Beazer Homes: Stop Hoarding Cash And Return It To Shareholders

Summary

• Homebuilder Beazer Homes is trading at 5x EPS and has half its market cap in excess cash on its balance sheet.
• Interest rates are likely to remain low for long, aiding the housing market and preserving the earnings power of the company.
• The stock offers 60% upside if management can immediately take steps to return cash to shareholders.
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Introduction

As the market continues to rise, and people chase flashy momentum names, there are some stocks being left by the wayside. I'm finding opportunities in the home-building sector, with many of the companies trading at single digit multiples.

A month ago, I recommended investors buy the shares of homebuilder Taylor Morrison (TMHC). The company's recent results were so-so, but the stock still went up, reflecting the large margin of safety at a low valuation. I believe Beazer Homes (NYSE:BZH) has substantial upside with a large cash balance that management should use to highlight the value in its stock.

The company is headquartered in Atlanta and operates in thirteen states. It is one of the smaller public homebuilders, selling about 5,000 homes a year.

Stable macroeconomic backdrop with some puts and takes

There is some anecdotal evidence that the hot housing market is cooling a bit, with higher prices retarding some demand. I would say this is expected, with people getting vaccinated and returning to work. After the housing boom in the 2000s and the subsequent bust, we are back to the level of the 1990s. I believe this pace is sustainable with a larger and growing population. The chart below shows seasonally adjusted annualized new home sales in '000s.

Mortgage rates continue to be low by historical standards. It is still a good deal for people to buy homes they live in for less than a 3% interest rate. There is some concern that higher inflation will cause the Federal Reserve to increase interest rates soon. However, I believe that the Fed is exceedingly dovish (I don't want to use the word "wimpish"). Let's see when they start tapering bond purchases (a few months away at least), and then we can get around to thinking about interest rates going up. Although some people may believe that higher inflation will cause bond investors to demand higher rates, that is not necessarily the case. The same factors that cause inflation (high government spending, income transfers to people, monetization of the deficit) result in too much money chasing assets, including bonds, driving up their price and resulting in lower interest rates. There is simply no political appetite to restrain spending and I see interest rates being low for the duration of the current administration and possibly beyond. I believe rates will go a little higher from where they are now, but not significantly.

Inflation is rampant in the economy, raising costs for anyone who makes things. There is some good news on this front, with lumber prices having retreated from their spike earlier this year. However, the recent wildfires in Western Canada are causing some production to stop and could raise prices going forward.

Financial overview and outlook

In the three months ending June 30, 2021, the company's revenue of $$570 million was up 7% YoY while operating income doubled as expenses held steady. Net income of $37 million resulted in diluted EPS of $1.22 in the quarter, nicely ahead of the $0.90 consensus expectation. The company raised its expectation for fiscal year ending September 2021's EPS to be $3.25.

The consensus estimate is for the company to earn $3 per share this year and $3.38 next year. I believe these estimates are achievable.

The company has $358 million of cash and $1.1 billion of debt. Its market cap is $550 million and Enterprise Value is $1.3 billion. The company has been buying back a modest amount of debt, but is otherwise building up cash and working capital.

Capital allocation opportunity

The company should immediately commence returning half its cash balance to shareholders to whom it rightfully belongs. It should announce a $100 million share repurchase program, which would retire 15% of the share count, assuming the share price increases a bit to the $21 level. Additionally, it should commence a $2 annual dividend, which would represent 60% of net income going forward and represent a best-in-class 10% yield. Together, these actions will use $160 million of the company's $350 million cash balance over the next year. They would signify to the market that management is confident of the company's ability to remain profitable at the current level. Debt repurchases can continue as well, although with interest rates where they are it is debatable whether these represent a good use of capital. The company should be able to generate a reasonable amount of cash going forward as homes in its backlog are delivered and the dollar value of backlog stabilizes.

Valuation: Fair value of $30 for the stock

Buying back stock as I outlined above will increase EPS by 15% to the $3.75 level. I believe fair value for the stock is $30, based on an 8x multiple on this projected earnings power. This is lower than the market multiple and in line with current homebuilder valuations. Thus the stock offers 60% upside from the current $18 price. The other way of looking at it is to assign the multiple on the current earnings projection of $3.25 and add $4 for the excess cash.

