarter. If we adjust for these non-cash charges, NVR's adjusted net income came to $43.41 per share. Compared to the previous and prior-year quarters, that looks like a great metric, but Wall Street was expecting $47.96 per share for the quarter, and the stock was punished as a result.
The more you dig into the company's financial results, it becomes less clear as to why this wasn't a good quarter for the company. NVR posted improving numbers for just about all of its operating metrics. Compared to last year, new orders were up 18%, new settlements rose 4.7%, total backlog grew 23.9% to 8,500 units, and its cancellation rate declined to 14%.
The one metric that didn't look too encouraging was the average selling price for its new orders and backlog. This isn't necessarily a bad thing, though, because there is a secular shift among homebuilders lately to build more starter level or first-time buyer homes as more and more of the Millenial generation enters the housing market for the first time. It may eat into margins, but the Millenial age demographic is the largest population group since the baby boomers and will likely drive home sales for several years.
Much ado about share repurchases
All in all, there isn't too much to fret about in the company's most recent income statement. That is, until you hit the very last line of that income statement. Here is a breakdown of the company's share count over the past year.
|Metric||Q4 2017||Q4 2016||Full-Year 2017||Full-Year 2016|
|Basic weighted average shares outstanding||3.73 million||3.75 million||3.73 million||3.85 million|
|Diluted weighted average shares outstanding||4.31 million||3.99 million||4.24 million||4.1 million|
The thing that stands out here is the growing discrepancy between its basic and diluted share count. The large difference has to do with stock options for its management team that have not yet been vested. The additional 600,000 shares in potential options could significantly dilute future earnings for individual shareholders.
The reason these stock options and diluted shares look like a big deal is that the company has historically returned value to its shareholders via share repurchases. In 2017 alone, the company spent a total of $422 million on repurchasing 166,000 shares. However, the net effect was a reduction of 20,000 shares. Even more concerning is that the company's share repurchases aren't enough to cover its future stock options. If this trend continues, it's entirely possible all that capital allocated to share repurchases will simply be a transfer of cash to its management team rather than its investors.
What a Fool believes
From an operational standpoint, it seems as though Wall Street's expectations for NVR's most recent quarter were a bit too much. Meeting that lofty per-share estimate would have been challenging for any company. It seems as though its post-earnings sell-off was a bit much.
For close to two decades, NVR has done a magnificent job of using share repurchases to grow shareholder value. So, I think it's OK for NVR to get a pass this one time regarding its stock options and its share repurchases. The board has already authorized another $300 million in share purchases, so at least we know this buyback program will continue. However, if these share repurchase programs fail to reduce total share count over time because of generous stock options, investors should become concerned.