Hovnania Stocks: Lower Mortgage Rates and Quick Move Homes, Undervalued (HOV)

Hovnanian Enterprises, Inc. (NYSE:HOV) continues to generate impressive net sales growth driven by declining mortgage rates. In my view, a further decline in interest rates, organized “look” packages and the company’s strategy to move houses quickly could bring significant free cash flow. generation in the coming years. I also believe that the recent decrease in total debt, increase in assets, and increase in free cash flow may accelerate demand for the stock and push the stock price higher. Putting it all together and taking into account risks from rising interest rates, labor shortages or raw material shortages, HOV looks significantly undervalued at the current price level. In my view, the ongoing share buyback may increase the share price in the coming years.

HOV

Founded in 1959, the company designs and sells detached single-family homes, among other types of homes. The company presents itself as one of the largest residential home builders in the country. The company also offers mortgage and title services to clients. If we look at the number of employees dedicated to home building operations and financial services, it seems clear that HOV is primarily a home builder. Financial services do not appear to be the company’s core business model.

As of October 31, 2023, we employed 1,715 full-time employees, of whom 1,134 were engaged in our homebuilding operations, 143 were engaged in our financial services operations and 438 were engaged in our corporate operations. Source: 10-k

I think HOV is having a great time now. It is worth reviewing the company’s business model and prospects. In 2024, market participants in the home industry saw a decrease in mortgage rates, which appears to have a beneficial effect on the company’s net sales growth. Current interest rate conditions benefit the company’s business model, and HOV appears to be quite aggressive. The following lines were obtained from the latest quarterly report.

We have been aggressive in our pricing, incentives and concessions to align with today’s market. Source: 10-Q

I don’t usually look at the latest financial numbers, but the numbers in this case are so good that it’s worth including some numbers. We’re talking impressive quarterly income growth as well as increases in average home prices. If the company delivers further beneficial earnings growth, we could see demand for the stock.

For the three and nine months ended July 31, 2024, home sales revenue increased 9.1% and 8.2%, respectively, compared to the same periods a year ago. Home sales revenue increased due to a 4.8% and 7.1% increase in homes delivered, respectively, as well as a 4.1% and 1.0% increase in the average home price for the three and, respectively, nine months ended July 31, 2024. , compared to the periods of the previous year. Source: 10-Q

Fast moving homes could accelerate net sales in a high interest rate environment

The company’s new strategy based on the design of fast-moving homes could bring substantial growth in future net sales in the coming years. These offers are specially designed for customers who need to know exactly what their mortgage payments will be. HOV also reported a significant reduction in the complexity of these new strategies and an increase in commercial efficiency. My financial model includes beneficial assumptions about the new fast moving house strategy.

As a result of the sharp increase in interest rates starting in FY 2022, we have shifted our focus to increasing the availability of fast-moving housing. The reason behind this change in focus is that QMI homes offer our customers more certainty about their mortgage payments at closing. QMI homes also allow us to offer customers mortgage rate discounts that would be cost prohibitive for homes with a longer lead time. QMI houses greatly reduce the complexity of choices for our customers and significantly increase efficiency for our trade, construction and procurement teams. Source: 10-k

Organized “Looks” packages could bring efficiency and increase FCF margin

According to its latest quarterly report, HOV has noted a reduction in options for customers. As a result, customers are said to execute a more streamlined selection, which also makes the company’s sales and construction processes much more efficient. Under these conditions, I believe the company could experience significant free cash flow growth and FCF margin growth in the coming years.

We recently started offering curated ‘Looks’ packages for customers to choose from, rather than a large number of a la carte options. This approach has continued to expand and provides customers with a more efficient selection process and allows us to be more efficient in procurement, sales and construction. Source: 10-k

Increases in the total amount of assets and equity indicate successful operational performance

Over the past five years, the company has reported an increase in total cash and total asset value. In my opinion, recent increases in cash flow from operations and free cash, as well as cash accumulation, indicate successful business operations.

Additionally, I believe the company is well positioned today to fund future projects, finance marketing campaigns and build more inventory. If we do experience a recession, HOV seems better prepared than other companies in the same industry or in any other sectors.

