Outlook For Manufactured Housing

TWST: Give us a broad overview of what's going on in the manufactured housing market at this point.

Mr. Nouri: As you probably know, over the past six years, manufactured housing has really seen a recession. It's gone from 360,000 shipments in the late 1990s to about 130,000 shipments, excluding FEMA, last year. However, we are seeing something of a rebound in manufactured housing, as we are seeing a little bit of the financing opening up; banks, including U.S. Bank, have come into the lending arena and opened up financing. Also you see markets like California, Florida and Arizona, which are very strong retirement markets, really holding up the manufactured housing market.

TWST: What was the cause of the big decline? Was it people moving away from manufactured housing or the lack of financing?

Mr. Nouri: Throughout the 1990s, the banks lent to everyone. You came in, you had a face and you got a loan. There were all these loans outstanding on these manufactured homes and a lot of them were becoming delinquent in 2000-2001, so a lot of the homes were being repossessed. There were two problems with this. One is, when they repossessed the homes, the values of the homes were probably half or a third of what they were at the time of the original loan. And also there was a lot of inventory. So really, the manufacturers were having a tough time getting new homes out, when there were all these quality used homes coming through the business.

TWST: So where does that process stand now? Has it been totally unwound at this point?

Mr. Nouri: We think that a lot of the inventory has been flushed through the system. A lot of the quality used inventories are now through the system and a lot of park managers are saying that they have to go back to buying new manufactured homes. So we should see a benefit from this of about maybe 10,000 shipments this year and maybe 15,000 in 2007.

TWST: The base demand is picking up a bit.

Mr. Nouri: Yes.

TWST: What has been the impact of FEMA and Katrina on this marketplace?

Mr. Nouri: If you look at FEMA in 2005, it added about 15,000 to 17,000 shipments; in January, it will probably add another 3,000 to 6,000, when all is said and done. So it has really helped the manufacturers to get a little incremental profitability. More important, they see it as a way to enter the rebuilding in New Orleans and the whole Gulf Coast area. There are about 350,000 homes that were destroyed. So if they can get a 10%-15% piece of that, then the manufactured housing industry should see a pretty good benefit for it over the next two years.

TWST: Is that kind of housing going to be allowed in disaster zones like that?

Mr. Nouri: There are some areas where the manufactured housing institute is working with FEMA in order to allow these homes there because in reality, these homes will be able to survive disasters. If you take Florida, for instance, the HUDCO down there has homes withstanding winds of anywhere from 100 to 140 miles per hour. Really, the ones that are built now are just as stable as site build homes, so it is more of a perception thing and getting the rules changed before there is any reconstruction. It is pretty clear the reconstruction really wouldn't happen until the back end of this year, maybe the last quarter of this year into next year, because there is still a huge clean-up effort that is going on down there.

TWST: So nothing is going to happen fast?

Mr. Nouri: No, it will be more of a long-term positive for manufactured housing. And also they see it as, if they are able to get in there and sort of improve their image, it will improve shipments nationwide.

TWST: Did the FEMA demand help clean up the balance of the inventory or was this mainly new build product that they were picking up?

Mr. Nouri: No, it was mainly new build product. It increased the manufacturers' capacity, so a lot of them are operating at about 60% capacity and this might have brought it up to 80% temporarily. And because a lot of them don't want to lose that business in 2006, they are working really hard to maintain that sales level.

TWST: During this prolonged and sharp downturn, what happened to industry capacity?

Mr. Nouri: The number of manufacturers was slashed, the number of factories was slashed, and basically the best players are surviving right now. Also the number of retailers dramatically went down because people thought that they could just open a store and sell manufactured homes. If you were selling five before and you are only selling one now, it is very hard to make a profit. So that's also a reason why the shipments came down, but now a lot of the manufacturers seem to get what's going on and they've right-sized their operation. So right now, I'd say a lot of the industry is at 70%, 75% capacity depending on the geography.

TWST: So the facility contraction is behind the industry at this point.

Mr. Nouri: Yes, I would say so. I mean, going forward, you will probably see consolidation within the industry with the bigger players buying some of the smaller players.

TWST: What are the benefits of further consolidation, just economies of scale?

Mr. Nouri: Economies of scale is one thing. Also, if a manufacturer doesn't really have a good hold on its geographic footprint or if they want to introduce new products, they might go shopping. Say Company A does manufactured and modular housing and they want to introduce modular housing in a new market; if they buy a manufactured housing company in that new market they will be able to use their distribution channels to sell modular housing as well.

