September 13, 2011

 

Introduction 

 

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Obviously the homebuilders would be a direct beneficiary of a housing recovery, especially a recovery in 

new home construction. We view cable companies as beneficiaries as household formation (discussed previously) 

will likely prove to be a powerful tailwind (more broadband and video subscriptions, etc.). While construction 

aggregates companies such as Vulcan Materials, Texas Industries and Martin Marietta Materials derive a large 

portion of revenue from public works projects, their fortunes should be lifted by increased new home construction in 

the coming years (more roads, bridges and sidewalks, etc.). We believe that security companies such as Ascent 

and Tyco will get a boost from new household formation as these new homeowners will likely consider installing an 

alarm service. Finally, traditional home furnishing companies should benefit as homeowners look to furnish their 

new purchases.  

Positioning for a Housing Recovery 

Over the past 1-2 years, prominent investors have targeted the housing industry as an attractive 

investment opportunity. In Berkshire’s 2011 letter to shareholders, Warren Buffett noted that Berkshire-owned 

MiTeck (supplier of engineered products for the building components industry) recently made five bolt-on 

acquisitions in recent months. In addition, Berkshire has boosted its housing exposure through the acquisition of 

Acme, an Alabama brick maker. Meanwhile, prominent hedge fund manager Bill Ackman of Pershing Square 

delivered a presentation in November 2010 discussing the merits of investing in single family housing.  

As we noted above, there are a number of industries that are poised to benefit from a rebound in housing. 

While homebuilders would clearly be a direct beneficiary of a rebound in new home construction, we would note 

that today’s publicly traded homebuilders are not your father’s homebuilder stocks. Specifically, we believe that a 

number of homebuilders contain significant risks ranging from loan origination risks (retained loans as well as 

representations and warranties) to off-balance sheet land development arrangements. Further, while new home 

construction is likely to rebound at some point in the future, the exact timing of a recovery is uncertain and will 

depend on a number of variables including the amount of time it takes to work off the current inventory and shadow 

inventory. Accordingly, we believe this introduces additional balance sheet risk for homebuilders and could 

present meaningful liquidity issues should a recovery in new construction be delayed.  

The Asset Analysis Focus Approach to Benefiting From a Housing Recovery 

Our preferred method to profit from a housing recovery is to focus on companies that will benefit from an 

improved housing market, but are not necessarily dependent on a rebound in new home construction. In searching 

for names to feature in this year’s issue, we specifically focused on identifying companies that would be aided 

regardless of what course a recovery takes. For example, if a housing recovery is aided by investors snatching up 

the current/future supply given the potential for a robust rental market, we want to be able to benefit from this trend. 

We could see this trend primarily benefiting home material companies (floors, carpets, appliances) or their 

distributors as well as demand for credit checks. Conversely, if the industry growth comes from outsized demand 

from new household formation spurring demand for existing inventory, the aforementioned trends would still hold – 

more home renovation, new floors, air conditioners, etc. For all of the names that we selected for our in-depth 

reports, the return of new home construction to more normalized levels would provide an additional catalyst/growth 

opportunity, but the turnover/absorption of housing returning to more normalized levels would be the primary driver. 

We also concentrated on companies that were able to maintain profitability through the recent crisis and emerge in 

an even stronger position. We believe this will provide protection should the real estate recovery take longer than 

expected to develop or if the economy were to suffer a double-dip recession. Other favorable characteristics of the 

names we have selected include: 

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Strong replacement oriented/recurring revenue business models 

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Favorable competitive environment 

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Robust free cash flow generation 

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Good international growth prospects 

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High barriers to entry 

We have identified four companies that we believe will participate in a housing recovery and have provided 

an in-depth report on each company. A summary of these companies is provided below:  

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Introduction 

 

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Equifax Inc.   (Ticker: EFX   $31.01) 

Equifax is one of only three large global players in the credit reporting and credit information businesses 

and currently boasts a number one or number two market share in most of its major markets. A housing recovery 

bodes particularly well for Equifax given its direct mortgage exposure (15% in 2010) and implication for job growth, 

which should translate into increased consumer credit demand. Further, institutions are demanding more advanced 

analytics about consumers’ ability to pay in response to the recent downturn, which should increase demand for the 

Company’s proprietary databases and analytical services. While a housing recovery will likely provide a nice boost 

for Equifax, we believe that there are a multiple number of growth drivers that could favorably impact future results. 

