NVR Inc. (NVR) is one of the largest homebuilders in the United States, operating in thirty-four metropolitan areas in fourteen states and in Washington, D.C. The Washington D.C. metropolitan area is its largest market, accounting for approximately 16% of NVR’s home closures in 2021 and ~22% of its homebuilding revenue. The company sells homes under the trade names Ryan Homes, NV Homes and Heartland Homes. While Ryan Homes is primarily marketed to first-time buyers and first-time buyers, NV Homes and Heartland Homes are aimed at premium and luxury buyers.
One thing that differentiates NVR from other home builders is the fact that it does not engage in land development. Instead, it typically acquires finished lots from third-party developers pursuant to fixed-price finished lot purchase agreements (LPAs) that require deposits that can be forfeited if the company fails to meet the LPAs. Deposits required under LPAs are generally up to 10% of the total purchase price of finished lots.
This strategy helps NVR avoid the financial demands and risks associated with direct land ownership and land development. If the company chooses not to perform under these LPAs, its obligation and its economic losses are limited to the amount of the deposit that the company has made. It is a low-risk strategy that requires less capital deployment and thus improves the company’s return on equity.
Key NVR Inventory Metrics
Given the company’s lean business model, one of the most important metrics for it is return on equity. The company’s return on equity is around 40.51%, while most listed homebuilders are in their 20s. Even the best in class home builder, DR Horton’s (DHI) the return on equity is about 9% lower than that of the NVR. The company’s return on assets is also relatively high for similar reasons. The following table compares NVR’s return rates with DR Horton, Pulte Group (PHM), Lennar (LEN) and Toll Brothers (TOL).
The business is doing well in other metrics as well thanks to the strength of the housing market. Its revenue increased by 18.73% in fiscal 2021, with an increase of approximately 9% in the number of units delivered (or settlements) and the average sale price (or settlement). If we compare the current average selling price of $403.9k with an average backlog price of $454,200, it looks like the average selling price is still on the rise in the coming quarters.
The company’s gross profit margin also improves as selling, general and administrative (SG&A) expenses as a percentage of revenue decline.
Is NVR stock overvalued?
If we look at NVR’s current valuations, it is trading at 10.98x forward earnings versus its 5-year average forward P/E of 16.55x. So clearly the company is not overvalued relative to its historical valuations. If we look at the sell-side consensus estimates, it is expected to show revenue growth of around 18.70% year-over-year in the current year, while its earnings are expected to grow by around 39.78% in year-on-year. The stock is trading at such a low P/E multiple due to concerns surrounding the potential impact of anticipated interest rate hikes on the housing market. However, I believe these concerns are already being reflected in valuations, with stocks trading below historical levels. NVR successfully weathered past downturns and came out much stronger on the other side of the cycle. I expect a similar outcome this time around as well and therefore find current valuations attractive.
How does NVR’s rating compare to its peers?
If we compare the P/E ratio of NVR with its peers, it appears on the higher side. However, the company’s high return on equity along with a low risk light asset strategy also means that the company can grow its earnings at a higher rate over the long term and with lower risk. For example, if we compare NVR with any other homebuilder that has a large amount of real estate on its balance sheet, the other homebuilder will face significant depreciation risk if the real estate market crashes. We saw it during the great housing recession. However, for NVR, the losses will be limited to the deposit it has paid. For this reason, the NVR typically trades at a premium to other asset-intensive homebuilders.
There’s another reason why I’m not too worried about NVR’s relatively higher valuation compared to its peers. Valuations for almost all homebuilders are extremely low on an absolute basis. Therefore, although it is relatively higher, the NVR still looks very attractive.
Is stock NVR a good long-term choice?
The NVR is a good long-term investment. The company’s high return on equity makes it a good long-term compound. Management is also doing a good job in terms of returning cash to shareholders. The business is run efficiently and the general and administrative expenses of the business as a percentage of revenue are lower than those of its peers. Additionally, the company’s low-risk strategy ensures its long-term survival through various real estate cycles.
Also, despite concerns about potential interest rate hikes that could impact home sales, I remain optimistic about the industry’s long-term outlook. If we look at industry data, there was significant underbuilding in the housing industry in the decade following the Great Recession. I believe this has created a mismatch between supply and demand and even if the interest rate rises, housing demand will likely remain strong. I’ve talked about it in a previous post here, but I’ll briefly summarize it here. From 1959 to 2007, total annual US housing starts averaged about 1,546,900 homes, while single-family housing starts averaged about 1,101,800 homes. . However, from 2008 to 2019 there has been significant underbuilding with total annual housing starts of approximately 949,400 and single-family housing starts of approximately 656,500.
Thus, from 2008 to 2019, there was an average annual deficit of approximately 597,500 [ =1,546,900 – 949,400 ] total houses and ~445,300 [ =1,101,800 – 656,500] single-family homes relative to long-term averages. In other words, to get back to long-term averages over the next decade, total housing starts would have to average about 2,144,400. [ =1,546,900 + 597,500] and single-family housing starts will need to average ~1,547,100 [ =1,101,800 + 445,300] from 2020 to 2031.
There is a significant amount of pent-up demand in the market that has been unleashed after the pandemic. While we should undoubtedly see some slowdown in interest rate hikes, I don’t think we’ll see anything like what happened in the Great Recession. Once inflation is brought under control and interest rates stabilize, the cyclical recovery could resume in housing, to the benefit of homebuilders.
Is NVR action a buy, sell or hold?
Often, due to an overreaction of the market, we end up getting a well-managed, high-quality company at a reasonable valuation. This is one of those instances where concerns over upcoming interest rate hikes have resulted in a good buying opportunity for potential NVR investors.
If we look at the SA authors’ rating, the Wall Street ratings, and the quantitative ratings, all indicate that the stock is a good buy at current levels.
NVR is a good buy at current levels due to its extremely attractive valuations (~10x P/E), low-risk model (which provides a downside cushion in the event of a property market downturn), and good track record of execution.