Saturday, May 12, 2012

The Fresh Market - Like Whole Foods But Better


The Fresh Market

The Fresh Market is a 113-store grocery chain aimed at middle to upscale demographics. With roughly two-thirds of sales from perishables – including whole and natural foods – TFM is similar to Whole Foods in product range and target market.

I recommend buying TFM. At roughly one-sixth WFM’s system-wide square footage, and no stores in the country’s western half, TFM offers much better long-term store growth opportunities and far better current profit margins than its larger peer.  

As with Whole Foods, TFM’s growth prospects have begun to accelerate over the past four to six months, compared to already high levels of growth. For its recently reported January quarter TFM posted 7% comparable sales growth, its fastest quarterly increase in five years. Around this same time WFM’s comps jumped 8.7%, and its management said the first few weeks of its April quarter had risen 9.4%. (Please see table below.)



Comparable Sales


12E
11
10
09
08
07
Fresh Market
TFM
6.5%
5.0%
5.0%
-1.1%
-1.5%
4.5%
Whole Foods
WFM
8.5%
8.4%
6.5%
-4.3%
3.6%
5.8%

With demand rising at the high end of the grocery market, TFM’s recent guidance of 4-6% comparable growth in FY12 is beginning to look conservative. Given comparable sales increases of <4.5% in the first half of the prior year (FY11), H112 (ends July) are the easiest comparisons since 2009.

Even though the bulk (5.7% of 7%) of Q4’s comparable sales were driven by increased traffic levels, gross margin rose more than 50 bp’s. As pricing / traffic is more consistent with past levels in 2012 of 50/50, expect gross margin improvements will more than offset any cost pressures related to new units planned for the western US.

Already, TFM’s operating margin is well ahead of WFM’s. (Please see table below) As scale economies begin to work in TFM’s favor, look for overhead costs (i.e. G&A) to fall and TFM’s overall margin lead to widen.


Operating Margin

12E
11
10
09
08
07
TFM
7.9%
7.5%
7.1%
6.1%
4.6%
4.9%
WFM
6.0%
5.4%
4.9%
3.5%
3.6%
4.5%

From its current base of just 113 stores, I expect TFM will grow its store base by 12-15% yearly (>2x WFM’s potential growth), toward management’s goal of 500 units. (Please see table below.)


Stores

12E
11
10
09
08
07
TFM
128
113
100
92
86
77
WFM
339
314
299
284
275
276


The average TFM store size of 21,000 square feet is just over half the size of the typical WFM allows TFM to operate in smaller markets, where WFM cannot go. But as it enters new markets, TFM will increasingly face WFM (rolling out smaller, 33,000 sq. ft. stores), and other grocers, for competition in the same market. But, judging from in-market competition in places like Atlanta and South Florida, there is room for both competitors to remain highly profitable while drawing from the same population base.  

Wednesday, June 8, 2011

Three All Weather Builders to Buy: NVR, TOL, MDC

The broad economic headwinds still facing builders, highlighted in my recent report (“Housing: No Worse, But No Better”), suggests a cautious approach to homebuilders. This risk-averse view is based primarily on the following general industry assumptions:
1. existing home sales at 5m pace
2. new home sales at 300k rate
3. overall home prices flat in 2011 (ex distressed sales)

Below I recommend the three homebuilder stocks, NVR, Toll Brothers (TOL), and MDC, that I consider best positioned for this low-demand environment. Each of these builders has unique competitive advantages (discussed individually below), along with characteristics I consider key to thriving in, or at least riding-out, the down-cycle:
1.      little to no debt
2.      rising prices in backlog
3.      prospective profits in 2011
4.      attractive valuations

NVR
This builder owns no land outright, purchasing all its (finished) lots through options. (Please see table below.)


