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Published on the Value Lab 26/1/22

Skyline Champion (NYSE:SKY ) was an investment we made in the 2018-2019 flash crash. We believed in the economics and price performance of modular housing, convinced stigmas wouldn't endure. We made great money and 2xed our quite substantial investment and then took our leave, as we weren't sure momentum could continue. But it did. SKY has achieved massive fundamental growth since then, and the housing boom after COVID-19's initial outbreak has only helped them further along. Given their resistance to issues in material procurement, we see both good value and timing at the current multiple. The model is cash-generative and they're gaining on site-built competitors. The stock is a buy.

Q2 showed strong results. The gross profit grew meaningfully with scale and pricing moving ahead of input price pressures, which were substantial especially with lumber at the beginning of the year. Modular housing assembly line logic makes material utilisation higher, a great advantage over site-built incumbents at this point in time. Where Pulte (PHM) and other site-built competitors grew in the high single digits, SKY is growing over 50% and gaining share.

2020 was naturally a troubled year for the company, but even relative to 2019 figures, the company has moved substantially ahead in its results.

Inflation, while impacting input costs, has also been a force for good for the company. The much greater affordability, but also immigration trends and general issues with house prices, makes modular homes very attractive. As the stigma becomes more of a non-factor regarding the quality of modular houses, SKY continues to be favourably secularly positioned, both in terms of the overall trends in housing growth but also at the expense of site-built competitors which are fundamentally less profitable and provide more costly services due to worse industrial logic.

From a valuation perspective we are talking about a business with a multiple in the low double digits. Given the growth trajectory, we can use TMA (fair multiple analysis based on DCF logic) to run a quick spread of possible reasonable valuations based on several growth appreciation period scenarios. The ROIC is unbelievably high at 29%. With only ~600 million of equity in the business, and barely any debt to speak of, with cash balances equal to 10% of the market cap, this is almost inevitable. It is mainly a consequence of that fact that the business has not been profitable for more than a couple of years. But is also means the emerging profitability is not being appreciated by markets. But even taking the actual market cap for looking at invested capital, which is not really correct to do since it's not the amount of money that the company has had at its disposal with equity financings, there is still a strong ROIC of 5% relative to a WACC around 4%. A spread like that with 50% growth rates and at least a couple more years of growth, puts a fair multiple on today's earnings anywhere between 20-24x on EBITDA. Using the book equity, would be between 27-39x EBITDA.

While there are risks of a slowdown in housing, modular housing is still a class of its own, and actually has its offsets in the case of economic downturn since low-income housing is often modular. The high ROICs of the company having emerged recently from profitability justifies a much higher valuation in tandem with growth, which just supercharges their high capital return profile. While we don't expect as much upside as is shown above, as TMA in this case is sensitive to the way we calculate invested capital, we consider SKY an interesting prospect, and may consider dipping our toe in again.

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This article was written by

Valkyrie Trading Society, formerly Bocconi's Valkyrie Trading Society, is a society of Alumni that have graduated into successful financial services careers. We seek to provide honest and global dividend-value insight leveraging our group's broad and deep experience in finance to contribute to Seeking Alpha. We provide more obscure research on our marketplace service, The Value Lab, covering value stocks in global developed markets.

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