Skyline Champion - A Compelling Housing Play

Summary

• Skyline Champion is America's second-largest producer of manufactured houses.
• The company has certain advantages over on-site producers and should benefit from the COVID-19 impact on the housing market during the next recovery.
• Balance sheet strength is remarkable and the valuation is fair. However, I like to wait for a second wave of selling before I start buying.

After covering a number of residential REITs focused on manufactured housing, I took a closer look at a company that has been on my radar for a long time. The Indiana based Skyline Champion Corporation (NYSE:SKY) is a leading manufacturer of manufactured homes. The company has benefited from a rapid increase in demand due to rising home prices and a better quality of manufactured houses. Unfortunately, the COVID-19 crisis has caused the stock price to take a big hit - along with the economy in general. Regardless, I believe the company is nearing an interesting valuation that will give investors reason to buy this stock as a long-term housing play.

Source: Skyline Champion

What's Skyline Champion?

Let’s start by mentioning that Skyline Champion is officially characterized as a residential construction company. In this industry, the company is the 14^th largest operator among stock-listed companies with a current market cap of $1.40 billion. The thing that sets Skyline Champion apart from its competitors is its unique business model. Whereas other ‘traditional’ homebuilders fight for market share in crowded metropolitan areas, Skyline Champion enjoys a 17% domestic market share in the manufactured housing industry. This makes the company the second-largest operator in this space with Clayton Homes being number one with a 47% market share. Don’t bother looking that one up as it’s a Berkshire Hathaway (BRK.A) (BRK.B) holding (smart move Buffett!). Anyhow, Skyline Champion is the result of a combination of both Champion and Skyline, which combined their operations in 2018 to build a company focused on manufactured homes, modular homes, park models, commercial modular construction, smart logistics, and retail operations.

Source: Skyline Champion Investor Presentation (November 2019)

While the company’s administrative buildings are in Indiana and Michigan, most of its retail operations are in the South (Texas, Louisiana, Florida). Its manufacturing facilities are spread throughout the entire country and the South-West of Canada.

Why Skyline Champion?

Most of the business trends I am giving you now were outlined by Skyline Champion at the end of 2019. While COVID-19 was not an issue back then, I strongly believe that all business trends are still valid and support a bull case.

One of, if not the biggest bull case for manufactured housing is the affordability of manufactured housing compared to site-built (traditional) houses. Between 2011 and 2018, the price premium of site-built houses has increased by roughly $100K with 80% of homes sold below $150K being manufactured houses. In addition to this macro trend, manufactured housing producers benefit from lower labor costs as a percentage of the total cost of goods sold and are able to benefit from less material waste. That’s the simple benefit of producing everything in a facility instead of working on multiple projects. The labor force effectiveness is higher as well as manufactured housing production benefits from centrally managed flexibility and often rural-based production – meaning lower labor prices. Manufacturing facilities also offer the benefits of being less weather dependent and buying in bulk with significant shipping advantages as everything has to be shipped to a central location.

With that being said, let’s take a look at what Skyline Champion considers one of its biggest chances to shine. The graph below achieves two things. First of all, it shows annual manufactured housing shipments. As you can see, these shipments took a hit in the years prior to the Great Financial Recession and have recovered since then. The blue line shows manufactured houses as a percentage of single-family housing starts. Prior to the 2008 recession, this number already declined as easy access to financing caused buyers to prefer on-site built houses. Since then, building permits (general housing sentiment) has improved significantly, while the percentage of manufactured homes remained at 10%. In other words, companies like Skyline Champion benefited but did not outperform.

Source: Skyline Champion Investor Presentation (November 2019)

You probably already noticed it, but the graph above is not up to date. That’s why I made the graph below, which shows the monthly seasonally adjusted annual rate of manufactured home shipments. Prior to 2018, growth rates were between 10% and 20% most of the time, which is an impressive growth rate. Unfortunately, the growth rate quickly went south in 2018 as higher rates and peaking global economic growth pressured demand. Then, in 2019 and the first quarter of 2020, demand soared again, reaching 10% growth in early 2020.

Source: Author’s Spreadsheets (Raw Data: US Census Bureau)

Unfortunately, due to weakness in 2019, the company did not improve revenues between Q2/FY19 and Q2/FY20. Note that the company's fiscal year is roughly 2 quarters ahead of the calendar year. In other words, we are dealing with the period Q4/2018 to Q4/2019, which makes sense as growth in this period was down. Given Skyline Champion's size, it is nearly impossible to avoid a sales decline. However, during this period, the company improved its adjusted EBITDA margin from 6.7% to 9.2% due to favorable synergies, rationalization of product offerings, and operating improvements. Regardless of how bad 2020 (calendar year) is going to be, I believe the company is poised to further enhance efficiency measures. The graph below shows longer-term sales growth. Note that this improvement is pretty much worthless as it was caused by the combination of Skyline and Champion. The peak was caused by slower shipments as I just discussed.

Data by YCharts

While the ongoing COVID-19 pressure will certainly crush shipments, keep in mind that manufactured housing will see strong demand once the economy bottoms. The way it looks right now, housing prices are remaining stable as cheap money is supporting investments. All of this is happening while the lower-income population is taking the biggest economic hit as hotels and restaurants were closed with major manufacturing plants being shut as well. Add to that, that in 2017, 45% of the United States population made less than $50,000 per year. While this data is three years old, the trend hasn’t changed. I expect the coming housing recovery to boost manufactured housing as a lot of people who are financially recovering will refrain from paying top dollar for single-family housing and buy more affordable manufactured houses.

Gameplan & Valuation

The current COVID-19 situation makes finding an entry incredibly difficult. Right now, the company is trading at 22.9x next-twelve-months earnings and is down 22% year-to-date. The one-year performance is up 3.4%. The stock is up from less than $16 in March to currently almost $25 as investors used the massive sell-off to buy cyclical stocks. Regardless of how bad COVID-19 is going to be, it's good to know that the company has a debt/equity ratio of only 0.23 and a current ratio of 2.10, meaning that current assets cover 210% of current liabilities.

While I believe that Skyline Champion will be a huge winner during the next economic upcycle, I am not willing to buy the stock at $24.8. I am convinced the situation is different from a situation that would warrant an easy V-shaped recovery as we saw pretty much after every sell-off since 2009. I think the markets are going to give us the opportunity to buy some great stocks at lower prices this year. Note that I am saying this while holding significant long exposure. I am not short, nor all in cash. To me, it is just important that I do not add new investments after they have gone up more than 60% in a matter of weeks. I would love to buy the stock below $20 if I get the chance.

My main message here is to keep Skyline Champion on your watchlist. The stock will likely turn into a strong alpha trade that could easily reach new highs once the company gets economic support (higher building permits).

Stay tuned!

Thank you very much for reading my article. Feel free to click on the "Like" button and don't forget to share your opinion in the comment section down below! My long-term investments are stated in my Seeking Alpha biography.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

This article serves the sole purpose of adding value to the research process. Always take care of your own risk management and asset allocation.