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Morningstar | NVR's 3Q Earnings Miss and Disappointing New Order Growth Drive Shares Lower; FVE to $2,390. See Updated Analyst Note from 18 Oct 2018

Shares of NVR fell as much as 9% during intraday trading on Oct. 18 following the no-moat homebuilder's third-quarter earnings release. We believe NVR's earnings miss (reported EPS of $48.28 versus the $50.94 consensus estimate) and its tepid new order growth of 2% fueled the sell off. After reviewing NVR's third-quarter results, we modestly tempered our near-term average selling price and homebuilding profitability assumptions, which caused our fair value estimate to decrease less than 1% to $2,390 per share. Despite our recently downward-revised housing outlook, we still expect several more years of solid residential construction activity ahead, driven by the large and aging millennial population, continued job and wage growth, and an increased supply of entry-level homes.

NVR's third-quarter total revenue, which includes revenue from its mortgage banking operation, increased 11% year over year to $1.85 billion, just beating Wall Street's estimate. Home deliveries grew 14%, but the ASP of deliveries fell about 3% due to a mix shift to lower priced products, faster growth in NVR's lower-priced South East market, and moderating home prices. New order growth, at just 2% year over year, was disappointing in our view. The cancellation rate of new orders was 16% compared with 13% last quarter as well as the year-ago quarter. The pace of community absorption was mostly unchanged relative to last year at about 3 orders per community per month.

Excluding a $7.4 million impairment charge recorded during the quarter related to one of NVR's joint venture partnerships, homebuilding gross margin declined 90 basis points year over year and 10 basis points sequentially to 19%, which is still well above NVR's 10-year average gross margin of approximately 18%. Selling, general, and administrative expenses as a percentage of sales increased 10 basis points to 6% due to incremental stock compensation. Adjusted homebuilding operating margin contracted 110 basis points to 13.1%.

NVR's ending backlog value of approximately $3.6 billion is up 7% year over year. We're forecasting that approximately 52% of NVR's backlog will convert to home deliveries during the fourth quarter.

NVR's average community count during the quarter was 479 communities, unchanged from the year-ago quarter. However, the company ended the third quarter with 96,400 lots under its control compared with 94,200 at the end of the second quarter and 84,000 lots at the end of third-quarter 2017. We're optimistic that NVR will be able to translate its large supply of land into a growing community count, which if the demand environment plays out like we think, should fuel better top line growth for NVR over the coming years.

While we've long respected NVR's commitment to an almost pure land-light strategy, for which we've awarded the firm an Exemplary stewardship rating, in our view, NVR's stock had been persistently overvalued as investors had been willing to pay up for NVR's superior returns on invested capital and copious share repurchase programs. In recent weeks, that dynamic has changed, and NVR now trades below our fair value estimate. At the time of writing, NVR is still a three-star stock, but if shares of NVR would depreciate further and cross our four-star threshold, we'd be happy buyers of the only homebuilder that managed to generate both positive earnings and operating cash flows during the depths of the housing crisis.