Lowering the total amount of debt may bring new demand for the stock

Management appears to be reacting to the recent rise in interest rates. Over the last ten years, HOV has significantly reduced the total amount of debt. Given the current amount of free cash flow and CFO generated by HOV, in my opinion, the company will be able to further reduce its debt obligations. As a result, in my opinion, most market participants will most likely not fear the current amount of debt.

We reviewed the total senior grades reported by HOV. Reported interest rates include 10%, 8%, 11.75%, 13.5% and 5%. Given these rates, we assumed a WACC of 9%, which we assumed to be conservative enough. We’ve lowered our free cash flow projections from 2025 to 2031, so I think interest rates can change quite a bit.

• 10.0% Lien 1.75 Senior Secured Notes due November 15, 2025
• 8.0% Senior Secured Notes with 1,125 Lien Notes due September 30, 2028
• 11.75% Senior Secured Notes 1.25 Lien due September 30, 2029
• 13.5% Senior Notes due February 1, 2026
• 5.0% Senior Notes due February 1, 2040. Source: 10-k

Valuation of my stock

My financial model is based on the successful implementation of the fast moving house company strategy. We also assumed that a reduction in the number of options available to customers could make operations significantly more efficient, which could accelerate future free cash flow growth. Additionally, I would expect investors to take into account the recent decline in total debt, which may bring demand for the stock and lower the WACC. Finally, we also considered the previous FCFs delivered by the HOV.

My numbers included a small increase in free cash flow from 2025 to 2031, assuming a 9% WACC and 11x EV/FCF. The results included a total enterprise value of $2.9 billion, an equity valuation of $1.8 billion and a fair price of nearly $306 per share.

• FCF SALE @ 9% WACC: $1,202.65 million
• VAN TV @ xFCF 2031 of 11x: $1,720.14 million
• Total EV: $2,922.79 million
• Net debt: $1,053.40 million
• Equity: $1,869.39 million
• Shares outstanding: 6.1 million
• Target price: $306

In my opinion, the company is significantly undervalued compared to other peers. The company’s TTM GAAP P/E, Ev/TTM Sales, Ev/TTM EBITDA and Ev/TTM EBIT are significantly lower than peers report. All in all, HOV seems pretty cheap.

It’s also worth noting that the company seems to be growing at a faster pace than its competitors. In my opinion, as soon as more analysts research the company, we could see an increase in demand for the stock.

Stock buybacks at $140 per share

The company has bought back shares in the past and I believe HOV will continue to do so in the future. If the cash flow generation continues, in my view, management may try to please shareholders through further share buybacks.

The company bought shares at $140 per share, which is not that far from the current market price. We can’t be that far wrong because HOV knows better than outside investors the true value of the shares. The company traded at over $1799 per share. Right now, it’s not trading far from $209 per share.

During the nine months ended July 31, 2024, we repurchased 188,800 shares under the share repurchase program with a market value of $26.5 million, or $140.31 per share, and during the nine months ended On July 31, 2023, we repurchased 118,478 shares. a market value of $4.8 million or $40.51 per share. Source: 10-Q

Risks from lack of raw materials or working conditions

The company’s business model is subject to fluctuations in the price of raw materials. Raw material shortages could occur and impair future net income or FCF growth. In addition, I believe that labor shortages or wage increases may also bring a deterioration in the company’s future financial statements. Labor shortages have been reported during COVID, so let’s just say that HOV could suffer from such a pandemic again in the future.

Risks from large changes in interest rates or further increases in interest rates

I believe that future significant changes in interest rates could affect future market conditions. The company needs some time to launch marketing operations and build houses. If interest rates change significantly, in my opinion, establishing new strategies can be more difficult. In addition, a further increase in interest rates may affect the Company’s ability to finance future operations or may affect the Company’s EV/FCF and EV/EBITDA ratios. Rising mortgage rates can also reduce demand for new homes. As a result, in my view, shareholders could suffer from the decline in share price.

Conclusion

Hovnanian Enterprises, Inc. continues to produce impressive net sales growth driven by lower mortgage rates. In my view, the further decline in interest rates, organized looks packages and the company’s strategy to move homes quickly could bring significant free cash flow generation in the coming years. I think the recent decrease in total debt, increase in assets and increase in free cash flow may accelerate demand for the stock and push the stock price up. Putting it all together and taking into account risks from rising interest rates, labor shortages or raw material shortages, HOV looks significantly undervalued at the current price level. In my view, the ongoing share buyback may increase the share price in the coming years.