In a bull case, earnings will come in at $4 per share and investors will assign a 9x multiple for a $36 target price, offering 100% upside. I do not consider this case to be very likely.

In a bear case, the company's revenue and earnings will miss estimates, with only $3 of EPS after buybacks. Disappointed investors will assign a 5x multiple, resulting in a $15 stock price for 17% downside.

In terms of comparables, D.R. Horton (DHI) trades at 9x EPS, PulteGroup (PHM) at 7x EPS, Meritage Homes (MTH) at 7x EPS, KB Home (KBH) at 7x EPS, LGI Homes (LGIH) at 11x EPS and Toll Brothers at 10x EPS. I believe there is room for consolidation in the sector and Beazer would make an attractive target with its low valuation and small size.

Risks are moderate

The biggest risk here is that the company's earnings will come in lower than expected due to macroeconomic, competitive, or execution factors.

A rapid increase in interest rates could prompt home buyers to pull back and equity investors to pay lower multiples. I believe that interest rates are unlikely to increase a lot with a dovish Federal Reserve and continued monetary expansion.

Shareholders depend on a company's management being good stewards of their capital. There is a risk that the company will make an overpriced acquisition that is material. This risk can be lessened by management returning cash to shareholders rather than hoarding it at the company level.

Conclusion

An investment in BZH offers the opportunity to generate a good return even as the market touches new highs. The company can and should catalyze the return on its stock by distributing the large amount of excess cash it currently holds to shareholders.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of BZH, TMHC either through stock ownership, options, or other derivatives. 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.

Comments

[Stock Scanner]

A blast from the past...Company did nothing for shareholders, but after a wild ride, the homebuilder boom has lifted all boats. Getting out of the stock now.

[Stock Scanner]

Folks, earnings out yesterday were good, with a benefit from energy efficiency tax credits. I guess feeding at the government's trough is what is in vogue in today's woke world! Company reduced debt by $50 million and sees itself generating $5 of EPS. That is good as they have now put a stake in the ground by publicly announcing it. What I didn't like: weak orders (I somewhat believe the company that they are intentionally throttling this) and weak cash flow (home inventory up by all of earnings in the last year).

[Stock Scanner]

Thanks for your perspectives. Debt repayment isn't a bad idea, certainly better than holding on to cash. To put some numbers here, rather than just a qualitative "they have so much debt", interest expense was less than a third of operating income last quarter. (Interest expense for homebuilders is not obvious on the income statement as they capitalize and then expense it in the cost of homes sold. I wish this were not allowed and they had to present it the conventional way. You have to add interest expense to the reported operating income, to get an adjusted figure, then see what the below the line interest expense is as a % of this). I'm generally comfortable with a quarter of operating income going towards interest - if operating profit halves, debt can still be comfortably serviced. So by this measure, some amount of debt repayment (to the tune of $200 million) would be justified. However, they have to buy their debt back at a premium. If they did $100 million of that over the next year and a scheduled $100 million repayment next year, it would be taken care of. Along with cash generated over the course of the year, this can be done in addition to what I have outlined in the article.

[Ultradeep]

All excess cash should be used to reduce debt and this is the core of company’s financial strategy. Agree that BZH is one of the cheapest of the homebuilder stocks and should be trading closer to $30 not $20.

[hksche2000]

Thanks to the (once in a lifetime) housing boom, BZH has done well TTM. After the recent 30% drop, its current share price is actually a bargain. Fortunately mgmt remembers the near death experience during the financial crisis, when BZH was caught off guard and way overextended. Super low IR over the last decade allowed it to survive and, recently, start thriving again. I'm glad I held onto my position even as BK was looming, but hope mgmt will con't sticking to its conservative position and not do any of the things the author is suggesting except further deleveraging.

[Bruski58]

Return to shareholders while holding so much debt? That is patently ridiculous and irresponsible. As a shareholder I want them to pay off debt, so to irresponsibly hand out cash merely for a short term sugar high and price pop would destroy my confidence that the company has shed the irresponsible practices that got us in this mess to begin with. Get debt below $500 million and then we can discuss dividends. In the mean time, as debt is paid down profits will increase by cutting the amount of interest paid at the high interest rates Beazer currently pays. This will create a growing earnings cushion and better credit ratings for lower finance costs to insulate us from the next inevitable bust.