TWST: So it is really a combination of things that is driving that.

Mr. Nouri: Yes.

TWST: Let's look at the other side. What is it that the consumers are looking for today in manufactured housing?

Mr. Nouri: Some of them are looking to own their own land. The manufactured homes of today and of 15 years ago are completely different. Some of these manufactured homes you can walk into and it looks pretty much like a site-built home. I think what people are looking for is quality. In 10 years, it is not going to be like a car and just lose all of its value. So they are looking for the value to stay it in. One thing the industry is doing to sort of help that along is they are implementing a J.D. Power and Associates system to rank all the manufacturers, so that should help consumer confidence.

TWST: Has that started yet?

Mr. Nouri: They are in the process of getting the approval from manufacturers, and the manufacturers have to pay a certain amount per house. Plus the manufacturers will be signing up for it, from what I have seen.

TWST: So it is something the industry is behind at this juncture.

Mr. Nouri: Yes, it is getting through it right now. You could say that it will be rolled out within 12 months.

TWST: Is the manufactured housing being built at this point bigger, is it better quality? What's different today from the peak of the last cycle?

Mr. Nouri: Yes, a lot of them are bigger. A lot of the houses they are selling now are triple or quadruple wide. They have better amenities inside, they can fully load them. Some manufacturers like Cavco Industries (CVCO) are making them with stucco, which really gives them a nice look.

TWST: Are they typically more expensive?

Mr. Nouri: Yes. The average price has gone up, probably somewhere in the range of 20% over the past six years.

TWST: How do they compare today with a stick-built house? Are they still at a significant discount?

Mr. Nouri: In most areas, they are significantly less. They are still about, on average, 30% to 35% less than site-built housing. The only thing is, if you look at Texas, they have seen shipments sort of slumping over the last six years. The reason for that is you can get a site-built house there for $120,000 and a nice manufactured house is going to cost about $100,000. So you have to really like the product that goes into the manufactured housing; plus with the traditional site- built housing, you are getting a better mortgage rate typically than with manufactured housing.

TWST: Let's touch on the financing side of this. Have some new players come into this business?

Mr. Nouri: Yes. I specifically cited U.S. Bank, probably the only primary player that recently came in. You look at Origin, and they are sort of expanding their portfolio slowly and steadily. Everyone right now is sort of creeping back into the market, if they are not already in, or expanding their loan portfolio a little at a time, sort of scoping the market out because everyone is still a little skeptical. It is only five or six years since the major recession when all these lenders lost their shares. So yes, I would say that it is picking up little by little, but it is still probably the biggest challenge for the industry because they have consumers that do come into retail stores and want a house, but they are not able to get a loan because the financiers are being a little tighter with the money.

TWST: Is it because the typical customer for this is lower quality credit?

Mr. Nouri: That's correct. They typically have a FICO score of somewhere between 600 and 630 and a lot of time, if they have a FICO score under 600, they won't be approved.

TWST: We've seen a big increase in less-than-top-quality credit companies. Have any of those guys taken a look at this business?

Mr. Nouri: No, I mean not from what we've seen, not from our channel checks, not from our going to the conferences. We haven't seen any of these low credit quality guys get into the manufactured housing space, but there is a school of thought that as site-built housing retreats a little bit, the lenders will have to look for another area for lending income. So they might revisit manufactured housing. Also we expect the negative effect of the manufactured housing blow-up in the late 1990s is wearing off a little. So there is sort of a wait-and-see attitude. And it is not going to be like the lenders are all going to enter the market this year in a big way; it will be a gradual event over the next two or three years, I think.

TWST: As you look at the industry, what kind of growth would you anticipate if we look out over the next two or three years?

Mr. Nouri: If we take out FEMA from 2005, we have a shipment number of around 130,000 shipments; 2006, we are expecting about 145,000 to 150,000 shipments; and 2007, we expect to see from 160,000 to 165,000 shipments. A lot of it is benefiting from the rebuilding on the Gulf Coast.

TWST: That will have a positive effect as we look out over the next couple of years.

Mr. Nouri: Yes, I think in 2007 it should hit pretty well.

TWST: Does the industry have to do anything different to meet the demands of that marketplace?

