Century Communities: Beneficiary Of Current US Housing Situation (NYSE:CCS)

Investment overview

I give a buy rating to Century Communities (NYSE:CCS), as I see it as a major beneficiary of how the US housing situation stands today. Low existing home inventory is pushing demand for new affordable homes, and this is an area that CCS has expertise in. Notably, CCS’s focus on spec homes enables it to deliver lower build times than the industry average, which is a key factor, I believe, in winning demand today.

Business description

CCS is in the business of homebuilding in the US and is one of the largest homebuilders in the industry, with a presence across 18 states and more than 45 markets. CCS has two key brands in its portfolio: Century Communities and Century Complete. The former offers an extensive range of home types with affordable price points. The latter focuses on entry-level customers with 100% spec homes.

Direct beneficiary of current US home situation

Like many other new home builders in the US, today’s situation of high interest rates in the US is a massive growth driver for CCS as well. At a high level, the impact of high rates leads to low existing home supply, as homeowners are not inclined to sell their homes and refinance their existing mortgages at a higher rate (nearly 60% of homeowners have interest rates below 4%). An extremely clear indicator of this effect is the sharp decline in existing single-family home inventory, which is currently at a level close to its all-time low. My macro view is that rates will likely remain elevated for the foreseeable future, with additional hikes being a very possible scenario given that inflation has been far more persistent than expected.

If we take a big step back and look at the US historical mortgage rates since the 1970s, there is certainly room for further increases. As such, I think it is safe to assume there is still room for rates to go up (the Fed did raise rates all the way to 17.5% to combat inflation in the early 1980s). Regarding the Fed’s stance on raising rates, they have certainly not taken the option of raising rates off the table if inflation remains sticky. The other direct impact of this high rate environment is that it pushes down consumers’ ability to purchase homes (the affordability index dropped to 95.9 in April, which is sharply lower than the last 3 years).

Stringed together, the positive benefits that CCS enjoys from the current situation are:

1. The lack of existing home inventories pushes consumer demand for new homes, and as a new home builder, CCS benefits from this.
2. Low home affordability pushes consumers to look for affordable homes, which benefits CCS as it focuses on providing homes at affordable price points.

Why CCS stands out

One of the few reasons I like CCS is because of its focus on spec home construction (98% of home deliveries are spec builds), which enables it to offer affordable homes and fast construction times. Spec homes are generally homes that are move-in ready with little customization, and as such, CCS has increased visibility into how much raw materials are needed, how much labor is required, and how much construction time is needed.

In other words, the entire construction process can be meaningfully streamlined, which improves overall build time. This is a particularly important advantage today because the faster CCS is able to finish construction, the earlier it is able to recognize an order delivery, which enables it to allocate resources to build the next home. Note that this is pretty much a zero-sum game; if CCS wins an order, that order (or demand) is going to disappear from the market (there may be consumers that buy two homes, but I believe this is a low percentage of demand). From the buyer’s perspective, because of the uncertain mortgage environment, the earlier they can move in, the faster they can secure the mortgage rates. For comparison sake, build times for CCS are around 4 to 5 months (or 120 to 150 days), which is ~25 to 40% lower than the industry average.

This focused strategy also gives CCS the ability to estimate overall costs with high confidence, especially since there are few variables (not much customization). What this means is that CCS is able to purchase large amounts of raw materials at once, fully maximizing its buyers’ bargaining power (stemmed from its scale, as mentioned in the 2Q17 earnings transcript). This cost savings could be passed on to consumers to ensure its home products stay affordable.

The results of this strategy were well communicated in the CCS 1Q24 performance. Century Complete orders grew 35% with absorption up 30%, while the CCS communities saw order growth of 45% with absorption up 18%. The demand momentum doesn’t seem to have slowed down at all, as orders during the first three weeks of April were consistent with overall 1Q levels. Taking management’s wording at face value, this implies that 2Q24 should see the absorption of around 11.4 million homes for 2Q24 (18% y/y growth).

Solid balance sheet

I don’t see CCS having any problems funding the investments it needs to meet the current demand profile, as its balance sheet remains solid. As of the latest filing, while CCS has a net debt position of around $862 million, it has sufficient access to liquidity (liquidity position of $1 billion and $208 million of cash) if additional funding is required. There is no near-term maturity to worry about as well, as the nearest debt maturity is in April 2026. There is also no constraint on growth from a lack of land lot supply, as CCS-owned lots can provide up to 3 years of deliveries. If need be, CCS has another >40 thousand lots under options. I really like the larger mix of option lots (which was 40% in FY22 but has improved to 58% in 1Q24) because CCS does not have capital tied to those lots (i.e., capital can be freed up for capital returns or business reinvestments).

Valuation

Based on my research and analysis, my expected target price for CCS is $93.

• Revenue growth strength should persist for the foreseeable near-term (using management FY24 revenue guidance as a benchmark), as I don’t expect any very major positive change to the housing situation in the US. Even if rates were to get cut, it will be done at a moderate pace, which means it is going to take a while before existing homeowners feel incentivized to put their homes up for sale again.
• As CCS needs to focus on providing affordable homes, I expect management to maintain margin at the 7% level (similar to pre-covid times) by reinvesting any excess profits to lower ASP in order to attract demand volume.
• The main driver to share price upside will come from CCS valuation multiple reverting back to its past 1-year average of 8.6x. CCS currently trades at 7.5x, at the low end of its 1-year average, and I don’t think it deserves to trade at this level given the very favorable macro conditions.

Risk

If rates were to increase significantly, due to whatever reasons, it may cause homebuyers to further delay any home purchase (i.e., overall industry demand for homes falls). In this case, while CCS will be less impacted relative to other high-end home builders, its earnings growth will still be negatively impacted. If the market turns around faster than expected, consumers are likely to feel more confident when it comes to home purchases, preferring more high-end homes and more customizations. In this case, CCS loses out because its business model does not cater to such demand. This may cause CCS earnings growth to screen as a laggard compared to peers, thereby causing its valuation multiples to be pressured.

Conclusion

I give a buy rating for CCS. The current housing situation in the US (low existing home inventory) coupled with the rising interest rate environment is favorable to CCS as it leads to increased demand for new, affordable homes. CCS’s focus on spec homes allows for faster construction times and potential cost savings. In addition, CCS has a solid balance sheet that has ample access to liquidity and land supply, which makes me believe it is well-positioned to capitalize on this favorable environment.