Homesites (2010)

Total
Owned
Beazer Homes
28,996
23,176
DR Horton
119,400
89,700
K Hovnanian
32,055
14,379
KB Home
39,540
30,227
Lennar
104,456
84,482
MDC
12,194
8,035
Meritage
15,224
12,940
NVR Inc.
52,300
-
Pulte Homes
149,253
133,380
Ryland
24,539
16,300
Standard Pacific
23,549
17,650
Toll Brothers
34,852
28,891
Source: SEC filings.

This unique, asset-zero approach, while heavily dependent on development partners, allows significant returns on investment (near 100%) in good times. In difficult times negligible inventory limits carrying costs (and associated risk of depreciating land) and helps ensure substantial profitability. (Please see table below.)


GrossProfit

Pretax Profit

11E
10
09

11E
10
09
Beazer Homes
47
86
21

(192)
(148)
(187)
DR Horton
566
682
65

25
100
(552)
K Hovnanian
24
9
(565)

(285)
(295)
(672)
KB Home
254
273
114

(41)
(76)
(311)
Lennar
533
539
284

101
95
(760)
MDC
161
146
150

30
(71)
(107)
Meritage
151
168
4

23
3
(155)
NVR Inc.
574
543
497

362
322
298
Pulte Homes
249
343
(400)

(272)
(351)
(1,975)
Ryland
98
122
(35)

15
(85)
(260)
Standard Pacific
183
217
142

(18)
(12)
(110)
Toll Brothers
85
112
(197)

26
(117)
(496)
Source: SEC filings.

In fact NVR is the only large builder to post profits each year through the downturn. Nearly half its revenues and the majority of its profits arise from the Washington, D.C. and Baltimore, markets which continue to buck weak national housing trends. For example, in March (the most recent measurement period), Washington D.C. was the only metro to have higher average sales prices in the Case Shiller 20 index.

NVR is the most expensive homebuilder, if based on book value, at around 2.2x. However this measure gives the company little credit for its huge net cash position (about $1.2 billion) or its buyback program – by which its has reduced share count by 5% in the past year. More appropriate, is EV/BV, which at 1.7x for NVR, is a discount to the group’s 1.8x (Please see Valuation at the end of this report.)

Toll Brothers (TOL)
At about $550,000, TOL’s average home price exceeds all builders’. (Please see table below.) Having a near-monopoly among production builders aimed at high end buyers, gives TOL considerable advantage, in good times and bad. In 2010, options on its (single family) homes averaged $145,000, and generated gross margins that I estimate between 30% and 40%.


                Average Selling Price ($000)


11E
10
09
08
07
06
Beazer Homes
205
215
231
253
287
285
DR Horton
211
206
213
234
259
274
K Hovnanian
283
290
289
305
343
329
KB Home
221
215
207
236
262
278
Lennar
258
246
247
271
292
300
MDC
291
284
278
303
338
354
Meritage
259
254
238
268
304
324
NVR Inc.
306
297
296
338
373
399
Pulte Homes
259
259
258
284
322
337
Ryland
242
242
245
201
235
295
Standard Pacific
348
346
313
336
390
380
Toll Brothers
552
566
592
655
672
692
  Average
286
285
284
307
340
354
Source: SEC filings.

Toll Brothers’ luxury skew attracts buyers with relatively attractive credit profiles and lower average loan to value ratios. Meanwhile, TOL’s own balance sheet is investment grade, rare among builders. Finally, insiders own 16% of the shares.

Only half of TOL’s sales volumes (measured by unit sales) in 2010 is derived from single family, with a growing portion of turnover driven by lower risk areas, including multi-family (28% of units), active adult (13%) and high rise (9%).

One caveat: because TOL participates in its own development activities, it tends to carry a large amount of inventory, i.e., more than $3 billion, or 2.3x 2011 estimated sales, the highest ratio among all builders.

MDC
The company is inventory lean, with yearend 2010 inventories, representing less than half of the sales I expect for the current year. MDC’s owned lot position (in the previous table) rarely exceeds more than 70% of all its controlled land. Its low inventory levels free up cash that it distributes to shareholders through a dividend yielding a group-high 4%.


