A Long Play on a Worsening Real Estate Market: Drew Industries

| About: LCI Industries (LCII)

Robert RobottiNewsletter Value Investor Insight carried an interview August 25th with Robotti & Co. manager Bob Robotti (pictured left), whose $500 million fund focuses on small and microcap stocks and has generated an average net return of 17.4% per year since its launch in 1983, versus a 10.3% for the Russell 2000, according to Value Investor Insight. Here's the segment of the interview in which Mr Robotti discusses his position in Drew Industries (DW), which was trading at $24.95 at the time of the interview (chart and current stock price here):

What attracted you to... Drew Industries (DW)?

BR: This is a relatively straightforward story. Drew sells component parts – like windows, doors, chassis and axles – to manufacturers of recreational vehicles and manufactured homes. They do business with almost all manufacturers and probably have 50% market share in both businesses. The revenue mix is two-thirds RVs, one-third manufactured housing. There are two main things that attracted us here. First, we’re convinced they have an excellent model for growth. They’ve been very good at identifying products that will have broad appeal and then making small acquisitions to fill out their product line and leverage their relationships and sales infrastructure. We’re also big believers in the turnaround potential of the manufacturedhousing industry – where Drew operates at maybe 50% of capacity and where they have historically earned higher margins.

Why do you think the manufactured housing business is set to improve?

BR: The industry has been beaten up for some time. In the late 1990s, the industry was selling 370,000 new homes per year, driven by very aggressive financing offers. Many of those loans blew up, dumping a lot of inventory on the market. At the same time, falling interest rates made stick-built homes a more affordable option for many people. As a result, sales of new manufactured homes fell to 130,000 per year and have stayed around that level. We now think higher interest rates will refocus many low-end buyers’ attention on the relative affordability of manufactured housing. Lending to the industry is now much stronger and default rates are way down. In fact, terms have gotten so rigid that legitimate potential buyers – who generally have lower FICO scores – can’t get loans. We expect that all to adjust as time goes on. Clayton Homes is the biggest player in the industry and you can imagine one reason Berkshire Hathaway (BRKA) bought it was for the opportunity to lend money to that business can double for them in the next few years.

With the stock currently trading just under $25, how are the shares valued?

BR: The stock currently trades at around 11-12x our estimate of next year’s earnings. As they continue to add new products and the manufactured-housing business turns, we think earnings will increase at double-digit annual rates. With that kind of growth and the high-teens multiple we believe the business will then deserve within three years, you’ve got a lot of upside from today’s price. help finance the industry’s rebuilding. Getting back to even 200,000 new manufactured homes sold per year, which is fully achievable, would result in tremendous upside for Drew. We think that business can double for them in the next few years.

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