Unlike most of the homebuilding industry, NVR (NVR 0.58%) doesn't buy up land in hopes of cashing in during up cycles. The company is much more conservative with its capital allocation, looking to avoid boom-and-bust results in favor of consistent performance.
On this clip from Motley Fool Live's Industry Focus, recorded on May 20, host Nick Sciple and Motley Fool analyst John Rotonti discuss NVR's unique model and the results it has generated over the years. NVR is, according to Rotonti, in a class of its own.
Nick Sciple: We tell the story of rising demand in a market where, anywhere you look, there's a shortage of homes. Where does NVR play into this? Why do you think NVR is the company that is best positioned to take advantage of this misalignment between supply and demand?
John Rotonti: NVR is the fourth-largest homebuilder in the U.S. It builds in 14 states clustered along the East Coast and into the Midwest. Housing is an essential business, it serves a crucial need, it's a major driver of the U.S. economy and the American Dream. Excuse me. I didn't mention this, just residential fixed investment, building new homes every year, is about 4 to 5 percent of U.S. GDP, so really important to the US economy. If you do 4 percent of 22 trillion, that's like almost a trillion-dollar business. Is just building new residential investment every year. It's a really simple business. If you look at their 10-K, the first section of every 10-K is the business, theirs is three pages long or three-and-a-half pages long. Simple business. Here's what they do. Most homebuilders buy land, put that land on their balance sheet, and then develop that land, and then build on that land. NVR does not do that. That is capital-intensive and when you layer on a capital-intensive business model of buying and owning land, developing land, and then building on that land, keeping that all on your balance sheet, when you layer that capital intensity in a really cyclical industry, the two Cs, cyclical and capital-intensive, you can get into trouble.
Sciple: Because there's usually debt involved in there, too.
Rotonti: Exactly. NVR actually, it came public in a leveraged buyout back in 1987, filed for bankruptcy in 1990. Key moment in its life, it filed for bankruptcy because it had this traditional homebuilding business model, cyclical with a lot of debt and a lot of capital intensity. Filed for bankruptcy, ever since then completely changed its business model, Nick, to become a unique asset-light business unlike its major competitors. It does not own or develop land. It doesn't keep that on its balance sheet. Rather, it secures lot purchase agreements, which are basically an option or the right to buy a finished lot by just putting down 10 percent of the finished lot price. By not forking over all of that cash at once and instead using these options, NVR can reserve the land on which it wants to build while maintaining a ton of liquidity. That's the most unique thing about its business model, that it doesn't own and develop land, which is part of the homebuilding culture, rather it has this asset-light model. No. 2, it also tries to be the market-share leader in each of the markets it participates in, not nationally. If you look at the rest of the industry, they brag about being the national market-share leader or in the top three. NVR doesn't care about that. They want to be No. 1 or No. 2 in each market they participate in, because when you can cluster your workers together, your subcontractors together, when you can maintain the closest relationships with local land developers and local subcontractors, you can become efficient, you can create productivities and efficiencies. Their goal is to be the market-share leader in each of their markets, these clustered markets along the East Coast. They also vertically integrate. Seven of their factories are within 90 percent of their communities. Basically, they build the home off-site. The four walls of the home, all built off-site. Staircases, all built off-site. Interior walls, built off-site, brought there on a truck and then just stood up and nailed together. It's vertically integrated prefab stuff. They have fewer home models, so it's easier to keep track of their home models. Lot of stuff that makes them more efficient.
The cool thing is you would think, "Hey, they use these options, why don't other homebuilders use options?" It's because homebuilders love the adrenaline and the excitement of owning land and selling it at a huge profit in up cycles, Nick. It's almost like wildcatters in the oil industry. They love that adrenaline rush of being able to make huge profits in up cycles from owning land. NVR doesn't care about that, they're fine growing slower in up cycles and then using down cycles to enter new markets. When everyone else in the industry is struggling literally to survive, they enter new markets. NVR in the global financial crisis, in the housing crisis, they entered six new markets, and they bought back unbelievable amounts of cheap stock. Then if you look at how they performed, this differentiated business model that we just talked about enabled NVR to be the only publicly traded homebuilder to remain profitable every year during the worst of the global financial crisis. Its return on invested capital never dipped below 12 percent in the worst of the global financial crisis. That's more than the home industry builder average today. Their lowest of their low is higher than the industry average today. By the way, homebuilders are making a lot of money today because it's been an up cycle for the last decade. Still their lowest of their low, better than the industry average today. Then Ensemble Capital recently put out a note on NVR and they said, "Despite NVR's land-light strategy success, the industry's use of land options remains lower than it was during the housing boom in 2004-2006." They're not moving toward NVR's land-light, asset-light business model. The industry is sticking to the asset-heavy own the land and pray model.
Sciple: Is there a disadvantage to this model? I guess you don't have as much upside in the bull markets, but you said you would trade that for more stability throughout the cycle.
Rotonti: Totally. NVR maintains massively high returns on invested capital and profitability across a cycle, Nick. That is not the case for the industry. Let's put some numbers on this. NVR, the only company with net cash and a lot of it, Nick, 1.2 billion in net cash. Every other player has large amounts of net debt. Altman Z-score, it's a measure of the likeliness a company will file for bankruptcy. The higher the better. The industry averaged 3.7, NVR 8. My point is, Nick, the differentiated business model, the uniqueness of this business model, it shows up in the corporate fundamentals. A lot of investors will say, "Oh, I have this unique business, it's so rare, it can't be replicated." No, that's not true. Show me when it shows up in the numbers. NVR, it shows up in the numbers. Industry average ROIC last five years, 7.8 percent; NVR's, 30.6 percent last five years. Industry average ROIC last 12 months, 10.5 percent; NVR's, 38.7 percent. The trade-off, Nick, if these are last five-year numbers when the industry has been hot, you will see NVR grows slower than the industry in an up cycle. Revenue, five-year CAGR for the industry, 12.4 percent; NVR, 8.4. Net income for the industry, 27 basically; NVR, 19 percent. But still NVR buys back stock, so it's growing its earnings per share at 21 percent. This is growth, and it's amazing growth at ROICs of 38 percent. There's nothing like this. It's in a class of its own.
