Avatar Holdings: Even Ben Graham Would Buy This Housing Stock
by Louis Basenese, Small Cap and Special Situations Expert
Friday, June 25, 2010: Issue #1289
Following this week's record low reading for new home sales, you might think now is the worst time to bet on a housing recovery.
The aftermath of such disappointing news represents an ideal contrarian opportunity. And I'm convinced that now is the perfect time to bet on a real estate recovery - at the housing market's "ground zero," no less. Yes, I'm talking about in Florida and Arizona.
Now, before you think I'm crazy, consider this: Even the late, great value investor Benjamin Graham would agree. Here's the deal...
Avatar Holdings: A Profitable Formula That Involves No Guesswork
If you're looking for me to tell you precisely when a rebound in real estate prices will materialize, I unfortunately don't have a crystal ball.
However, I do own a pocket calculator and it reveals an extreme disconnect between the market price and the liquidation value for Avatar Holdings (Nasdaq: AVTR) - a developer of active adult and primary residential communities, with over 16,000 acres in Florida and Arizona.
The formula I'm using to make the determination here is one with a storied and irrefutable track record - Ben Graham's Net Current Asset Value (NCAV) per share.
Net Current Asset Value (NCAV)
The NCAV formula is as simple as you can get.
You simply subtract a company's total liabilities from its current assets. Then divide by the number of shares outstanding. It doesn't include any assets with subjective values like goodwill or intellectual property and involves absolutely no forecasting.
Running the numbers on Avatar reveals that the stock is worth $32.86 per share. However, it's currently only trading for about $20 per share. That means you can purchase the company for roughly 60 cents on the dollar.
Ben Graham would only purchase stocks trading at or below 65% of their NCAV. Or more simply, he only bought stocks trading for 65 cents on the dollar or less.
So as you can see, even by Ben Graham's strict criteria, Avatar ranks as a buy.
Patience is a Virtue With This Housing Stock
I assure you that such disconnects don't last indefinitely. Eventually, investors or an acquisition-hungry company will take notice and bid up the price.
That's why the long-term performance of stocks trading below NCAV is so impressive, topping 35% per year since 1985.
However, I need to make one thing clear: Profiting from Avatar will require patience. After all, I'm not a complete idiot.
I recognize that the real estate crisis is far from over. Unsold homes, foreclosures and delinquencies continue to pile up. And now, even prime borrowers are behaving badly, defaulting on their loans. At the same time, sellers remain stubborn, which means prices need to fall even further.
That said, we're much closer to a bottom than a top. And unlike almost every other homebuilder, Avatar is fundamentally fit to survive this downturn.
Avatar's Management Goes on An Oscar-Winning Scavenger Hunt
Rather than acting like turtles, curling up in their shells until the crisis passes, Avatar's management team is vulture-like, scavenging the land for historic discounts.
And the executives are finding them.
For example, take the company's purchase of Seasons at Tradition in Port St. Lucie, Florida in September last year. Here's what Avatar scooped up...
- 87 completed and partially completed homes.
- 267 developed lots.
- 364 partially developed lots.
- Approximately 400 undeveloped master planned lots.
Total cost: $7.4 million.
When the previous owner - the now bankrupt homebuilder, Levitt and Sons - defaulted on the property, the firm still owed $86 million. So in other words, Avatar picked up the assets at a 91% discount.
Avatar Holdings: Don't Follow the Herd... Be Contrarian
With over three decades of experience in the field and a $213 million war chest, no doubt Avatar will uncover many more bargains in the months ahead.
The company's other strategies include...
- Extreme Cost-Cutting Measures: Since 2005, management has slashed staffing numbers by 60%.
- A Retooled Business Model: This includes the abandonment of building McMansions in favor of smaller houses with less amenities at lower price points (i.e. the sweet spot of the future market).
It's these kinds of things that should put Avatar in a perfect position to rake in profits when the real estate recovery finally materializes.
Avatar is perhaps one of my most contrarian picks. But I have no reservations making it...
- The company is well-capitalized. It's sitting on almost $19 per share in cash.
- Insiders own a sizeable 22% stake, ensuring they're in it for the long haul.
- The stock benefits from no analyst coverage - a harbinger of significant price jumps once a recovery takes hold and Wall Street finally clues in.
- Most important of all, we can buy shares - and an interest in over 16,000 acres in Florida and Arizona - on the cheap. The discount is legit, too, since real estate is carried on the books at historical cost and the majority of Avatar's holdings were purchased prior to the peak in prices.
So fight your gut and be a contrarian. It's time to buy residential real estate in Florida and Arizona. And when it comes to Avatar, even Ben Graham would agree.
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