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:
Strong replacement oriented/recurring revenue business models
Favorable competitive environment
Robust free cash flow generation
Good international growth prospects
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:
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.