Newsletter Value Investor Insight carried an interview May 26th with Springhouse Capital manager Brian Gaines (pictured left), whose fund focuses on undervalued small cap stocks. Springhouse Capital has generated an average net return of 29.6% per year since its launch, versus a 13.9% annual for the S&P 500, according to Value Investor Insight. Here's the segment of the interview in which Mr Gaines discusses his position in Levitt Corp. (LEV), which was trading at $16.80 at the time of the interview (chart here):
Tell us about one of your current favorites that has been beaten down, Levitt [LEV].
BG: Levitt has three parts to it. The first is their branded homebuilder, Levitt and Sons, which many people have heard of from their development of Levittown on Long Island. They’re now focused on building for recent retirees – mostly in Florida, but they’re expanding into Georgia, South Carolina and Tennessee. They have comparable levels of supply to other homebuilders, with five years’ worth of owned or optioned inventory.
The second part is a division that does master-planned communities, where they own many acres of land and develop it both themselves and by selling land to other builders. They have a huge tract they’ve started to develop in Port St. Lucie, Florida and also have land they bought last year in South Carolina.
The third asset they have is 9.5 million shares of Bluegreen Corp. [BXG], a publicly traded timeshare company.
Levitt’s shares are the lowest they’ve been since the company was spun off in late 2003. Margins have been squeezed by rising building costs and a cooling market in Florida, where most of their business has been. They’ve also ramped up selling, general and administrative costs in expanding outside of Florida, which the market doesn’t like at this point in the housing cycle. The extra costs in starting new developments are hitting before the revenue comes in from selling the homes.
So you believe the market is overreacting?
BG: We think about Levitt by valuing the parts. Starting with the easiest part first, the traded Bluegreen stake is worth $5.50 per Levitt share, after-tax. We think that’s probably undervalued and on the upside it could be worth closer to $7.
The Levitt and Sons homebuilding business has a book value of $7.50 per share, after conservatively allocating total debt to each part of the business. It’s still making money, but because of the pressures I mentioned earlier, probably only a third of the $1.50 per share it earned in 2004.
I can’t tell you exactly how the homebuilding cycle is going to play out, but I can judge whether I think there will be impairment to the $7.50 book value. For a variety of reasons, I don’t think there will be. The properties are well located and most have appreciated significantly since going on the books over the past several years. In general, active-adult communities are less susceptible to speculation and price collapse, and Levitt itself has avoided speculative building. I don’t deny that homebuilders can trade at discounts to book, but in Levitt’s case I think the $7.50 book value is achievable over time. One free option we like is that eventually the market will get comfortable with the homebuilding cycle, and this piece will likely trade at a decent premium to book. So the upside value is closer to $10 per share.
We assume the land-development piece of the business is the hardest to value.
BG: Land is clearly the most volatile piece and we’re probably heading into a time when land isn’t in high demand. This is an example of a risk we’ll take – we’re willing to live through the temporary period when land swings in value.
The South Carolina land they bought last year cost them about $2.50 per share. We think it’s still worth at least that, given that they didn’t buy in an overinflated geographic market and they’ve since received all the building permits for it. On the upside, the South Carolina land could be worth closer to $4 per share.
Of the 4,200 acres in Florida, 3,400 are residential and 800 commercial. They sold residential acreage there to Toll Brothers two years ago for the equivalent cost of about $80,000 per unfinished acre, which is what most of the remaining land is. Given that local brokers tell us land prices appreciated 25% per year in the two years since the sale, we think putting that $80,000 value on the residential acres they have left fully accounts for the risk of land values falling in an ugly market.
This is well-located land – there’s almost no land left to develop south of Port St. Lucie on the Atlantic Coast – in a state that will continue to grow in population. At $80,000 per acre, that makes the residential acreage worth $10 per Levitt share, after taxes.
The only other piece to consider is the 800 commercial acres, which based on similar historical metrics is worth over $300,000 an acre, or another $8.50 per share after tax.
What about debt?
BG: Excluding debt I’ve taken out in the homebuilding valuation and taking into consideration the company’s other real estate assets, the remaining net debt comes to about $4 per share.
So adding the conservative values of the assets and subtracting the debt brings you to a value of $30 per share, versus the current price of $16.80.
BG: Yes. There will be an ugly time as land values adjust in the short term, but the underlying asset values more than protects us. We think we’ll be paid very well for living through any temporary pain.