I have never considered myself a “momentum investor,” but I have always known that future growth is a critical factor in making a profit from any investment. Because my focus is on value compared to current price, it is very common for me to find myself reviewing stocks that have suffered a recent price decline due to some event that I believe to be short term and not something that will produce a permanent impairment to the value of the business. Therefore, it almost always feels a bit strange to me when I find myself performing a full analysis on a business that qualifies as a “growth stock” or “momentum stock.”
My affinity for value and safety also leads me to spend a lot of my time analyzing businesses that provide a product or service that is necessary to our survival or at least our way of life. The very basics of these needs are food, shelter and clothing.
As I was reviewing businesses that showed up on my stock screening programs on Saturday, I noticed the rare appearance of a homebuilder. It caught my eye because it has been many years since one appeared and the last time one did, it produced a stunning gain over the ensuing three years.
A growing business priced like a bargain
Century Communities (CCS, Financial) is involved in the homebuilding industry in Atlanta, Georgia, central Texas, Colorado, Houston and Nevada. They acquire property, obtain the zoning and development permits necessary and perform the construction marketing and sales of single-family homes (both attached and detached), town homes and flats. The company was founded in 2000 but was only offered as a publicly traded business in June of last year. At that time, shares were offered at $23.00/share, about 7% above where they trade as of Friday’s closing price of $21.46.
Even though housing prices have now been on the rise for a few years, they were decimated so badly in the 2008 collapse that the current Housing Affordability Index, as reported by the St. Louis Federal Reserve still sits well above its 30-year normal range. This indicates that housing remains very affordable at its current level of 153.1. The affordability index measure how easily the average person can afford the payments on an average house. The higher the number, the more affordable home ownership is.
Since the index is in a declining pattern and interest rates are expected to start rising soon, there is an added incentive for anyone wishing to buy a home in the near future to do so soon. Since we must have a place to live, this business also meets my desire to invest in businesses that provide critical products or services.
The currently level of affordability and the potential for interest rates to rise could easily combine to provide a catalyst for short term growth in this industry. On August 6 Century Communities released operating results for the quarter ended June 30. While the results of one company cannot be used to assess an entire industry, they revealed some very impressive results for this business. Some of the highlights of the most recent results compared to last year are:
- Net income increased 84% to $9.8 million
- Pre-tax income grew to $14.4 million, representing an increase of 79%
- Total revenue was up 137% to $189.0 million
- Home closings increased to 636 homes a rise of over 200%
- Gross margins in the homebuilding segment of the business increase 91% to $36.6 million
- Selling, General & Administrative (“SG&A”) as a percent of home sales fell to 12.2%, for an improvement of 243 basis points
- Adjusted EBITDA rose 87% to $19.0 million
- Net new home contracts increased 156%
- Backlog expanded to 1,005 homes, an increase of 155%
During the conference call to discuss the results, Chairman and Co-CEO Dale Francescon stated: “We achieved this growth while also maintaining our homebuilding gross margin percentage sequentially and further reducing our SG&A as a percent of home sales revenues compared to a year ago on our scalable platform. Into the second half of 2015, we are excited by our prospects to further grow our business, improve our profitability and meet expectations for full year 2015.”
He went on to inform the listeners that: “Our markets continue to exhibit positive fundamentals including rising employment and favorable population growth amid a limited supply of new homes which was evident as we ended the quarter with a record backlog of 1,005 homes.”
Chief Financial Officer Dave Messenger commented, “Given our positive results in the first half of 2015, we are increasing our full year 2015 guidance. Based on our current market outlook, for the full year 2015 we expect our home deliveries to be in the range of 2,200 to 2,600 homes and our home sales revenues to be in the range of $700 million to $800 million, excluding the impact of any future acquisitions. At the end of the full year 2015, we continue to expect our active selling community count to be in the range of 80-90 communities.”
These are pretty bullish comments for an earnings conference call and seem to provide an indication that the executive level of the company is quite comfortable with the current projections the analysts covering the stock have published.
How is the business currently valued?
The table below displays the company’s quarterly results over the past four reporting periods. Keep in mind that the worst periods for homebuilders will almost always be winter and spring because of the propensity for inclement weather. What the earnings history does show us is that, based on the trailing 12 months actual earnings of $1.29/share, the business currently carries a price to earnings multiple of 16.63, which is about 10% below the average for the S&P 500 which currently carries a multiple around 19 times earnings.
| Earnings History | Sep 14 | Dec 14 | Mar 15 | Jun 15 |
| EPS Est | 0.39 | 0.19 | 0.24 | 0.39 |
| EPS Actual | 0.19 | 0.34 | 0.30 | 0.46 |
| Difference | -0.20 | 0.15 | 0.06 | 0.07 |
| Surprise % | -51.30% | 78.90% | 25.00% | 17.90% |
So we have a business that is growing very rapidly with a that is quite affordable on an historic basis AND management that has openly express a level of comfort with the analysts’ forward projections.
