Dream Finders Homes, Inc.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

Dream Finders Homes, Inc. is a high-growth homebuilder operating in several states across the US, with a focus on entry-level and first move-up homes.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Dream Finders Homes (DFH) operates as a national home builder with a focus on building and selling entry-level and first move-up homes in high-growth markets. They offer various designs that are intended to attract a diverse set of buyers and often have partnerships with developers in master-planned communities. Their operations are concentrated in the Southeast, the Mid-Atlantic, the Midwest, and Texas.

Business Overview:

  • Revenue Distribution: DFH generates revenue primarily through the sale of new homes. The company also has a mortgage banking segment that assists customers with financing, although the revenue from this area is very small compared to revenue from the homebuilding division.
  • Trends in the Industry: The homebuilding industry is cyclical and is currently experiencing a period of high-interest rates which have impacted affordability and overall sales volumes. There’s a continuous trend in demand for affordable homes in high-growth areas, but also some volatility caused by macroeconomic conditions.
  • Competitive Landscape: The homebuilding industry is highly competitive, with many national and regional players. DFH competes with both private and public homebuilders, including large national players and small local builders. Competition is often based on location, price, and speed of construction, with customer experience playing a key role in success.
  • What Makes the Company Different: DFH emphasizes a strategy of “asset-light” operations, using contracts with land developers and minimizing large capital investments. They offer homes in a variety of price points and often make use of pre-designed plans for efficiency. They have a relatively fast delivery times, averaging ~150 days, and also have a low percentage of sales which are spec-built (homes constructed for immediate sale).

While they have a growing revenue, their overall business performance is very volatile and fluctuates based on the macroeconomic climate, showing how sensitive the business is to interest rates and housing cycles

Financial Analysis: The company has shown strong revenue growth since the start, however, the volatile macro-economic climate has lead to high losses and volatile performances.

  • Revenues: The total revenue has continued to grow year-on-year, however at a slower growth rate in the last period (2023, first three quarters). As of September 30, 2023, Homebuilding revenues contributed 93.5 % and Financial Services contributed 6.5% to revenues.

Revenues from Homebuilding increased to $538.7 million compared to $508.7 million for the same period in the previous year. While revenue is growing, they have recently had issues with high cancellations and also slowing down of the housing market

  • Margins: Overall gross margins has seen some improvements in the most recent quarter but the cost of labor and building materials still remains high and also affecting their margin.
  • Net Income: For the first three quarters of 2023, DFH generated a loss of $76.7 million, which means they are not profitable.
*The company's financial performance is highly susceptible to the economic climate and shows that they are unable to translate their growing sales into profitability* *   **Balance Sheet:** DFH has a reasonably healthy balance sheet. The company has been taking on additional debt to finance growth. As of September 30, 2023, cash and cash equivalents stood at $180 million, while total debt was $1.5 billion. Debt ratios are not exceptionally high for the homebuilding industry, which is often capital-intensive. However, they continue to rely on long-term debt to fund growth. The net debt to capital ratio increased from 38.7% at year-end 2022 to 54.7% in September 2023. Also, their tangible book value per share has shown large declines over the past two years, falling by approximately 17%, as well as their equity.

Although debt is not excessively high, increasing it and decreasing tangible book value is not a good sign.

  • Cash Flow: The company has positive operating cash flow despite net losses. This implies that it is managing its working capital well enough. But these are not necessarily indicative of the long-term viability of the company.

Although they have a somewhat healthy balance sheet they still carry a high degree of volatility and need to be cautious because of that.

Moat Assessment:

  • Rating: 2/5
  • Justification: DFH has limited pricing power and faces significant competition in a cyclical industry. Their competitive advantages, such as a streamlined building process and an asset-light model, are difficult to sustain as they can be easily copied. Furthermore, there is little brand loyalty, as consumers generally buy homes based on price, location and other needs, and not due to brand preference.

Though DFH can compete well, they can’t do so while maintaining high profitability and ROIC over the long-term, they will be pressured to lower their margins and will be easily interchangeable.

Risks to the Moat:

  1. Macroeconomic Sensitivity: Fluctuations in interest rates and economic cycles will continue to impact demand, affordability and profitability significantly. The most recent earnings call has emphasized the negative impact of inflation and declining housing affordability to their performance, also as cancellations are rising because of these.
  2. Competition: Other builders could replicate their successful strategies. Established brands with stronger presence could offer the same and better alternatives. Also, any new entrant will have an easy time in this low-barrier industry.
  3. Input Costs: Rising labor costs and building material prices can erode their margins, as their ability to pass the costs to the customer is limited. Also, the cost of land is currently high, creating pressure on their margins.
  4. Geographic Concentration: A significant portion of DFH’s business is concentrated in the South-East, Texas, and Midwest. Economic downturns in these regions could significantly impact their overall performance. Also, some issues, such as Florida’s home insurance problem, are also making them vulnerable.
  5. Market Cycle: Being a cyclical business, a steep downturn can cause a decline in revenue and profits due to a lack of buyers.

If interest rates rise further, their financial performance would be even more vulnerable.

Business Resilience:

  • DFH has some resilience in that they focus on entry-level and first move-up homes, which are generally more stable than luxury markets. Also, they are not heavily tied up in excess inventories or land-inventory, allowing them to scale up or down faster and quicker than other companies. Management seems good at handling economic slowdowns.
  • However, overall business results are not consistent, and are easily dragged down by external economic conditions, which significantly reduces their resilience.

The business’ long-term prospects are highly dependent on favorable economic conditions, otherwise it is likely that its competitors can easily compete away the gains

Understandability Rating:

  • Rating: 3 / 5
  • Justification: The company is fairly easy to understand on a high level because they are basically building homes and getting a cut of those. However, analyzing the financial statements of any construction business, accounting intricacies, and the relationship between the company’s performance, macro economic factors, and their valuation takes an above-average amount of time to master. Their business model and growth strategies can be easily summarized, however, understanding the effect of their capital allocation and operating efficiencies requires more effort.

Balance Sheet Health Rating:

  • Rating: 4 / 5
  • Justification: They have a quite healthy balance sheet with sufficient liquid assets to cover short-term expenses, which have decreased substantially in recent quarters. Though their debt load is increasing, it is still well within manageable levels for the type of business that they are involved in. The rising interest rates and recent inflation will make this harder for them, however. As their tangible book value and equity has decreased a bit, this also lowers the rating a bit.

They have a decent liquidity cushion to withstand a potential economic downturn, but they will have to be very mindful and proactive, because a further decline can make them extremely vulnerable.

Recent Concerns / Controversies:

  • There have been concerns regarding cancellation rates rising and a slowdown in the housing market. The Management stated that they would focus on value creation rather than high volume growth, and are working on strategies to make their offerings more compelling for the current market.
  • There has also been some worries on the high debt of the company and how they are financing their growth given the rising interest rates. Management commented on their last earnings call that they are reducing their risk on land and leveraging their partnerships with land developers. Also, the CFO mentioned that a reduction in debt was a priority.

Management seems aware of the problems they are facing, but it remains to be seen how their plans and strategies would pan out.