Undervalued Company of the Week – BHS

The company of the week this week is Brookfield Homes Corp. (BHS), a homebuilder with operations in California and Washington.  As we did last week, we will be looking reviewing the company using Warren Buffett’s approach for the Business & Management Review.  We will also use Benjamin Graham’s overall philosophies to guide our Financial & Value Review.

Business & Management Review

1.  Is the business simple and understandable?

     Brookfield Homes is not in a complicated industry.  They are in the business of constructing homes and selling them to luxury and move-up buyers. 

2.  Does the business have a consistent operating history?

     Brookfield Homes was spun off from Brookfield Properties Corporation in January of 2003 in order for Brookfield Properties to strengthen its pure play strategy in the premium property business.  Brookfield Properties was founded in the 1920s and has been successful in the real estate industry throughout its history.  Since the spin-off, Brookfield Homes has experienced excellent growth in its operations along with virtually all other homebuilders.  Usually we would seek companies that have attained a more apparent consistency in their history, but we believe the history of Brookfield Properties must be taken into account.  Brookfield Homes is not a mere start-up that is only 3 years old – the company has a considerably longer history as a division of Brookfield Properties.

3.  Does the business have favorable long-term prospects?

     The focus here is on the long-term.  Home prices may fall in the next year or so, but over the long term the company is sure to remain profitable.  As the target customer of Brookfield Homes is the upper-middle class, we believe the company has the potential to be resistant to downturns in the economy.  Also, the company’s main focus is on properties in California where the land value over the long-term is sure to continue to rise.  California will always be a location where people are driven to live – we cannot say the same with certainty for a homebuilder focused on building luxury subdivisions in North Dakota.

4.  Is management rational?

    We believe management to be rational.  The management is focused on the long-term prospects of the company and interests of the shareholders.  The company is working and planning over 7 years ahead, targeting properties and planning construction projects.  We believe this approach will benefit the company over the long-term, as management is not discouraged by the prospect of lower prices in the short-run.

5.  Is management candid with its shareholders?

     Brookfield Homes has an average to below-average investor relations website.  While all of the required information and annual reports are available, we have seen better and have come to expect more disclosure and candor with shareholders.  More messages directly from the management would be appreciated so prospective investors can get a better feel for the people they place their money in.

6.  Does management resist the institutional imperative?

    We believe the company’s management resists the institutional imperative.  However, as mentioned in the previous point, we would like to be provided with more information from the management to confirm this. 
 

Financial and Value Review

Upon our review, we find Brookfield Homes Corporation to be suitable for the enterprising investor but not the defensive investor following Benjamin Graham’s value investing strategy.  The company’s size, current ratio, and lack of an independent operating history of at least 10 years eliminate it from the defensive investor’s portfolio.  With a PE ratio (see Our Methods) of 7.11 and an ROIC of 16.10%, we believe this is an excellent investment opportunity.

We believe the company has potential to reach $52/share in the next few years.  We even find that if the company delivers a measly 5% growth rate over the long-term, its earnings should be valued at $43.

Neither of us held a position in Brookfield Homes Corporation at the time of publication.  Also, please read our disclaimer and Our Methods.

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