Skyline: On an acquisition spree
Skyline: On an acquisition spree
With Skyline Champion Corporation (“SKY”, “Skyline”, and “Company”) dropping over the recent month to the ~$65 levels we decided to revisit our thesis and evaluate whether its price is attractive. Since then, the acquisition of Regional Homes was announced on the 28th of August driving the price close to $74 before coming down to the $70 levels.
This write-up is a top-up analysis of our detailed write-up Skyline Champion Corporation – A Compelling Investment Opportunity and the Q4’23 earnings review Skyline Champion Corporation – What went wrong?
Report contents:
1. Performance update
2. Strategic investments
3. Peer to peer analysis
4. The catalysts (and the risk)
5. Valuation
6. Conclusion
1. Performance update
The Company has seen an exponential growth over the years, with FY22 (year ended on April 2, 2022) showing a growth rate of 55% surpassing the $2B milestone, while in FY23 it grew by 18% reaching $2.6B. Over FY15 to Q1’FY24, SKY depicted a revenue Compound Annual Growth Rate (“CAGR”) of 15.1% while gross profit and operating profit grew considerably higher; reaching margins of 30.7% and 17.9%, respectively.
Source: Koyfin (affiliate link with a 15% discount for StockOpine readers) | We personally use Koyfin on a daily basis to screen for stocks, extract financial data and ratios, read earnings transcripts and run peer comparisons, StockOpine analysis
The 55% growth in FY22 was driven by higher volumes (from 21,214 to 26,165, i.e. 23.3%) due to increased demand and ScotBilt acquisition as well as higher Average selling price (“ASP”) depicting an increase of 27.2% in US and 30.7% in Canada, respectively. Higher ASP was a result of increased prices to combat cost inflation pressures and the increasing demand of larger houses.
The 18% growth in FY23 was price driven as ASPs improved by 20.9% in US reaching $97,500 and 14% in Canada reaching $122,900 while total volume was down by 1% (US volumes remained flat and Canada volumes declined by 20.6%). A key reason justifying the increase in US prices, other than inflation impact was the FEMA (Federal Emergency Management Agency) revenues of $200.3M. FEMA units have higher specifications and consequently higher average prices.
Source: Skyline filings, StockOpine analysis
Despite the recent growth, over the last two quarters, i.e. Q4’23 and Q1’24, a decline was observed due to dealers and community REITs destocking as a result of the backlog they have accumulated over the last few years. It is worth noting, that dealer and retail channels were strong in Q1’24, showing a healthy end-consumer market. As a side note, the 36% decline in Q1’24 revenues, changes to 28% when FEMA revenues are adjusted.
“as we saw healthy demand from end consumers and a return to growth in our retail sales channel. Despite good retail order intake, we are still seeing a pause in the community REIT channel as they continue to set and finish their backlog of existing new home inventory. We expect this to continue through the end of our fiscal second quarter.” Mark Yost, CEO
Source: Koyfin (affiliate link with a 15% discount for StockOpine readers), StockOpine analysis
Moving forward, sequentially, management expects a flat to slight decline in Q2, stabilization in Q3 and picking up thereafter due to the expectation of REITs resuming their orders in September. Ultimately, a year on year (“YoY”) drop of 27%-29% should be expected.
Speaking of orders and quotes (a leading indicator of orders), in Q1’24 the YoY increases were 28% and 44%, respectively, while the sequential increases were 50% for orders and 17% for quoting. Considering that REITs, which account for 35%-40% of SKY’s business, ‘halted’ orders, it is evident that the demand is coming from the end-consumer, a positive signal and a promising one when REITs resume their orders.
On a mid-term horizon, SKY expects a healthy demand from community REITs, increasing manufactured to rent trends, the need for affordable housing and favorable market demographics for millennials and baby boomers populations (key buyers of manufactured homes (“MH”)) to act as flywheels.
