Sector Watch: Modular homes
While the overall housing market is cooling, this is not necessarily the case for the modular home market. Modular homes, which are homes built in sections at a factory and then transported and assembled on-site, are a relatively new concept. They differ from traditional site-built homes and from manufactured homes, also known as mobile homes. Modular homes sales were particularly brisk after Hurricane Katrina, when the government paid nearly $900 million for mobile and modular homes to shelter dislocated residents. While Katrina-related demand fueled huge sales gains for modular home builders in 2006, growth is not entirely disaster-related. Their affordability compared to site-built homes is driving demand as well; the cost of modular homes typically averages 10% to 25% less than site-built homes.
Housing starts and modular home sales have moved in different cycles since the 1970s. One reason for this is the interest rate impact. When interest rates go up, demand for modular homes rises as well as new home buyers seek more affordable alternatives. Also, rising interest rates squeeze family budgets and some homeowners seek relief by trading down to a modular home.
Demographics are favoring long-term growth for the modular home industry. Retiring baby boomers on fixed budgets are expected to drive demand for modular homes in the Sunbelt states. In addition, while down from 2005 peak levels, demand in the New Orleans market is expected to remain strong for years to come.
Modular home starts in the United States totaled approximately 38,300 last year, representing about 2% of total 2006 housing starts. In the Northeast, Atlantic and Midwest, modular presently accounts for approximately 5% of all housing starts. In the West and South, areas primed for growth due to retiring baby boomers, penetration is less than 1%. Modular structures are also used in the construction of prisons, military housing, hotels and multi-story apartments. Demand is fueled by modular housing’s advantages versus off-site construction, which include dramatically reduced construction time, lower costs and minimal site disruption.
Fleetwood Enterprises Inc.
One of the small-cap companies poised to benefit from modular housing growth is Fleetwood Enterprises Inc. (NYSE: FLE). Fleetwood is a leader in recreational vehicle and trailer manufacturing and marketing, and is aggressively expanding in the modular home segment. The Riverside, Calif. company’s Trendsetter division operates 20 modular housing manufacturing facilities nationwide.
In March and April, Fleetwood’s Trendsetter subsidiary announced new projects expected to add $30 million to revenues. Trendsetter was selected to provide modular homes for a new 160-unit condominium housing development on the Gulf Coast. A major win for the company was a contract to build seven modular apartment buildings for the U.S. Army at Fort Bliss. The Army is contemplating additional phases to this project, as well as similar projects at other base.
Fleetwood expects to report an 18% year-over-year decline in fiscal 2007 sales to $2.0 billion because of lower RV and manufactured housing sales. Restructuring costs relating to plant closing will result in 2007 net losses analysts peg at $1.27 per share. Going into fiscal 2008, however, rising backlog and modular housing initiatives should rekindle growth, which analysts forecast at 100% next year and 30% annually over the next five years. At the current $10 price, Fleetwood trades at a Price/Sales multiple of only 0.3 times annualized sales. My $14 target price is nearly 50% above the current price.
Palm Harbor Homes Inc.
Another company benefiting from modular home demand is Palm Harbor Homes Inc. (Nasdaq: PHHM). Among the largest marketers of factory-built homes, Palm Harbor Homes is differentiated by its vertically integrated operations - retailing, financing and insuring in addition to manufacturing. This company focuses on the high-end, customized market; four out of every five homes it builds are customized with owner-selected features. Palm Harbor operates 18 manufacturing facilities and sells its homes through 116 company-owned superstores and more than 200 independent retailers. In fiscal 2006, sales grew 16% to $710.5 million and earnings reached $11.1 million, or $0.49 per share.
During the first nine months of fiscal 2007, modular home revenues rose 45% and represented about 32% of recurring revenue. Declining manufactured housing sales and restructuring charges caused the company to record net losses of $4.3 million, or $0.19 per share, but the company expects to approach breakeven by year-end and increase sales to $735 million next year. At a $15 share price, Palm Harbor Homes trades at 0.5 times revenues and 50% below its 52-week high. My $20 price target for these shares is 30% above the current price.
