NVR Stock Forecast: Where It’s Heading In 2022 (NYSE:NVR)

New homes on a quiet street in Raleigh NC

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NVR, Inc. (NYSE:NVR) is a US-based home-builder involved in the business of single-family homes, condominium buildings, and townhomes. To buttress their core homebuilding operations, they also operate a mortgage banking division that originates loans and sells them in the secondary market.

One of the better homebuilding stocks around, backed with impressive financial metrics

Prospective investors with an eye on the US homebuilding space have a plethora of options to choose from, but I believe NVR is one of the better options around.

Geographic and market diversity- Firstly, NVR appears to be one of those well-spread and diversified homebuilding entities that have its foot in the door across various segments and markets. Location wise, they operate within 34 metros across fourteen states and Washington D.C. Then they also cater to different categories of buyers across different brands; first-time or move-up buyers are serviced by the Ryan Homes brand, whilst NVHomes is oriented towards mid-market buyers with more discerning architectural and designer tastes. Luxury buyers are then serviced by the Heartland Homes brand. Thus, if some of the lower segments of the housing market are running out of gas, NVR can still generate ample business through its mid-market and luxury-based brands.

Less immune to land development risks- Then, one of the most striking facets of the NVR story is its acquisition strategy which makes it relatively immune to challenges that accrue from land development issues. Rather than engaging in land development, NVR predominantly acquires finished building lots from third-party developers in the form of fixed-price Lot Purchase Agreements (LPAs).

NVR does not pay the entire purchase price upfront, but rather only initially deposits 10% of the aggregate purchase price of the finished lot. NVR also has the liberty to not acquire these finished lots under contract by delivering sufficient notice in advance. This helps them avoid some of the crippling liquidity challenges those other homebuilders face. Crucially, they can also avoid some of the soft costs linked to architecture, design, engineering, permitting and impact fees, legal and consultant studies for assembling funding packages, or studying environmental impacts, that all typically account for 20-30% of project costs.

Impressive financial metrics- As they can save on a ton of soft costs, you’re looking at some pretty impressive EBIT margin numbers for NVR; EBIT margins of 18.3% are twice as much as the sector median.

EBIT margin

YCharts

This also provides them with ample cushion to cover interest costs linked to $1.5bn of senior notes outstanding. Note that over the last five years, the company’s annual EBIT, has, on average, been able to cover the annual interest bill by a whopping 35x!

Interest coverage ratio

YCharts

Also don’t get put off with the $1.5bn worth of total debt, as NVR has more than ample cash on its books to cover this, resulting in a net cash position of $940m (incidentally this isn’t a one-off, and it has been maintaining a net cash position for the last five years).

The other impressive facet of the operating model is the ability to convert a bulk of the annual EBIT into operating cash flow (the conversion has ranged from 75-83% over the past few years). This provides the foundation for NVR to be a consistently strong FCF generator. You won’t find too many home builders that have been able to expand their FCF base every single year for the last seven years (from FY14- to FY21 NVR’s FCF has grown at a CAGR of 25%). Speaking of the FCF, also do consider that the FCF yield on NVR’s stock currently works out to 6.9%, above its 5-year average of 5.6%.

Buyback support- Considering its strong cash flow generating prowess, NVR is well placed to share some of this largesse with its shareholder base. Admittedly, whilst it has never paid a dividend and does not intend to do so, do note that it is fairly active when it comes to share repurchases. Since 2012, it has engaged in buybacks every year, to the tune of at least $227m p.a. and stretching to figures of over $1500m p.a. Do consider that in recent periods, the ferocity of buybacks has ramped up relative to historical levels. Over the last five years, buybacks per quarter have averaged less than $200m, but over the last three quarters, we’ve seen buybacks ranging from $375m to $400m per quarter.

Buybacks

YCharts

Since the stock has corrected by around 20% this year, I believe, we could be looking at a good value opportunity for NVR to deploy the bulk of its new $500m buyback plan which was announced last month..

Industry-level conditions don’t look great and are weighing on the NVR share

Whilst one can’t have too many complaints about the standalone NVR story, I believe the broader industry-level scenario points to some challenges, and this is what’s primarily driven the weakness in the NVR stock.

Homebuilders are facing a range of challenges including high input prices, worker shortages, and limited material availability. Incidentally, the NAHB (National Association of Home Builders) confidence index has been sliding over the past four months and recently dropped to its lowest level since September last year. I don’t believe the short-term future looks particularly bright as validated by an index that measures home builders’ expectations of single-family home sales over the next six months; this metric recently dropped by 10 points sequentially and is currently at its lowest point since June 2020.