Mr. Nouri: I don't think so. I mean, a lot of the retailers in the late 1990s had poor practices and didn't really treat the consumer well and a lot of that has been corrected. So I think that the industry is in the right place and they are positioning themselves right on the Gulf Coast. They've had a few conferences where they bring local officials together and local builders, so you have the builders and the manufactured housing builders sort of coming together and marketing the product to consumers. So I think the image is improving.

TWST: What are the risks to this rosy recovery scenario?

Mr. Nouri: I think that one risk would be if interest rates stay low because if they stay in the 6 to 7 area over the next three years, which is unlikely, but if it does happen, then site-built housing will still compete very well with manufactured housing. Also, if the financing doesn't open up at all or if it tightens a little bit, that's going to be a pretty big drag on the industry. Florida has been very strong over the past few years, but if you see any retrenchment there ' I mean that accounts for probably nearly 10%-15% of shipments, so any retrenchment in that region would show up in the nationwide numbers.

TWST: How about the impact of the not-in-my-backyard syndrome ' that nobody wants a mobile home in their yard? Is it becoming more difficult to find sites to put these?

Mr. Nouri: I think that it will always be difficult to put a manufactured house in a site-built housing community, but I don't think that that's the main market for manufactured homes. I think that most of these manufactured homes are put in communities with other manufactured homes. So there are those zoning problems where people try to bring their manufactured homes to a site-built community, but most of them are going into their own communities, so I wouldn't really see that being a problem. The reality is that every state needs to accommodate some sort of affordable housing for some people, so I think that there is always going to be a place for manufactured housing in certain parts of the country.

TWST: When you talk with investors as this point, is there interest in this space?

Mr. Nouri: Yes, I think the interest has picked up because everyone is sort of looking for the turnaround to come through. A lot of the manufacturers reported great results in the fourth quarter largely because of FEMA, but I also think that a lot of them have gotten their gross margins up just because they have right-sized their operations. I think as investors see that the profitability is stable and that it is growing, those that have not been in, will start investing.

TWST: Is there a fear that FEMA is a flash in the pan and that things are going to go right back down again?

Mr. Nouri: I haven't heard that too much. I mean, FEMA was a flash in the pan, there was an extra 20,000, 25,000 units that did the industry a lot of good, but I think that a lot of people see the new houses replacing the inventory that was stuffing the channel earlier in the decade, so that'll account for 10,000 to 15,000 shipments. The industry is largely positive, I haven't heard much negative. It is quite a turnaround because before 2005, say from 2003 to 2005, there was a lot of built-in negativity, but with the hurricane and the rebuilding efforts, there is now a lot of more positive news surrounding the area.

TWST: What should investors be doing at this point?

Mr. Nouri: Your best bet is to buy one or two of the manufacturers. The only thing is, they are a little tough to get into because they have a low float, but I think, if you can buy and hold for 12 months, that some of these players would be very good investments.

TWST: What names would you look at, at this point?

Mr. Nouri: Right now, in the manufactured housing space, I cover Cavco Industries and Nobility Homes (NOBH) and I think that they are both positioned very well in the manufactured housing space. Nobility Homes is only in Florida. They have the best margins in the industry ' they have about 11% net margin; they have a 1% dividend; more important, they survived the recession of manufactured housing better than most other manufacturers. So they got a lot of business from the hurricanes down in Florida in the past two years and we see them replacing that by selling bigger homes that they haven't put into their retail channel until now. They have 19 stores that they sell their homes through very successfully and the greater percentage of homes that they can sell through those stores, the higher their profitability will be. And they have, right now, about $28 million in cash and the market cap is only $100 million. A couple of uses for this cash are that they could open a couple of retail stores, which is the most likely use for the cash, and another is that they could open a third factory in northern Florida and service that area better.

TWST: Do they have need for a third factory? Are they capacity constrained?

Mr. Nouri: They are not capacity constrained. Right now, in their two factories they are probably running at about 70% capacity, but the primary reason for that is because they can't find enough labor in the areas that the manufacturing plants are in. I mean, they could pump out more product, but they couldn't find the people in those areas that the manufacturing plants are in. So they are picking up there. These plants are very low cost, so if they open a third one, it could cost anywhere between $1 million and $4 million and they are very low cost to maintain as well. I don't think there's that much cost involved with opening a third manufactured housing plant.

TWST: So they've got a strong position in the important Florida market.

