The Bull Case for NVR (NVR)

With Quiver Quantitative’s recent institutional holdings data (NVR Institutional Holdings (quiverquant.com)), we can see that hedge funds and asset managers have been increasing their holdings in NVR Inc. (NYSE: NVR). Firms such as T. Rowe Price, Dimensional Fund Advisors, and Artisan Partners have all recently added to their NVR positions. Most notably, T Rowe Price increased shares held by 60.29% (as filed on 9/30), bringing their total NVR holdings to 65,667 shares worth around $469.2 million dollars at current market prices. With this in mind, we took a closer look at some of the reasons why many investors may be bullish on NVR Inc.

In October, NVR reported earnings results for the third quarter of FY23. Highlights of the quarter included net income of $433.2 million dollars, implying a 5% increase YoY ($125.26/diluted share). Other highlights included 4,746 units of new orders during the quarter (7% increase YoY) and an increase in the average sales price of a new order (1% growth YoY), coupled with a decreased cancellation rate YoY. NVR’s quarterly earnings reports are quite barebones, and despite this, we can see that the business is continuing to operate efficiently, growing bottom-line profit YoY while continuing to effectively grow the business (as evidenced by new order growth YoY). With these earnings results in mind, we believe that NVR is an extremely compelling investment opportunity trading at extremely cheap valuations. Oftentimes, high quality businesses like NVR trade at a premium due to their superior future earnings potential. However, this currently isn’t the case with NVR, giving investors ample opportunity to enter into a cheap position into one of the best run and efficient stocks on the stock market.

NVR, distinguished as one of the largest homebuilders in the United States, primarily generates revenue through the construction and sale of single-family detached homes, townhomes, and condominiums. The company operates under three trade names: Ryan Homes, NVHomes, and Heartland Homes, targeting a range of customers from first-time buyers to luxury home markets across thirty-five metropolitan areas in fifteen states and Washington, D.C. A key aspect of NVR's business model is its conservative lot acquisition strategy, which involves purchasing finished building lots through fixed-price agreements, thereby minimizing financial risks and dependencies associated with direct land ownership and development. This approach, along with their focus on pre-sold home construction and mortgage banking services through NVR Mortgage Finance, Inc., positions NVR as a largely non-cyclical player in the homebuilding industry, capable of mitigating the adverse effects of regional economic cycles.

In the highly competitive housing industry, NVR faces significant challenges from a wide array of homebuilders, ranging from local firms to national corporations, some with greater financial capabilities. Additionally, the company contends with competition from the home resale market. The homebuilding operations of NVR primarily vie for market share based on factors such as price, location, design, quality, service, and reputation, and despite these challenges, NVR has historically maintained a leading position in its operational markets. The housing market's cyclical nature, influenced by consumer confidence, economic conditions, and interest rates, further complicates the landscape. Factors like the availability and cost of land, labor, and materials, shifting consumer preferences, demographic trends, and mortgage finance availability also significantly impact the industry. NVR's dependence on a steady supply of building materials, often challenged by factors such as increased construction activity and supply chain disruptions, as seen during the COVID-19 pandemic, adds another layer of complexity to its operational environment.

Management is solid, and their capital allocation priorities do a great job of creating long-term value for shareholders. NVR likes to return excess cash to shareholders via share repurchases, and NVR has a long standing tradition of repurchasing shares despite the business’ extremely low count of shares outstanding. NVR repurchased 96,346 shares in FY20, 322,038 shares in FY21, and 323,652 shares in FY22. These are significant repurchases given the small number of shares outstanding. It also seems that, based on the amount of shares repurchased in each fiscal year, that NVR does a great job of only repurchasing shares when it makes sense (i.e. repurchasing shares when they are trading near or below intrinsic value). This is an extremely important characteristic of share repurchases, as it is a poor capital allocation strategy to repurchase shares trading far above intrinsic value (overpaying for share repurchases means that you are not getting enough “bang for your buck” and that you are missing out on additional repurchases). Additionally, these repurchases also help reverse the dilutive effect of the business’ equity plan (NVR issues new shares outstanding to give to employees and management). In FY21 and FY22, the amount of share repurchases more than eclipsed the number of new shares issued for this equity plan (FY20 was the exception, as the business repurchased a historically low number of shares). While management likes to return value to shareholders via share repurchases like highlighted above, NVR has never paid a cash dividend on its common stock, with no plans to do so in the future (according to their most recent 10-K). We are fans of this policy, as we believe share repurchases and reinvestments back into the business at high rates of return are much better capital allocation priorities that do a great job of creating long-term shareholder value. 

In terms of management incentives, management is incentivized well, with a compensation structure that does a great job of aligning shareholder and management interests, while also doing a great job of retaining executive talent over the long-term. The NEO compensation mix is composed of a base salary (15% of total compensation), an annual bonus opportunity (15% of total compensation) and a long-term incentive opportunity (70% of total compensation). In FY22, the annual bonus opportunity was based on new orders (20% weighting) and consolidated per-tax profit (80% weighting). These metrics are very important to the business, and this compensation structure does a great job of incentivizing NEOs to meet and even exceed predetermined goals based on these financial metrics. Additionally, 70% of the compensation structure is paid out via equity rewards in the long-term incentive opportunity. This is also extremely important, as it allows management to build equity in the business. This retains management over the long-term and puts a lot of their total compensation in the hands of the business’ stock and how it performs. Essentially, management is incentivized to meet important financial metric goals and drive stock price appreciation, much to the delight of long-term shareholders.