Already, the run rate of new home sales has been showing some weakness over the past few months. In February, it only came in at 772k (representing an annual decline of 6%), lower than market expectations of over 800K, and lower also than January’s figure of 778K. What was rather curious was that new home sales declined despite a boost in inventory (housing bulls have been keen to reiterate that low inventory should continue to support the housing market); currently we have 6.3 months’ worth of supply (in late 2020 this was closer to 3.5 months) and incidentally, this takes new home inventories to its highest point since 2008. Separately also do note that the cancellation rate of NVR’s new orders has been creeping up over time; in Q2 it was 8%, in Q3 it was 9% and in Q4 it was 10%.

If inventory has been picking up, yet sales are falling, you’re looking at conditions where buyers don’t feel confident enough to push the boat out. You wouldn’t hold it against them when you consider that home prices as a function of household incomes are at levels never seen before.

Affordability

Longtermtrends

The Fed’s hawkish pivot and the upward movement of benchmark interest rates have also left their mark on the 30-year mortgage rate which is now over 4.5%. Inflation is already eating into the average American’s budget and they are going to have very limited elbow room to face higher monthly mortgage payments.

You also have to consider what’s happening with the mortgage bond market; NVR’s mortgage banking business sells all the loans that it originates in the secondary market within 30 days from origination. Now with the Fed planning to shrink its balance sheet, you could have a situation where the market is inundated with the supply of even more mortgage bonds (MBS). This could send prices lower, even as the spread of MBS (agency) over treasuries grows. This has already expanded by 30x since November last year and currently stands at over 0.3%. If investors don’t have the appetite to absorb all of NVR’s mortgage division’s bonds, it may have to resort to other inconvenient modes of funding.

MBS spreads

FT

Does NVR’s current valuation make sense?

It’s rather difficult to state with any certainty if NVR’s current valuations feel fair; if you dissect the valuations through different lenses, one gets a mixed picture, rather than a definitive one. Let me elucidate.

Consensus estimates point to an expected FY22 EPS figure of $447.96; at the current share price that works out to a forward P/E multiple of 10.5x- no doubt cheap, when juxtaposed against NVR’s long-term forward P/E average of 16.5x. But then again, if you consider this multiple against the average forward P/E multiple of Seeking Alpha’s homebuilding universe of 22 stocks (forward P/E valuations are only available for 20 stocks though), this is still rather pricey, as it represents a 55% premium over the peer set average of 6.8x.

Some may say this is justifiable given NVR’s relative competence in the homebuilding market, but perhaps you could also look at the price to forward earnings growth ratio which seeks to determine if a company can deliver the requisite earnings growth profile to justify its P/E. Well in that case do note that NVR’s forward PEG ratio of 0.52 is twice as much as the peer set average of just 0.25!

I’d also urge investors to consider the drop-off in NVR’s sales and EPS two years down the line; consensus points to a 13% annual decline in FY24 sales and a 16% decline in the corresponding EPS. This would imply a pricier P/E multiple of 11.4x based on the FY24 numbers.

Estimates

Seeking Alpha

Closing thoughts- Is NVR Stock A Buy, Sell, or Hold?

Moving to the technical imprints of the NVR stock, note that since 2017, the stock has been trending up in the shape of a quasi-ascending channel/ wedge pattern. From April to November last year, it spent a long-time just consolidating below the upper boundary of the channel/wedge before breaking out of this zone at the end of the year. Unfortunately, bullish momentum proved to be short-lived and since the turn of 2022, the bears have had the upper hand. Not only has the stock dropped back into its traditional channel, it is also down over 20% on a YTD basis.

Chart

TradingView

Technically speaking, at this juncture, it is hard to make a case for the bulls to make a comeback and see the stock retest its previous highs in the shape of something like a V-shaped bounce. Rather, what you’re likely to see is one of two scenarios; Given the relentless selling since January, we could now see some consolidation or choppiness around the $4500-$5300 zones, similar to the imprints seen from April to November 2021. Alternatively, you could see further weakness towards the psychological landmark of $4000 which had previously served as a notable pivot zone in late 2019 and H2-20. If you’re interested in getting on board with NVR, I would recommend considering an entry around those levels, provided the macros are holding up relatively well.

To substantiate the technical picture on the standalone NVR chart, also consider looking at the relative strength ratio of NVR vs other homebuilders, as represented by the SPDR S&P Homebuilders ETF (XHB). Note that this ratio is currently in the middle of its long-term channel, implying that there’s no great merit in either owning NVR or selling NVR as the risk-reward feels fair.

Relative strength chart

StockCharts

NVR is one of the more competent names in the US homebuilding space, but considering the changing macro picture and industry-level dynamics, I don’t believe this is a segment that will benefit from positive investor interest in the near future. In light of this, NVR may find it difficult to swim against the tide and generate outsized gains. All things considered, I rate the NVR stock a HOLD.

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