Among the 20 new stocks recently purchased by David Tepper (Trades, Portfolio) for his Appaloosa LP hedge fund is D.R. Horton, Inc. (DHI, Financial), the largest homebuilder in the U.S.
I like to follow what Tepper buys because of his hedge fund's outstanding record. According to the GuruFocus Scoreboard, he is a long-time leader in returns. As this excerpt from the Guru Scoreboard shows, Tepper is tied for second place for the best 10-year returns:
DR Horton is a stock that investors have been in love with for the past year:
With a chart like that, it’s tempting to think the company is overvalued, but personally, I don't think that's the case.
About D.R. Horton
The company calls itself the largest homebuilding company in the U.S., as measured by the number of homes closed (sold). It operates under several brand names, including D.R. Horton, America’s Builder, Emerald Homes, Express Homes and Freedom Homes. They are segmented by market, as shown on its website:
It was founded in Fort Worth, TX in 1978 and has traded publicly since 1992. Expansion has taken it from a single location to 91 markets in 29 states, and diversification means it now sells homes ranging in price from $150,000 to more than $1,000,000. In 2020, it closed 65,388 homes at an average closing price of $299,100.
While it also offers mortgage financing, title services and insurance agency services, homebuilding accounted for 97% of its revenue last year.
In its 10-K for 2020, the company reported that its operating strategy focuses on enhancing long-term shareholder value by leveraging its financial and competitive position. Its tactics include:
- Attracting and keeping staff that are “aligned and focused on continuous improvement in our operational execution and financial performance.”
- Diversifying geographic risk by allocating and actively managing its inventory across operating markets.
- Developing new home communities that serve entry-level, move-up, active adult and luxury homebuyers.
Competition
The company reported that it operates in a highly competitive environment. Competitors include national, regional and local homebuilders, as well as resales of existing homes and the rental market. As for the home construction business, companies compete on price, location, quality, design and mortgage financing terms.
GuruFocus lists these five companies as America’s biggest publicly-traded home builders by revenue:
- D.R. Horton Inc : $24,170.60
- Lennar Corp (LEN, Financial): $23,308.99
- PulteGroup Inc (PHM, Financial): $11,470.89
- NVR Inc (NVR, Financial): $8,004.33
- Toll Brothers Inc (TOL, Financial): $7,690.66
Financial strength
As a home builder, D.R. Horton must put up some or all of the cash needed to buy and develop land and construct new homes. Later, when the title to a house transfers to the new owner, the company receives and recognizes the revenue. In cases where a customer requests custom changes, upgrades or other options, payment comes in advance.
For its mortgage and title businesses, it also must invest funds upfront, funds that customers will later repay; similarly, it must create reserves before selling insurance.
All these activities mean homebuilders must operate with relatively heavy debt, but like banks making loans, they generate revenue through these activities.
Of course, a homebuilder with strong cash flow has an edge because it is its own source of capital. D.R. Horton’s cash flow and its uses are shown in this slide from the fiscal Q2 2021 presentation:
It scores well on both the Piotroski F-Score and Altman Z-Score; the 7.00 on the former suggests a “very healthy situation,” and 6.01 on the latter is considered “strong.” The company’s return on invested capital (ROIC) is nearly double its weighted average cost of capital (WACC), indicating value creation for shareholders.
Profitability
D.R. Horton has generated strong and consistent margins across the past decade:
Return on equity (ROE) was even stronger in fiscal 2020 (which ended on Sept. 30, 2020):
Revenue has grown by an average of nearly 20% per year over the past 10 years:
Although the line on the graph doesn’t rise as dramatically, Ebitda has been growing even faster than revenue:
EPS has grown by an average of 25.69% per year:
As noted, these graphs and data relate to the 10 years ending Sept. 30, 2020. What has happened since then? Have soaring prices for lumber and other products hurt the company?
According to the second quarter fiscal 2021 earnings release, for the period that ended March 31, the metrics were actually even better than those in the same period of 2020:
- Consolidated revenues increased 43% to $6.4 billion.
- Net income per diluted share was up by 95%, to $2.53 billion.
- Net sales orders increased 35%.
- It bought back 4.5 million shares for $350.4 million.
The release also guided the following for full year fiscal 2021:
- Consolidated revenues of $26.8 to $27.5 billion, compared to $20.3 billion in fiscal 2020.
- 82,500 to 84,500 homes closed, compared to 78,458 homes in 2020.
- Share count down 1.5% compared to the end of fiscal 2020.
So, it’s clear that higher material costs aren’t expected to dampen growth, suggesting, in turn, that consumers are prepared and able to pay more for their new homes.
Performance
As the following chart from the 10-K for 2020 shows, D.R. Horton pulled ahead of the pack and the S&P 500 in fiscal 2020:
More specifically, it has had the following annualized returns:
- 2021 year-to-date: 29.22%
- One year: 60.05%
- Three years: 28.40%
- Five years: 24.41%
- 10 years: 23.97%
Total annual returns, by year, have been:
- 2017: 86.86%
- 2018: -14.67%
- 2019: 26.65%
- 2020: 56.86%
- 2021: 28.64%
Dividend and share repurchases
D.R. Horton has aggressively grown its dividend over the past decade:
However, it doesn’t look like much in the table above because the share price has also risen:
After seven straight years of increasing its share count, it started buying back shares two years ago:
Valuation
As this 10-year trailing 12-month chart shows, investors have enjoyed excellent capital gains through the past decade:
Given the sharp increase in the stock price since March 2020, some observers consider the shares overvalued. For example, the GuruFocus Value Chart rates it as "modestly overvalued:"
However, earnings have also been growing, giving D.R. Horton a modest price-earnings ratio of 10.21. The median for the homebuilding and construction industry is 12.88.
Ebitda has also gone up rapidly, by an average of 19.20% per year. Combined with the relatively low price-earnings ratio, that gives the company a PEG ratio of 0.53, well below the fair value target of 1.00 (PEG refers to the price-earnings ratio divided by the growth ratio, with the growth ratio being the five-year Ebitda rate).
The discounted cash flow (DCF) calculator also considers the company undervalued. Based on three-and-a-half star predictability rating, the calculator shows a significant margin of safety:
Gurus
Overall, the gurus have bought and sold roughly the same number of shares over the past two years:
At the end of March, the company was in the portfolios of 17 gurus., including:
- George Soros (Trades, Portfolio) of Soros Fund Management: 4,407,755 shares representing 1.22% of D.R. Horton’s shares outstanding and 8.4% of the fund’s holdings.
- David Tepper (Trades, Portfolio), who had a stake of 1,165,000 shares at quarter’s end.
- Pioneer Investments (Trades, Portfolio) reduced its stake by 21.23% during the quarter to finish with 1,002,252 shares.
Conclusion
It should be no surprise that David Tepper (Trades, Portfolio) took a significant stake in D.R. Horton in the first quarter. The guru probably saw its robust growth on both the top and bottom lines, its ability to allocate its capital resources and its insulation from rising material prices.
Today, it looks undervalued based on the price-earnings ratio, PEG and DCF metrics. It also pays a solid dividend that is obscured by the rising share price. And, of course, there is the current tailwind provided by consumer demand for housing. Its history also suggests the company will continue to do well in the long term, regardless of the short-term fluctuations in the housing market.
Value investors prepared to live with some debt may find the company’s valuation a reason to look more closely, in my opinion. I don't think the housing bubble has reached its peak just yet. Growth investors who expect the housing market to keep growing might also be interested, and income investors who would like consistent capital gains and dividend income could also give D.R. Horton their attention.