NVR is a very efficient business. The business currently operates at a LTM ROE of 45.1% and a LTM ROIC of 39.3%. With a WACC of 8.9%, NVR currently operates at a ROIC to WACC ratio of 4.42x, showcasing the business’ ability to generate excess returns on capital relative to the business’ weighted average cost of capital. Businesses that operate with strong returns on capital are compounders, businesses that are able to rapidly compound earnings and intrinsic value over the long-term, much to the delight of long-term passive shareholders. Looking further, we can see that NVR has had stellar sustained growth in operating income (EBIT), paired with material EBIT margin expansion, within the last ten years. Looking at operating income is important, as it shows the profitability of a business’ core operations. Since 2013, NVR has grown operating income at a CAGR of 17.5%. Additionally, during that same time frame, operating margins expanded from 10.8% of revenue in 2013 to 20.6% of revenue today (LTM Operating Margin). 

Analyzing NVR’s income statement, we can see some stellar sustained growth in revenue, gross profit, and earnings within the last ten years. Since 2013, NVR has grown revenue at a CAGR of 9.6%, with gross profit growing at a CAGR of 13.9% in that same time period. The excess growth in gross profit relative to revenue can largely be attributed to expanding gross margins. In 2013, NVR operated at a gross margin of 18.2% of revenue, compared to today where the business operates at a gross margin of 26.4% of revenue (LTM gross margin). This material expansion in gross margins over the last decade hints to the fact that NVR might benefit from pricing power. These margin expansions show that the business has been able to raise prices with a smaller increase in COGS, which shows that the business may have strong competitive advantages in the homebuilding industry . In terms of earnings, NVR has grown EBITDA at a CAGR of 17.3% since 2013, with EPS growing at a CAGR of 25% in that same time period. This large growth in EPS can largely be attributed to share repurchases. NVR is a cannibal, decreasing shares outstanding by 28.9% since 2013 through share repurchases.

Looking at NVR’s balance sheet, we can see that the business operates in solid financial health. NVR holds around $2.88 billion dollars worth of cash and equivalents on the balance sheet, paired with no short-term borrowings and $913.5 million dollars worth of long-term debt. With a net debt of -$1.85 billion dollars (meaning that the business holds around $1.85 billion dollars of excess cash on the balance sheet), we can see that NVR has a very long runway to cover its current long-term debt obligations. It is a great characteristic for rapidly compounding businesses like NVR to operate with a low debt load relative to cash. When businesses don’t have to worry about debt, they can put money to work in other places that create long-term value for the business and shareholders. For example, the business can use the cash to further share repurchases (NVR’s management has continued to repurchase shares and lower shares outstanding, despite the business’ low shares outstanding count of around 3.18 million shares), reinvest back into the business at high rates of return (NVR has a high ROIC to WACC ratio of 4.42x), and offer/increase a dividend. All of these initiatives create value for shareholders and allow for NVR to continue to rapidly expand intrinsic value over time.

Analyzing NVR’s cash flow statement, we can see some stellar sustained growth in net income and free cash flow within the last ten years, showing the increased operational efficiency of the business over time. Since 2013, NVR has grown net income at a CAGR of 20.5%, with free cash flow growing at a CAGR of 22.1% in that same time period. This growth in free cash flow can largely be attributed to expanding free cash flow margins. In 2013, NVR operated at a free cash flow margin of 6% of revenue, compared to today where the business operates at a free cash flow margin of 18% of revenue (LTM free cash flow margin). The large expansion in free cash flow margins within the last decade acts as a catalyst for future free cash flow generation. Expanding free cash flow margins and strong top-line revenue growth act as a “twin engine” for free cash flow generation. With this ever increasing pile of free cash flow, NVR can use it to reinvest back into the business at high rates of return, continue to repurchases shares, and offer/increase a dividend like mentioned above.

After conducting a reverse discounted cash flow analysis, we can see that NVR is trading at share prices that imply a -1.4% growth rate (CAGR) in free cash flow over the next ten years, using a perpetuity growth rate of 3% (largely in line with US GDP growth) and a discount rate of 8.9% (NVR’s WACC). As highlighted above, we believe that NVR is an extremely high quality business, and we believe that the market is severely underestimating NVR’s ability to generate free cash flow going forward. Even despite positive tailwinds for the general homebuilding industry, NVR is trading at an insulting low valuation. While past performance is not indicative of future results, we believe that a more accurate growth rate to place on NVR’s future free cash flows is 10%, which implies a share price of $15,327/share and an implied return of 114.4%. Please keep in mind that these valuations and projections are based solely on our proprietary models and their inputs, and we encourage all investors to do their own due diligence before entering into a position in NVR.

Keep an eye out for NVR stock’s latest news, data, and more with Quiver Quantitative (NVR | NVR, Inc. Stock Data, Price & News (quiverquant.com)).

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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