Mr. Nouri: Yes. And from their point of view, they are gaining market share in Florida. I sort of see that too. I mean historically, they have been selling lower end homes. Right now, they are trying to get in some more of the medium price range home. If they do, one, it will bring up their average selling price and, two, it is another selling channel for them. Just pushing more product through the same stores is going to bring up profitability pretty quickly.

TWST: You said they have a premium margin. Why? What is it that they do to achieve that?

Mr. Nouri: It is very lean and it's a closely held operation. The Founder and CEO owns about 67% of shares, so he watches the company very closely. But also they have an insurance subsidiary, they have a financing subsidiary and they have retail stores. So every home that they sell, they are not just making the money off the home, but they are making the money off of the retailing, the insurance, and the financing, which is important because they and Clayton Homes are really the only two manufacturers that have been able to make money off of those complementary services.

TWST: Why is that? It doesn't sound like it is a difficult part of the business.

Mr. Nouri: No, but take Champion Homes, for instance. They are all over the country, so they have a tough time controlling their retail operation and controlling the good lending. Nobility Homes has 19 locations, they are in Florida, and the CEO and CFO talk to all the associates and the retailers on a very frequent basis. So it is closely held, and they can manage it pretty closely the way that they want to manage it.

TWST: And the other name you mentioned was?

Mr. Nouri: It is Cavco Industries, out of Arizona. The one thing that these companies have in common is that they are both in great retirement markets. Nobility is in Florida and Cavco is in Arizona. Cavco is the market share leader in Arizona, but also they have been making a lot of money shipping to California. Right now, they actually opened up a plant at the end of March in Texas, which sort of benefits from any rebuilding that would go on in the Gulf Coast area. It would be a lot easier to ship from Texas than it would be from Arizona and a lot more economical. And also what Cavco does that Nobility doesn't is they sell log cabins and park model homes, which are particularly marketable to a retiree. That product has done very well for them, sort of given them an extra leg to go up on with their growth. And they are opening another plant in Phoenix over the next 12 months that's going to be double the size of their current plant that produces both HUD-approved homes and the specialty homes. Right now, they are operating at about 90% capacity; when they bring these two plants on line, it will add another 30% or so capacity.

TWST: What kind of longer-term growth can they generate and where they are going to get it?

Mr. Nouri: If you look at EPS growth, they can probably both generate 15% EPS growth over the next five years, 15% to 20%. Some of it is going to come from margin expansion and some of it from market share gains, but I definitely think that as the industry grows, these guys are going to grow with it.

TWST: So they are in a position to take advantage of what's going on in the industry in general?

Mr. Nouri: Yes, they are both very well managed companies and they know where to take advantage of opportunities. As I said, as the industry grows, these guys will grow as well. And there is a clear profit margin to grow quicker than their competitors just because both of these guys have very good profit margins as opposed to industry. They have always had a history of bringing up the profit margin better, quicker when the capacity increases.

TWST: You've talked about both of these guys growing capacity. What's the risk that too much capacity comes back into the industry and deflates the recovery?

Mr. Nouri: That is a risk. I mean, you look at 130,000 shipments, that's really a base number for demand around the country that realistically wouldn't go any lower than that. So with the additional capacity, there is risk, but there is not a lot of additional capacity coming on. There are a couple of plants in Florida and Arizona, but as far as the middle of the country, you can almost still see plants being closed because with the recessionary events that have been going on there ' US auto manufacturers closing their plants ' there hasn't been a lot of demand for manufactured housing. When you look at Arizona and Florida long term, there should be a very strong demand there, and that's where the capacity is being increased.

TWST: Are the factories that were closed, gone or are they just sitting there idle, waiting to come back on line if things get better?

Mr. Nouri: They are just sitting there idle. Some of them have been able to sell some to use as shipping warehouses. But, for instance, Champion has a lot of idle factories that they are just sort of sitting on and paying a million or two a year in cost and property management that probably will never come on line again. Champion, in particular, has three plants in Alabama that are idle, and the demand in Alabama probably isn't going to increase enough for them to open those three plants. There is just really not that demand for those plants in those areas.

TWST: So the facilities are there, but they may be in the wrong place.

Mr. Nouri: Yes, exactly.

TWST: So it's a benefit for the guys who are opening facilities close to the hot markets, I guess.

Mr. Nouri: Yes, exactly.

TWST: Thank you. (TJM)

Note: Opinions and recommendations are as of 4/13/06.

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