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No. of Recommendations: 11
Hello Fools,

Working through an IETC on Homebuilder NVR Inc. (AMEX:NVR)

Those of you with no lives might recall that NVR came up in Mike Klein's initial post on screening for IETC candidates: http://boards.fool.com/Message.asp?mid=22637715

And before I go through the write-up, and how I've addressed certain items (rightly, or wrongly), I'll get the following out of the way first.

--Ahem--

Yes, I'm aware that we're in a housing bubble that's going to burst any day now, cratering the homebuilders.

Yes, I'm further aware that NVR management has treated the company's stock as their own personal piggy-bank - issuing, by most any measure, an obscene amount of options to pretty much every employee, and then repurchasing scads of their own shares to more than offset the dilution.

In other words, the company has largely become a flow-through vehicle for free-cash-flow to land in the pockets of management and employees (actually, the breadth of option grants to pretty much every employee is positive in the sense that massive option grants are not strictly reserved for those in the ivory tower). As distastful as the practice can be viewed, I build it into my model in two fashions, and am comfortable that I've adequately discounted the effects. For what it's worth, my value on the shares is around $850, and this is based on slowing to negative growth over the next five years. I've owned the shares for nearly the past five years, so you can see they've been a fair investment.

http://finance.yahoo.com/q/bc?s=NVR&t=5y&l=on&z=m&q=l&c=

That said, I'm not expecting similar performance going forward, and two weeks ago - Oct-03 - I put a limit order in to sell at $900. It closed that day at $886. Today, it closed at $757.75.

Oops.

-~-~-~-~-~-~-~-~-~-~-~-~-~-~-~-~-~-~-~-~-~-~-~-~-~-~-~-~-~-~-~-~-~-~-~-~-~-~-~-~-~-~-~-~-~-~-~-~-~-~-~

Okay, the point of all this. I'd like critque of my assumptions (or make fun of the glaring holes that I might have missed)

Much like most of the homebuilders, NVR has two lines of business. Homebuilding (really?!?) and mortgage banking. The homebuilding segment is responsible for 98.5% of total revenues, and the substantially all of the mortgage banking segment is dedicated to financing their home buyers. Still, the presence of that mortgage banking segment, gums up the IETC calculations somewhat, as things like Mortgage Loans, held for sale and Mortgage Servicing Rights, as well as mortgage banking Notes Payable are a larger presence on the the B/S than the division's contribution to sales.

Issues in the IETC process:

* R&D is non-existant. Advertising expenses capitalized over 3 years.

* NVR does not break out advertising expenses in their financial reports. I looked up several
competitors that do break-out their advertising expenses: Pulte (PHM), D R Horton (DHI),
Lennar (LEN), KB Homes (KBH), Beazer (BZH) and Hovnanian (HVO). It become rather apparent that
companies with higher revenue (PHM, DHI, LEN) spent comparatively less as a %-of-revenue, on
advertising than the lower revenue companies. NVR comes in near the lower revenue companies. Regressed
advertising expenses as %-of-revenues against total revenues, and the regression model with an
R-squared of 35.3% was good enough for me. From the regression, advertising expense estimates
are:

Advertising Expense
Year Estimate ($000) % of Revenue
--------------------------------------------
1999 $ 1,990.8 1.1%
2000 2,305.8 1.1%
2001 2,612.3 1.1%
2002 3,126.1 1.0%
2003 3,677.6 1.0%
2004 4,319.7 1.0%
TTM 4,672.7 1.0%
--------------------------------------------

* A characteristic of homebuilders is their low capital requirements. In lieu of capital
expenditures, there's significant investment in inventory, building lots (although NVR mitigates
this more than their competition through their land option program). In CapEx, I include typical
capital expenditures, business acquisitions, and the increase in contract land deposits.
Contract land deposits, classes as a long-term asset, make up the majority of what I'm considering
investment in 'fixed' capital. Note that I don't subsequently amortize this amount, since
we're uncertain as the life of these deposits - from the 10-K, it's typically <1 to 3 years. This
lack of amortization is going to depress defensive income.

1999 2000 2001 2002 2003 2004 TTM
------------------------------------------------------------------------------------------------------
Increase in Contract Land Deposits $22,085 $33,335 $59,533 $75,577 $53,939 $118,680 $182,266
Business Acquisitions 3,697 - - - - - 7,465
Purchase of PP&E 9,070 5,027 6,694 12,262 9,456 9,761 13,857
------------------------------------------------------------------------------------------------------
Total $34,852 $38,362 $66,227 $87,839 $63,395 $128,441 $203,588


* Customer deposits - treated as a current liability akin to deferred revenue.

* Those pesky Mortgage Loans, held for sale and Mortgage Servicing Rights mentioned above
are incuded in working capital calculations as 'other current assets'

* Following the passing of Sarbanes-Oxley, NVR now has to consolidate in its results,
assets/liabilities not owned, but that NVR has an interest in. This was included in enterprising capital.

* Excess cash held to be anything over 2% of revenues.

