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Resideo Technologies (REZI): A Somewhat Cheap, But Also Somewhat Unsafe Spin-off from Honeywell

This is a revisit of Resideo Technologies (REZI). My initial write-up of Resideo was done before the stock was spun off from Honeywell. Three things have changed since that initial interest post.

One: Honeywell spun-off Resideo. So, we now have a price on Resideo.

Two: I’ve created a five part scoring system – a checklist of sorts – for the stocks I write up here at Focused Compounding. This helps me more systematically order what stocks I should be writing up for the first time, re-visiting, etc. and what stock ideas I should make less of a priority. I’ll score Resideo using this 5-point checklist later in this article.

Three: Resideo released its first quarterly earnings as a public company. Management hosted an earnings call where they took analyst questions. They put out some earnings slides with that call as well. So, we have a bit of an update since last time.

I can tell you now that this third event is the least interesting. It’s the one I’ll spend the least time talking about. What matters most here is that we now have a price on Resideo stock and I can now score Resideo on my 5-point checklist. Let’s start with the checklist.

The 5 questions I’ll be asking are:

1)      Is Resideo stock overlooked?

2)      Do I understand the business?

3)      Is this a safe stock?

4)      Is this a good business?

5)      Is this a cheap stock?

I score each question on a scale that goes: -1 (“no), 0 (“maybe”), +1 (“yes”).

Is Resideo stock overlooked? – Maybe (0). The answer can’t be a straight “no”, because this is a spin-off. Spin-offs, in general, lead to stocks being overlooked – at least at first – because shareholders of the bigger company (in this case, the very big company Honeywell) get shares in this much smaller company without doing anything. They may sell the stock without giving it a lot of thought. Also, this spin-off didn’t seem to be a huge focus for value investors and what I did read online from value investors often treated it as something of a throwaway by Honeywell. Basically, not a lot of people are writing about how this is a high quality business. They are writing about how this company is slow growing, fully mature, and includes the burden of paying Honeywell indefinitely to cover environmental liabilities. So, this isn’t a particularly focused on spin-off. But, it’s still a stock with a market cap over $2 billion. It’s listed on a major exchange. It did an earnings call with analysts. I didn’t hear questions from analysts at especially big firms. This is probably a pretty overlooked stock for a $2 billion to $3 billion market cap. But, in the world of the kind of stocks I often look at – it wouldn’t count as overlooked at all. I’ll split the difference and say Resideo “maybe” overlooked (0 points).

Do I understand the business? – Yes (+1). I owned a stock – …

Vertu Motors: A Cheap and Safe U.K. Car Dealer

Vertu Motors owns more than a hundred car dealerships in the United Kingdom. About half of the time – so, at 50+ locations – Vertu Motors also owns the land on which the dealership is built. They lease the other half of their locations. The stock trades on the London Stock Exchange (the AIM market, specifically) under the ticker “VTU”.

Back on November 14^th, 2017 Focused Compounding member Kevin Wilde sort of wrote up Vertu Motors. He did an idea exchange post on U.K. car dealers. The stock he focused most on was Vertu Motors.

Why?

Why focus on Vertu Motors specifically?

And why focus on U.K. car dealers generally?

Publicly traded U.K. car dealers seem to trade at lower prices than their U.S. peers. In the U.S., car dealerships are usually sold at a premium to tangible book value. Car dealer stocks tend to trade at a premium to tangible book value. In the U.K., some publicly traded car dealers – like Vertu Motors – have shares that can be bought below tangible book value.

We can try to come up with arguments for why U.S. car dealers should be more expensive than U.K. car dealers. But, the math isn’t very convincing. For example, if we look at the rate of growth in Vertu Motors’ tangible net assets per share over the last 5 years – it isn’t lower than what U.S. car dealers would be able to achieve. At times, Vertu Motors stock has grown net tangible assets per share by 10% or more a year while also paying a dividend. The company was not very successful growing PER SHARE asset values in the years immediately after its founding (though it did increase the size of the company and improve its economics during this time). Since scaling up, the company seems capable of getting a 10% growth rate in net tangible assets without using leverage. Car dealers often use some leverage. And – as I said earlier – Vertu Motors stock can sometimes be bought below its tangible net assets. The company’s management includes their own 10-year calculation of free cash flow generated versus assets employed and comes up with a number around 10% a year. If I take the most recent half of the company’s existence and use the rate of compounding in net assets per share (instead of FCF like the company uses) I’d get a similar rate of value creation. Basically, I’m going to assume here that Vertu Motors can generate about 10% worth of “owner earnings” relative to its net tangible assets.

We can use that information to answer the question: “Is it cheap?”

When first looking at a stock, I often ask 5 questions: 1) Is this stock overlooked? 2) Can I understand this business? 3) Is the business safe? 4) Is the business good? 5) Is the stock cheap?

Because I started today’s discussion with the company’s ability to generate earnings relative to tangible equity – let’s start …

Green Brick Partners (GRBK): A Cheap, Complicated Homebuilder Focused on Dallas and Atlanta

I chose to write-up Green Brick Partners (GRBK) this week for a couple reasons. The first is the company’s headquarters: Plano, Texas. I live in Plano. And the company gets about half of its value from its Dallas-Fort Worth homebuilding operations. My “initial interest post” checklist goes something like this:

• Do I understand the business?
• Is it safe?
• Is it good?
• Is it cheap?

The single most important questions is number zero: “Do I understand the business?” Since I’ve lived for about seven years right by this company’s lots – I should understand it better than most homebuilders. The other half of the company, however, is in the Atlanta area. That is a place I know nothing about. So, the answer to question zero would be that I understand half the business here well.

The next easiest question to answer – after “do I understand the business?” – would be #3 “is it cheap?”.

So, we’ll skip right to that one. It is, after all, the other reason that put Green Brick Partners at the top of my research pipeline.

I have in front of me the balance sheet for Green Brick Partners dated September 30^th, 2018. This is the last day of the most recent quarter the company has provided results for. Under “inventory” we see $648 million. Under “cash” we have $33 million. There’s another $12 million under “restricted cash”. The unrestricted part of cash is offset almost exactly with customer deposits. The restricted part of cash is just $12 million. Debt is about $200 million gross. So, that leaves about $188 million in net debt. If we netted out that inventory less that net debt we’d be left with $648 million in inventory less $188 million in net debt equals $460 million. The company has a little less than 51 million shares outstanding. So, $460 million in real estate free from debt divided by 51 million shares outstanding equals $9.02 a share. Let’s call that $9 a share. That’s very close to the company’s officially stated net tangible book value of $8.97 a share. Again, that’s basically $9 a share. We can compare this to the market price of $8.06 a share at which GRBK stock closed today. So, we have a stock with tangible book value – almost all land (about 50% in Dallas Fort-Worth and about 50% in the Atlanta area) – of $9 a share against a market price of $8 a share. Green Brick Partners is trading at about 90% of book value. So, a price-to-tangible-book ratio of 0.9 looks cheap.

However, this is where we start getting into the more complex aspects of Green Brick Partners. The company’s balance sheet shows only $15 million (about 29 cents a share) in “noncontrolling” interests. Green Brick, however, has only a 50% economic interest in its Dallas Fort-Worth and Atlanta homebuilders. The fair market value of the 50% owned by its partners – basically, the top management of these “controlled builders” – would …