Investor Essentials Daily

With inventories at all-time lows, demand is not a problem for this homebuilder

Century Communities, Inc. (CCS)
August 11, 2021

As the pandemic has pushed mortgage rates to all-time lows and led more and more Americans to move away from crowded cities, inventories of new homes have reached their lowest levels in decades.

This has created a quite favorable environment for homebuilders, who now face the enviable problem of “too much” demand for their services.

Despite the tailwinds the industry faces from elevated demand, rating agencies still rate this company’s debt as high risk, which seems overly pessimistic given the firm’s cash-generating abilities.

Also below, the company’s Uniform Accounting Performance and Valuation Tearsheet.

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It is rare for the headline “new sales hit 14-month low” to be a bullish signal for an industry, never mind the share prices of its component companies.

Yet, this is exactly what we’ve seen for homebuilders over the past 2 months, as news of a low in new home sales registered this past June has largely sent stock prices higher.

The reason why has little to do with demand and all to do with supply.

While demand may be through the roof, homebuilders around the country are struggling with visibility on costs and supply bottlenecks, limiting the amount of new orders they accept.

This is a great issue for homebuilders to have, as it essentially means supply cannot keep up with demand, and that the market will enjoy prolonged tailwinds going forward.

With homebuilder sentiment at historically high levels, this is a great cash-generating environment for these companies to be in.

And yet, looking at the credit ratings assigned to many homebuilders by the big Wall Street rating agencies, one would think they are on the brink of default.

For instance, $2.3 billion homebuilder Century Communities (CCS), which has operations across booming markets in the South and Western U.S., has a BB- rating from S&P, signalling a 10%+ risk of default over the next 5 years.

Here at Valens however, we see things a bit more clearly than those who rely on as-reported financials.

Our Credit Cash Flow Prime (CCFP) analysis is able to get to the heart of Century Communities’ true credit risk.

In the chart below, the stacked bars represent the firm’s obligations each year for the next five years. These obligations are then compared to the firm’s cash flow (blue line) as well as the cash on hand available at the beginning of each period (blue dots) and available cash and undrawn revolver (blue triangles).

As you can see, Century Communities doesn’t even have any debt maturities in three out of the next six years. In fact, cash flows and cash on hand massively exceed the company’s 2025 and 2027 debts, suggesting ample liquidity and little difficulty meeting future obligations.

Rather than a distressed credit, Century Communities is actually in a quite comfortable cash position, meaning S&P’s non-investment grade BB- rating, with a 10%+ risk of default, makes little sense.

Using the CCFP analysis, Valens rates Century Communities as an investment grade IG4+, which corresponds with an expected default rate below 2% over the next 5 years, a much more realistic projection once a holistic understanding of the company’s risk is taken into account.

Ultimately, as rating agencies seem to be overstating Century Communities’ credit risk, we recommend buying its bonds as the company continues to enjoy tailwinds from the tight housing market.

If you want to hear more credit ideas like this one, each quarter we publish our top credit dislocations in our Conviction Credit List. You can click here to learn more and discover how to subscribe.

SUMMARY and Century Communities, Inc. Tearsheet

As the Uniform Accounting tearsheet for Century Communities, Inc. (CCS:USA) highlights, the Uniform P/E trades at 6.0x, which is below the global corporate average of 23.7x, but around its historical average of 6.7x.

Low P/Es require low EPS growth to sustain them. That said, in the case of Century Communities, the company has recently shown a 45% Uniform EPS growth.

Wall Street analysts provide stock and valuation recommendations that in general provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.

We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, Century Communities’ Wall Street analyst-driven forecast is an EPS growth of 82% and 10% in 2021 and 2022, respectively.

Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Century Communities’ $70 stock price. These are often referred to as market embedded expectations.

The company is currently being valued as if Uniform earnings were to shrink 17% annually over the next three years. What Wall Street analysts expect for Century Communities’ earnings growth is well above what the current stock market valuation requires in 2021 and above the requirement in 2022.

Furthermore, the company’s earning power is 2x the corporate average. Also, cash flows and cash on hand are 3x above its total obligations—including debt maturities, capex maintenance, and dividends. This signals a low credit and dividend risk.

To conclude, Century Communities’ Uniform earnings growth is above peer averages and the company is trading below its average peer valuations.

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research