Among the Company’s promising growth opportunities include strong new product development, recent 

investments/acquisitions in unique data assets and the growing demand for credit and risk information outside of 

the traditional finance/mortgage industries.  

Mohawk Industries, Inc.   (Ticker: MHK   $44.04) 

Founded in 1878, Mohawk Industries is the oldest and largest flooring company. We believe the Company 

will be one of the prime beneficiaries of an eventual recovery in new residential housing construction. In the 

meantime, the Company is focusing on the replacement and remodeling end markets and international channels to 

weather the housing recession.  Mohawk maintains strong competitive advantages, including a leading distribution 

network, low-cost manufacturing, and a broad line of product offerings.  At current levels, the Company is trading at 

7.0x depressed LTM EBITDA. We believe Mohawk warrants a higher valuation multiple due to its competitive 

advantages, favorable business mix, international growth prospects, well regarded management team and ability to 

generate strong free cash flow.  

Watsco, Inc.   (Ticker: WSO   $57.25) 

Watsco, Inc. is an independent distributor of heating, ventilation, air conditioning, and light commercial 

refrigeration (HVAC/R) equipment and supplies in the U.S. Watsco is the largest competitor in an otherwise 

fragmented industry characterized by strong barriers to entry, rational competition and local monopolies, relatively 

steady pass-through margins, a growing install base offering strong long-term recurring revenue sources (75% of 

Watsco’s revenue), and positive long-term pricing and margin implications from the trend toward more energy 

efficient units. Due to the recent housing market collapse and restricted consumer spending, industry-wide unitary 

equipment shipments have plummeted to levels not seen since 1995. An eventual drawdown from historic levels of 

pent-up replacement demand and a recovery in new home construction offer tremendous incremental revenue 

opportunities for the industry. In the meantime, Watsco remains on pace for record profitability in 2011 due to 

strong expense controls and the Company’s recently-established (at bargain purchase prices) joint ventures with 

Carrier Corp—which we believe reflect both the Company’s operating skills and the absence of competing bidders 

given its unique position. 

Whirlpool Corporation   (Ticker: WHR   $53.27) 

Whirlpool Corporation is a well established and recognized Company within the major home appliance 

market (#1 share of worldwide major appliances), and portable appliance market. Several negative forces (weak 

housing fundamentals, low consumer confidence, etc.) have been meaningful headwinds for WHR sales and 

profits. In our view, WHR management has taken several important steps to mitigate the difficult fundamentals of 

the current marketplace and position itself for long-term success. Assuming housing market fundamentals 

eventually improve to a more normalized level, we would regard WHR as an attractively valued means of 

participating in a potential recovery. The Company’s leading market share position, globally recognized brands, and 

strong distribution capabilities should ensure that WHR retains a solid competitive position over the long-term. 

Moreover, growth opportunities associated with potential market share gains, extension of product lines, and 

increasing exposure to emerging markets should serve to further bolster WHR’s potential cash flow generation and 

earnings power. 

 

In addition to the in-depth reports on these four companies, we have provided snapshots of three 

companies (including 2 new ideas) that we believe will also receive a significant boost from a recovering 

housing/real estate markets. Home Depot and Wells Fargo fit our preferred housing recovery theme, while The 

Howard Hughes Corporation is a unique asset play where the bulk of the Company’s current book value is tied to 

new home construction. In our view, HHC represents a lower risk way to play new home construction (vs. the 

homebuilders) with a multiple number of attractive future growth opportunities. 

 

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