* NVR's equity is rather low, given their massive share buyback plan. It could be argued, should
reverse the effects (as per TMFAdmiral's article on the P/B ratio last week) to get a better
estimate of enterprising capital for estimating enterprising interest. Without alteration,
WACC calculated out as:

1999 2000 2001 2002 2003 2004 TTM
--------------------------------------------------------
8.68% 8.94% 9.60% 8.78% 9.05% 9.80% 9.50%

* Income Statements (all figures in $mil save per share profits):

Accrual: 1999 2000 2001 2002 2003 2004 TTM
--------------------------------------------------------------------------------------
Revenue 1,990.8 2,305.8 2,612.3 3,126.1 3,677.6 4,319.7 4,672.7
Cost of Sales 1,610.7 1,834.1 2,002.3 2,335.4 2,711.9 3,156.3 3,365.1
SG & A 180.8 185.6 204.9 250.0 255.8 286.4 322.3
Interest Expense 21.0 15.6 13.6 14.9 14.8 13.0 12.9
Interest Income (13.6) ( 6.5) ( 7.0) ( 6.2) ( 5.2) ( 4.2) ( 4.1)
Other Income ( 2.3) - ( 4.4) ( 4.0) - ( 3.7) ( 5.5)
Other Expenses - 1.6 - - 4.1 - -
Taxes 76.3 108.6 157.9 204.6 276.4 348.8 390.9
--------------------------------------------------------------------------------------
Total Expenses 1,881.9 2,147.5 2,375.5 2,794.7 3.257.8 3,796.5 4.080.5
--------------------------------------------------------------------------------------
Profit 108.9 158.2 236.8 331.5 419.8 523.2 592.2
Diluted Shares 12,088 10,564 9,526 9,194 8,674 7,877 7,914
Profit per Share 9.01 14.98 24.86 36.05 48.40 66.42 74.83
--------------------------------------------------------------------------------------



Defensive: 1999 2000 2001 2002 2003 2004 TTM
------------------------------------------------------------------------------------------
Revenue 1,990.8 2,305.8 2,612.3 3,126.1 3,677.6 4,319.7 4,672.7
Cost of Sales 1,610.7 1,834.1 2,002.3 2,335.4 2,711.9 3,156.3 3,365.1
SG & A 180.8 185.6 204.9 250.0 255.8 286.4 322.3
Other Expenses 8.9 10.1 8.3 - 4.1 - -
Inv't Fixed Capital 20.1 24.5 51.1 80.2 55.0 119.6 194.2
Inv't Working Capital (57.4) (68.1) 108.1 (22.4) (94.5) 33.5 48.9
Interest Expense 21.0 15.6 13.6 14.9 14.8 13.0 12.8
Taxes 87.8 115.6 165.3 227.9 275.7 348.0 395.8
------------------------------------------------------------------------------------------
Total Expenses 1,872.0 2,117.5 2,553.5 2,886.0 3,222.8 3,956.8 4,338.1
------------------------------------------------------------------------------------------
Profit 118.8 188.2 58.8 240.1 454.8 362.9 334.5
Diluted Shares 12,088 10,564 9,526 9,194 8,674 7,877 7,914
Profit per Share 9.83 17.82 6.17 26.12 52.43 46.07 42.27
------------------------------------------------------------------------------------------



Enterprising: 1999 2000 2001 2002 2003 2004 TTM
----------------------------------------------------------------------------------------------
Revenue 1,990.8 2,305.8 2,612.3 3,126.1 3,677.6 4,319.7 4,672.7
Cost of Sales 1,610.7 1,834.1 2,002.3 2,335.4 2,711.9 3,156.3 3,365.1
SG & A 180.8 185.6 204.9 250.0 255.8 286.4 322.3
Other Expenses 8.9 10.1 8.3 - 4.1 - -
Intangibles Reversal (21.6) (24.7) (27.6) (32.3) (37.1) (42.3) (45.4)
Intangibles (Advertising) 17.1 21.1 24.7 28.2 32.4 37.3 39.3
Intangibles (R&D) - - - - - - -
Interest Expense 64.5 57.6 67.3 77.8 85.7 102.6 127.1
Imputed Interest - Leases ( 1.5) ( 1.9) ( 2.4) ( 2.8) ( 3.4) (3.9) (4.7)
Taxes 92.5 121.6 168.3 232.3 282.8 353.6 401.1
----------------------------------------------------------------------------------------------
Total Expenses 1,951.3 2,203.5 2,445.8 2,888.6 3,332.1 3,889.9 4,203.7
----------------------------------------------------------------------------------------------
Profit 39.5 102.3 166.6 237.5 345.5 429.8 468.9
Diluted Shares 12,088 10,564 9,526 9,194 8,674 7,877 7,914
Profit per Share 3.27 9.68 17.49 25.83 39.83 54.57 59.25
----------------------------------------------------------------------------------------------


* Quality of Profits, and Earnings Power Charts are available at the following two links.
Somewhat of a staircase, but perhaps one walked by a drunken man.

QoP: http://tinyurl.com/bucvd
EPC: http://tinyurl.com/8c7cq

The stock prices on the QoP are the month ending prices in the months when the 10-Q (for TTM) or 10-K (for all year-ends) is released.

So what say you?

Cheers,

Jim
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