Inventory / Sales

11E
10
09
08
Beazer Homes
1.7x
1.3x
1.6x
1.5x
DR Horton
0.9x
0.9x
1.3x
1.4x
K Hovnanian
0.8x
0.8x
1.4x
1.1x
KB Home
1.0x
0.9x
1.2x
1.1x
Lennar
1.5x
1.5x
1.6x
1.0x
MDC
0.4x
0.6x
0.7x
1.0x
Meritage
0.8x
0.7x
0.9x
0.8x
NVR Inc.
0.1x
0.1x
0.1x
0.2x
Pulte Homes
1.1x
1.0x
1.0x
1.1x
Ryland
0.8x
0.6x
0.9x
0.9x
Standard Pacific
1.3x
1.0x
1.1x
1.4x
Toll Brothers
2.3x
2.1x
2.4x
1.8x
  Average
1.1x
1.0x
1.2x
1.1x
Source: SEC filings.
Note: 11E represents 2010 actual inventory dividend by 2011 estimated home sales.

About 80% of MDC’s land inventory represents purchases made since 2009, implying favorable lot costs and few impairments. In fact, the company has the second-best record for impairments (after NVR) and, thanks in part to minimal land charges, has consistently among the highest gross margins in the group.

MDC’s debt is investment grade. Its net cash (after debt) is around $300 million, about one-fourth of today’s $1.2 billion market capitalization, or about $6 per share.

Valuation
Asset-based multiples are the best valuation method for builders. Underlying book values – mostly land inventories – are relatively solid, for two main reasons:
  1. few material land impairments have occurred since big revaluations ended in 2009
  2. most of land on existing books – bought since 2009 – reflects today’s depressed values
  3. industry profitability is linked to home prices, which are stabilizing
           
Price / Book

EV/Book

11E
10
09
08
07
06

11E
10
09
08
07
06
Beazer Homes
0.8x
1.0x
1.0x
0.2x
0.2x
1.1x

2.5x
2.5x
5.9x
3.1x
1.2x
2.0x
DR Horton
1.2x
1.4x
0.9x
0.5x
0.4x
0.7x

1.5x
1.6x
1.3x
1.0x
0.9x
1.1x
K Hovnanian
nmf
nmf
nmf
0.4x
0.3x
1.0x

nmf
nmf
nmf
5.3x
2.0x
2.1x
KB Home
1.2x
1.4x
1.5x
1.3x
0.9x
1.4x

2.5x
2.8x
2.4x
2.2x
1.4x
2.1x
Lennar
1.1x
1.3x
0.9x
0.5x
0.7x
1.4x

1.9x
2.0x
1.5x
1.0x
1.2x
1.8x
MDC
1.1x
1.2x
1.1x
1.0x
1.2x
1.2x

0.9x
0.9x
1.5x
1.3x
1.1x
1.4x
Meritage
1.3x
1.5x
1.3x
0.7x
0.4x
1.5x

1.8x
1.9x
1.7x
1.5x
1.1x
2.3x
NVR Inc.
2.2x
2.5x
2.4x
1.8x
2.4x
3.1x

1.7x
1.8x
3.2x
2.5x
3.8x
2.9x
Pulte Homes
1.1x
1.3x
1.2x
1.0x
0.6x
1.3x

1.9x
2.0x
2.0x
1.5x
1.2x
1.7x
Ryland
1.1x
1.5x
1.5x
1.0x
1.0x
1.4x

1.7x
1.8x
1.7x
1.6x
1.5x
1.8x
Standard Pacific
1.1x
1.2x
0.9x
0.4x
0.2x
0.9x

2.2x
2.2x
2.3x
2.7x
1.9x
2.1x
Toll Brothers
1.3x
1.4x
1.2x
1.1x
0.9x
1.4x

1.5x
1.5x
1.3x
1.2x
0.7x
1.8x
  Average
1.3x
1.4x
1.3x
0.8x
0.8x
1.4x

1.8x
1.9x
2.2x
2.1x
1.5x
1.9x
Source: SEC filings.