Source: Skyline May 2023 Investor presentation
As long as we avoid entering a recession and the end-consumer remains strong we can presume that these estimates are reasonable. The only caveat worth mentioning, is that management of Cavco Industries (“Cavco”), the third largest player, indicated that REITs are expected to be “back to normal” a bit later in the year, possibly by year-end. Nonetheless, a month or two does not alter the long-term outlook.
Margins
As seen earlier, margins exponentially improved from FY22 onwards, demonstrating the operating leverage and pricing power of Skyline. Nevertheless, with operating leverage, there comes operating deleverage and this is what hit the Company in Q4’23 and Q1’24 when revenues declined by 23% and 36%, respectively.
Gross margin fell from 29.9% in Q4’22 to 28.7% in Q4’23 and from 31.6% in Q1’23 to 27.9% in Q1’24 while operating margin fell from 18.2% in Q4’22 to 14% in Q4’23 and from 21.6% in Q1’23 to 12.7% in Q1’24.
Along with the operating deleverage that is also justified by the lower capacity utilization (lower volumes especially on community-focused plants but also margin compression from new plants) it is worth noting that the product mix has also changed towards lower cost option homes with less specifications and thus less margin. Meanwhile, high margin FEMA revenues in Q1’23 and Q2’23 (non-recurring) affect comparisons.
“Capacity utilization is being adversely impacted by newly opened plants, notably our Pembroke, North Carolina facility, which opened in January and our facility in Decatur, Indiana, which started production this quarter.” Laurie Hough, CFO
Source: Skyline filings, Koyfin (affiliate link with a 15% discount for StockOpine readers), StockOpine analysis
Regarding FY24, based on management comments, it is anticipated that gross margins will decrease to the range of 26%-27%, leaning towards the lower end. Additionally, Selling, General, and Administrative (SG&A) expenses are expected to remain at similar levels, which according to our estimates, would result in an operating margin of 11%-11.5%. This is notably lower than the 19.9% recorded in FY23 and the 15.1% in FY22. Consequently, this would translate to an estimated EBITDA margin of 12.7% to 13.3%, which is below the 20.9% of FY23 and the 16% of FY22, despite management's mention of expecting margins to normalize to FY22 levels.
We previously stated that if EBITDA margins fell below 15%, we would revisit our thesis, however, we believe that the current headwinds are temporary. As REITs gradually resume ordering, new plants optimize operations, and ongoing research and development efforts to automate key production processes come to fruition, we anticipate an improvement in margins over time.
2. Strategic investments
Regional Homes acquisition
On 28th of August it was announced that SKY plans to acquire the 4th largest HUD manufacturer, Regional Homes for a total value of $458M comprising of a Purchase Price of $328M and assumed debt of $130M. The price could increase by $25M subject to earn-out provisions.
Following our analysis of the acquisition (which can be found here: Skyline Champion to Acquire Regional Homes), we concluded as follows:
“Comparing transaction multiple of 5.5x to trading multiples of 6.1x for SKY and 6.6x for CVCO, the price to be paid seems fair. Additionally, the returns on capital, despite being lower than SKY’s existing returns, are above its cost of capital, so at first glance the acquisition is value adding.”
Considering that balance sheet will also remain healthy after the transaction as available liquidity will exceed $375M, we remain confident that the benefits of the transaction outweigh the costs.
One thing that wasn’t pointed out during our analysis, was that Regional Homes has strong federal and state relationships and provides disaster relief housing to Alabama, Florida, Louisiana and Mississippi. We believe that this is a key strength especially when we consider the increasing rate of stronger hurricanes (costly and deadly) in the region (most recently Idalia in Florida).
ECN Capital Investment
A couple of weeks earlier, i.e. on 14th of August 2023, SKY announced its investment in ECN Capital (“ECN”), the largest independent MH lender (behind 21st Mortgage and Vanderbilt of Clayton Homes) and a long-standing partner of Skyline (since 1959). ECN originates loans for its partners like banks, credit institutions, institutional investors etc., manages the loans receiving fees in return and offers secured loans to finance dealer inventory (floorplan loans). We are strong advocates of this decision as the specific weakness was also noted in our prior write-up: