Harbor Custom Development: Value Play In An Overheated Market
Summary
- Real estate development company in the highly supply-constrained Puget Sound region.
- Low risk land acquisition strategy in which HCDI can exit at multiple points in time for profits.
- Fast revenue growth should continue as HCDI expands into new markets and unveils new housing products.
- Trading at significant discounts to homebuilder peers like Toll Brothers and Lennar at the current enterprise value.
- Management has decades of experience in real estate, owns a substantial percentage of the stock, and has been buying recently.
Harbor Custom Development (NASDAQ:HCDI) is an anomaly in an overheated stock market. While many IPOs are more than doubling at open, HCDI has collapsed over 50% from its open price of $7.5 and is languishing near all-time lows. If you look more closely, however, HCDI seems incredibly undervalued compared to peers despite strong growth and liquidity.
Real estate market
Today, HCDI operates in the Puget Sound real estate market, which has seen prices soar over the past few years due to strong population and industrial growth coupled with low housing supply. As you can see below, almost every region measured is seeing price appreciation:
Strong price action has continued into 2021, with news of the coronavirus vaccine fuelling the market. Many new listings have been snapped up in less than a month and many buyers are offering prices way above list price. This kind of market is ideal for a developer like HCDI as new developments can be sold out very quickly, as you can see below.
HCDI's strategy also includes expanding into other markets with strong fundamentals that would be preferred by residential homeowners like job growth, highly ranked education system, diversified economy, etc. So far, HCDI is planning to expand the Austin and Sacramento markets in Q1 2021 to build houses in the price range of around $1mil. Construction is expected to start in H2 2021.
About Harbor Custom Developments
Founded in 2014 by Sterling Griffin, HCDI is a real estate developer involved in every part of the land development cycle including – land acquisition, entitlements, construction of project infrastructure, home building, marketing, and sales.
Source: Investor presentation
HCDI reduces the risk of buying land by providing multiple exit points at different stages of the development cycle. This includes selling entitled land to downstream developers, selling land with infrastructure built, selling single-family homes to consumers, and renting out homes.
Source: Investor presentation
In mid-January, Harbor disclosed that they owned and controlled 9 Western Washington residential communities containing 642 lots and 378 units in various stages of development. Since then, they have conducted quite a few transactions that have increased their footprint in new markets and slightly reduced their Seattle footprint by selling 99 lots to Lennar(LEN).
The company has an experienced management team with substantial real estate experience. For example, founder and CEO Sterling Griffin has 35 years of experience with real estate due to working at multiple real estate firms. Experience is important because, like the stock market, the real estate market has its ups and downs so costs and revenues have to be managed well.
Financials
Land development might not sound like a sexy business, but Harbor is growing incredibly fast as you can see below, with more than 50% YOY revenue growth expected in 2020 and similar growth expected in 2021. HCDI plans to grow by not only increasing its product portfolio but also by expanding into new regions. Revenue mainly comes from home sales but some revenue also comes from selling finished lots(around 24% of 2019 revenue).
Source: Investor presentation
In addition to the single-family home market, HCDI also plans to offer townhomes and condominiums beginning in 2021 and start the development of suburban multifamily apartments. Harbor is also considering entering into the vacation & secondary home market.
At the end of Q3 2020, HCDI reported $24mil backlog of home sales that should help to derisk 2021 revenue projections.
Source: Prospectus
The company is profitable on an EBITDA basis and will likely be profitable on a net income basis this year. A large portion of the company's revenue and profitability is generated in Q4 as the majority of cash from home deliveries arrives in Q4.
Valuation
At the end of Q3 2020, HCDI disclosed that it had 5.6mil shares outstanding. In mid-Jan, HCDI raised another $24mil by selling 8mil shares at $3 per share. With 13.6mil shares outstanding, the market cap of the company is now $41mil. With $26mil in cash after the raise and around $1mil in debt, the EV of the company is around $16mil, or around 0.34x LTM sales.
| EV | 2020E rev | Growth | Gross margin | EV/2020 rev | |
| HCDI | $16mil | $47mil | 52% | 11% | 0.34x |
| TOL | $8bil | $7bil | -1% | 20.2% | 1.1x |
| LEN | $30.2bil | $22.5 | 1% | 23% | 1.33x |
| GRBK | $1.2bil | $1bil | 27% | 23% | 1.2x |
| FOR | $1.46bil | $1bil | 56% | 13.3% | 1.4x |
| TMHC | $6.2bil | $6.1bil | 29% | 18% | 1x |
This is a massive discount to peers, whether large peers that are growing more slowly or smaller peers that are growing at similar rates. I cannot think of any reason for this discrepancy besides the fact HCDI is less known and has a lower gross margin, but this should improve as the company continues to grow due to economies of scale. If HCDI were to trade in line with peers, it would be worth $5.3 per share, representing an upside of 67%.
Insiders own over 30% of the stock and have not sold any shares in the recent offering. In fact, one insider recently bought 35k shares after the offering at around $3, showing strong enthusiasm over the company’s future.
Real estate is cyclical, and if interest rates rise substantially a downturn could occur, which I believe could pose a risk to HCDI. Overall though, with a strong cash balance and buying support in the $3 region from both institutional investors and insiders, I think the downside risk for HCDI is very low.
Conclusion
Overall, I think HCDI is a deep value play with minimal risk and moderate upside. The company is operating in a supply-constrained market, is cash-rich, trading far below peers, and has strong price support due to insider and institutional buying. Whichever way the market decides to go, I think HCDI will do very well.
This article was written by
Analyst’s Disclosure: I am/we are long HCDI. 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.
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Comments (277)
Then why did they issue a preferred secondary undercutting their own shareholders by 40%.
and why do you tout in incessantly, unless you have a vested interest in it.