To take this review of current valuation a step further, we can again refer to Yahoo!Finance and find the table shown below that compares Century to their publicly traded competitors in terms of several standard measures of comparison.
| Direct Competitor Comparison | Â |
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This table reveals that Century is priced very much in line with the overall industry based purely on the trailing 12Â months earnings. But profitable investing is about buying at the right price today compared to what we can expect in the future.
Exactly what are the analysts expecting going forward?
As reported on Yahoo!Finance and shown in the table below, Century Communities is expected to earn $1.99/share in the current fiscal year ending Dec. 31, 2015. They are also expected to earn $2.80/share next year.
| Earnings Est |
Current Qtr. Sep 15 |
Next Qtr. Dec 15 |
Current Year Dec 15 |
Next Year Dec 16 |
| Avg. Estimate | 0.48 | 0.77 | 1.99 | 2.80 |
| No. of Analysts | 4.00 | 4.00 | 4.00 | 4.00 |
| Low Estimate | 0.39 | 0.61 | 1.76 | 2.26 |
| High Estimate | 0.62 | 0.97 | 2.20 | 3.25 |
| Year Ago EPS | 0.19 | 0.34 | 1.03 | 1.99 |
If the analysts are correct in their projections, and management at Century has already suggested they are comfortable with them, Century is currently trading at a valuation of only 10.78 times this year’s earnings and 7.66 times 2016 earnings. These are absurd numbers for a business projected to expand this year’s earnings by 93% over 2014 and then follow that with another 40.7% growth in 2016’s earnings beyond the numbers projected for 2015!
And while the current valuation of the business looks reasonable compared to the industry based on the results from the trailing 12 months, when we look forward through the end of next year, we are looking at a business that is projected to grow almost twice as fast as the homebuilding industry in general. Yet it is value as an average business within the sector. Barring any substantial disruption in the broad economy, the homebuilding industry should remain strong as supply tries to catch up with demand and affordability remains attractive.
| Growth Est | CCS | Industry | Sector | S&P 500 |
| Current Qtr. | 152.60% | 64.10% | 54.20% | 5.10% |
| Next Qtr. | 126.50% | 48.50% | 41.30% | 8.80% |
| This Year | 93.20% | 42.10% | 17.30% | -0.30% |
| Next Year | 40.70% | 27.10% | 11.50% | 11.90% |
| Past 5 Years (per annum) | 0.00% | N/A | N/A | N/A |
| Next 5 Years (per annum) | 41.17% | 18.19% | 13.95% | 7.23% |
| Price/Earnings (avg. for comparison categories) | 10.78 | 15.67 | 13.91 | 5.82 |
| PEG Ratio (avg. for comparison categories) | 0.26 | 0.35 | -2.08 | 4.89 |
Based on the current P/E of 10.78 times 2015 earnings, the stock could double and still only be price at par to the broader market in general. It would have to rise almost 50% to simply be trading at a P/E equal to the industry average even though it is projected to grow earning at twice the pace of the industry over the coming five years. This is due to the fact that Century is operating in high growth geographic regions of the country.
Analysis summary
As stated earlier, Century Communities carried out its initial public offering (IPO) in June of 2014 and opened trading at $23/share. Today, we can buy the shares at about a 7% discount to that IPO price. The advantage we get over those who bought the shares a year ago is that we have a year’s worth of operations and earnings history we can review. We also didn’t have to suffer through the horrible decline the stock suffered all the way into January of this year that carried the share price down below $15.00.
When I am considering an investment, I always like to read the transcript of the most recent quarterly conference call. I also like to take a quick glance at any recent trends in the earnings estimates being presented by the analysts covering the stock. If the projections have been declining over the past 90 days, I will dig a bit deeper into the business to see if I can determine what it is that is causing the concern and reduced expectations.
If the estimates are rising, I take a look at the broad industry AND the individual business to see if there are any obvious reasons for optimism. In this case, we have already reviewed the favorable affordability index numbers for housing and the potential for that to change and the incentive it could provide to those considering a home purchase to go ahead and make a decision to buy. The rising earnings estimates by the analysts covering Century Communities seems to reflect the positive environment for homebuilders in general
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Final thoughts and actionable conclusions
From the current price of $21.46/share, the stock of Century Communities would have to rise by 39.8% just to be trading at a P/E of 15 times this year’s earnings. It would have to rise by 95.7% to be trading at a P/E of 2016’s projected earnings 12 months from now.
Given the strong growth the business is showing and the favorable environment for the homebuilding industry in general, it is fairly easy to make a very believable case for this stock to double in the next 12 months.
Value stocks don’t often move that fast and I don’t see that many opportunities to make triple digit returns in 12 months just because of the nature of the metrics I use when seeking opportunities. In this case, I might well have found the exception to that norm.
Buy Century Communities up to $23/share. Due to the cyclic nature of the homebuilding industry, I suggest using a 20% trailing stop on this position. Should the stock double in price, I would suggest moving the stop to 5% on half of the position and 25% on the second half to lock in a guaranteed profit but still retain some exposure to additional upside.
