Building in The Big Leagues

By subSPAC

EXECUTIVE SUMMARY

• A perfect storm of inflation, aggressive monetary tightening, and recessionary fears in 2022 has rocked the Housing market.
• This is especially true for home builders like Landsea Homes, which went public through a SPAC last year.
• While not a household name, Landsea has firmly established itself as an affordable builder for first-time home buyers.

DETAIL

Happy Sunday, Friends! 

A perfect storm of inflation, aggressive monetary tightening, and recessionary fears in 2022 has rocked the Housing market. This is especially true for home builders like Landsea Homes, which went public through a SPAC last year. While not a household name, Landsea has firmly established itself as an affordable builder for first-time home buyers. This, along with a boom in remote work and record-low mortgage rates, has enabled the company to rapidly scale its revenues and profits. However, will the company keep up the same pace going into next year with all of the challenges plaguing the market? 

A Differentiated Approach to Homebuilding 

Investors generally easily overlook Landsea Homes as just another home builder at first sight. Landsea is the new kid on the block, only being founded nine years ago as a subsidiary of China’s Landsea green properties. However, the home builder’s meteoric rise is impressive nonetheless, as it has chalked up a significant national presence across half a dozen states, generating over $1 billion annually. A key reason for the company’s growth stems from its value proposition – offering affordable homes to first-time home buyers and millennials. Landsea’s homes are also built with sustainability and energy savings in mind, including automation and greener materials, which are crucial for ESG-focused younger buyers. 

Landsea took a large step last year to solidify its place amongst the largest homebuilders in the country. The company completed its SPAC deal in 2021 while refinancing its existing debt to free up cash, enabling it to acquire VE Homes and further accelerate its growth. The acquisition was particularly notable since it enabled the company to access the rapidly growing Florida and Texas markets, which have benefitted the most from the prevalence of remote/hybrid work and the expansion of venture/tech presence.

Considering the low-interest rates, the wage explosion, and the low supply, it is no wonder that the company performed so well over the last two years. However, looking ahead, Landsea faces significant challenges relating to demand due to a bleak economic forecast and sky-high mortgage rates. Other structural demand and supply side issues also point to a decline in revenues/profits, which could further put pressure on the company’s valuation. 

Builder’s Remorse? 

Considering Landsea’s relatively short tenure as a home builder, it will be interesting to see how the company responds to its first broader housing market decline. Thirty Year fixed Mortgage rates have been hovering around the 6-7% range over the past six months crushing demand. At the current mortgage rates, an average home in Austin, Texas, that would have had an average monthly mortgage of $1,200/$1,300 last year would now cost close to $3,000/month. Homebuilder sentiment also looks bleak, showing a reading of 33, which is close to matching the 30 seen during the April 2020 lockdowns in response to the pandemic. New Mortgage applications are now down 40% compared to last year, while refinancing demand has plummeted 86%. The average home loan sizes have also decreased to $387,300, the lowest level is seen since January 2021. 

Considering the fact that the Federal Reserve plans to hike interest rates by another 75-100 basis points to fight inflation, it is likely that new housing sentiment will remain depressed for the better part of the next year. Housing market forecasts for 2023 remain bearish, with most market experts anticipating a 20-25% drop in median housing prices (this isn’t surprising since median housing prices have skyrocketed from $320,000 in 2020 to $450,000 this year). Landsea is also likely to see the brunt of the impact of a housing slowdown since the company primarily targets price-conscious home buyers.

In addition to the near-term macroeconomic headwinds, Landsea also faces structural issues, such as the migration away from California (the company’s best market) and the slowdown in demand from tech-focused markets such as Texas/Florida. The biggest question remains whether the decline in home values will be offset in a similar proportion by raw materials/labor costs or if the company will see its margins being compressed. The former could lead to a significant but manageable revision in future earnings estimates, while the latter could lead to significant financial deterioration. 

Financials and Valuation 

Landsea has generated over $1 billion in revenues in the first three quarters of 2022 and is currently on track to close the year at around $1.4-$1.5 billion in revenues. The company has also seen a 400 basis points improvement in gross margins, which have trended close to 20%, but this is still on the lower end of the spectrum. As of the third quarter, Landsea had a portfolio of 12,410 owned and controlled lots, most of which were located across states such as Arizona, California, and Florida, with the value of its inventory estimated to be close to $1.18 billion. The company anticipated it would close out the year on a strong note, nearly doubling home deliveries to between 750-800 while seeing average selling price decline to between $560,000 – $580,000.

The company cited resilient demand on the back of factors such as scarce housing supply and strong wage growth across all sectors, but time will tell if this trend will persist. One area of concern is the company’s liquidity, which has slowly been dwindling due to its aggressive acquisition efforts. Landsea’s cash balance is now down to $117.4 million, while outstanding debt stood at $585.1 million.

If the company sees a decline in operating cash flows due to margin compressions next year, it may need to raise additional funds to stay solvent. This concern has primarily been weighing down the stock in recent months. With a market cap of $231.7 million (Enterprise value – $706 million), the stock trades at less than 3x TTM price/earnings. However, the stock could fare much worse if the company continues to see cancellations with its backlog and housing sentiment dampening further. 

Bottom Line 

Landsea Homes has firmly solidified its position amongst the largest homebuilders in the US, with its sustainable, affordable homes geared towards first-time buyers in up-and-coming locals. However, the company now faces several macroeconomic headwinds, structural growth challenges, and an expected decline in margins, which are all likely weighing down the stock. Furthermore, the company also faces significant liquidity challenges and an overleveraged balance sheet that could put it at risk of going out of business if economic conditions significantly worsen. 

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Originally Posted December 19, 2022 – Building in The Big Leagues