Making Room for an Under-the Radar Book Value Gem
Here's how I'm building more exposure to housing through this name with an interesting niche and an attractive valuation.
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Other than the occasional trade, my portfolio has had little to no exposure to housing-related stocks for the better part of two years.
Housing affordability levels have hovered near historical lows as mortgage rates quickly more than doubled from early 2022 due to the Federal Reserve’s monetary tightening. Combined with huge home price appreciation since the Covid pandemic and that made for a toxic environment for the housing sector. Existing home sales in both 2023 and 2024 came in at their lowest levels since 1995.
However, my view on the sector has started to change over the past month or two. Stocks of housing-related companies have gotten hit hard in recent months, providing more attractive entry points. Inflation also seems to finally becoming under control, which should allow Fed Chair Powell to reduce the Fed Funds rate again in the second half of this year.
I have recently established starter positions in both Beazer Homes BZH and The St. Joe Company JOE. These are two quite different housing-related concerns, but both equities sell for considerably less than book value. They have that in common with my third entry into the housing sector, Forestar Group FOR.
Forestar has an interesting niche in the market. It is primarily focused on land acquisition and its development into single-family residential lots. These are then sold to homebuilders.
Forestar basically buys land, grades it, brings in utilities, and performs other engineering work that provides the foundation for a new home community. It then sells this upgraded land to homebuilders. It targets a pretax annual return of at least 15% on these projects.
Almost all of Forestar's upgraded lots are currently purchased by D.R. Horton DHI, which builds around an eighth of all new homes in the U.S. There is a good reason for this relationship, as D.R. Horton owns just over 60% of Forestar. D.R. Horton has the rights of first refusal, but Forestar can then sell to other homebuilders if the company does not meet its price.
It has been a beneficial and symbiotic relationship over the years. Forestar has plenty of room to grow as it currently only supplies around 15% of the lots D.R. Horton purchases. Management has a medium-term goal to get that up to a third.
D.R. Horton has a vested interest in abetting Forestar’s efforts to become an even more important lot supplier given its ownership in the company. In addition, approximately half of the lots that Forestar controls are in Texas and Florida. These are the two fastest-growing states in the U.S., population wise.
Forestar's balance sheet is in good shape. With the recent 40% decline since the stock’s highs this summer, FOR trades for just over $21.50 a share. Its listed book value at the end of its most recently completed quarter was almost $32.00 a share.
Profits are expected to decline 5-10% in fiscal year 2025 (ends September), before rebounding nicely in FY 2026. Both years should see approximately 10% revenue growth.
The stock trades for less than six times trailing earnings and there has been some recent insider buying in the equity as well. Given that, it is hard to see Forestar not providing value at current trading levels.
The shares also set up well as a covered call trade, although liquidity in the options against the equity is not anywhere near last week’s trade trade idea around Amazon AMZN. However, even at the high end of the range provided below, the trade provides solid return potential.
Option Strategy
This is how one can initiate a holding in FOR with a covered call order. As a reminder, covered call orders involve buying an equity and simultaneously selling just out of the money call strikes against the new position.
Using the December $20 call strikes, fashion a covered call order with a net debit in the $17.00 to $17.50 a share range (net stock price - option premium).
This strategy at the top end of the range above provides downside protection of just over 14% with similar upside potential even if this equity trades down slightly over the option duration.
At the time of publication, Jensen was long AMZN, BZH, FOR and JOE.
