Summary
- AMR is a land developer and homebuilder in Rio Rancho.
- The company has massive assets in the city, which have been the topic of debate among deep value investors.
- In this article, I analyze AMR from a recurring income generation capacity.
- I find that the company is able to generate sufficient income to justify its current market cap. The data does not point to a home supply bubble in Rio Rancho or Albuquerque.
- The company's balance sheet provides an additional margin of safety, but is not the core of the valuation.
AMREP Corporation ( AXR ) is a land developer and home builder in the Rio Rancho city of New Mexico.
The company has recently started its home building segment after decades of dealing only with land development, and disposing of unrelated businesses in publishing and fulfillment.
AXR's recent earnings are influenced by one-time earnings related to the disposition of previous business segments. Further, the company carries most of its real estate inventories at historical costs. This makes valuing AXR a challenging task.
My approach to evaluating the company is founded on the company's operating income capacity, rather than on the liquidation value of its assets. I believe this approach is safer for non-controlling shareholders.
From that perspective, I believe AXR provides value at current prices. The company should be able to generate sufficient income to justify its current market cap, and has its balance sheet as an additional margin of safety.
Note: Unless otherwise stated, all information has been obtained from AXR's filings with the SEC .
Business description
Pioneers in Rio Rancho : AXR has been developing land in Rio Rancho since the 1970s at least. The company then became famous for opening streets in the desert and selling plots to investors across the U.S., many of which found them to be difficult to develop in solitude.
The strange situation of the gridded desert can be seen easily in Google Maps .
The company was then left with some contiguous and some non contiguous plots of land in the region. The story was researched in depth by Brian Grosso .
Today, the company still owns 1000 acres of undeveloped and under development land in the city. It also owns 17 thousand acres of undeveloped land that is difficult to develop because it is not contiguous, making development not as profitable.
For decades, AXR slowly developed and sold those lands to homebuilders in Rio Rancho, as the city expanded. Today, it is the third largest city in New Mexico, and already belongs to the same metropolitan area as Albuquerque.
Adventures in other businesses : The company also purchased a publishing business from Allied Capital in 2007. The business never took off, as publishing was suffering from a secular downcycle, and AXR sold its participation in it in 2015, plus remaining assets in the following years. Today, the company has no assets in that business.
AXR also has a plot in Colorado that is leased for O&G exploitation for a royalty on production. It also has 160 acres in Brighton, Colorado, that are suitable for house development.
Homebuilding : After the failed adventure in publishing, AXR decided to start its own homebuilding project in 2020, under the name Amreston. The company has been growing this operation consistently since, and this business could eventually generate more revenue than the land development business.
A balance sheet fortress : The main bullish thesis on AXR has been that its $70 million in real estate assets are significantly undervalued. Asserting this is difficult because it requires significant time to study each asset separately, and access to proprietary databases. The SA author Nicholas Bodnar has a fantastic article covering each of the company's assets .
I will not delve so much into this subject because I do not believe small investors should take an investment based on deep-value analysis that is only feasible for investment firms who can dedicate a significant amount of research time to a single stock.
Still, with debts of less than $4 million, total liabilities of $7 million, and assets of $96 million, including $12 million in cash, the company has a super strong balance sheet, even valued at cost. It currently trades at $70 million, meaning below book value.
Valuation
Instead of focusing on assets, I will focus my valuation on the ability of the company to generate income with those assets. This is more feasible with constrained research time, and is also more logical. Assets should only be worth what they can generate in income. If the company is unable to generate income with those assets, and the investor is not able to buy the company and sell the assets separately, then they are not worth that much.
Real estate is competitive : As Munger said at a Berkshire annual conference , real estate is a competitive investment landscape. Although AXR has an advantage in Rio Rancho because it owns a lot of land at historical cost, it still has to compete on a recurring basis. Further, because AXR is taxed like a corporation and not like a REIT, its returns are lower.
Geographical concentration : AXR's land development and homebuilding businesses are concentrated in a single city. The demographics and economics of this city and its neighbor Albuquerque move the company's profitability. This is a risk that other companies with more diversified assets and operations do not have. Personally, I do not see this as a terrible aspect given that certain long term trends, like trade relations between the U.S. and Mexico, benefit development in the region.
Volatile gross margins : AXR's gross margins on sold land and houses have been very volatile. In my opinion, this has not been generated by volatile real estate prices, but rather by the enormous size of the company's asset base. Depending on location, the different plots of land can have different prices.
The table below, compiled from AXR's annual reports from the SEC, shows volatility for the land development segment (AXR's fiscal year ends in April), reported by the company as 'land sale revenues'. The second row shows revenues for each fiscal year, in millions. This shows that margins were not influenced by revenue levels either.
2022 | 2021 | 2020 | 2019 | 2018 | 2017 | 2016 | 2015 | 2014 | 2013 |
45% | 31% | 17% | 14% | 30% | 28% | 15% | 26% | 23% | 40% |
$39 | $25 | $16 | $12 | $6.4 | $9.4 | $5.7 | $5.9 | $3.7 | $0.9 |
Gross margins on the homebuilding segment were 33% in 1H23 , 24% in FY22, and 16% in FY21. In this case, revenue has been growing consistently for the segment, indicating some scale efficiencies.
A $5 million SG&A structure : The company has to sustain $5 million in SG&A costs after disposing of its previous businesses. This, plus shareholder's income, has to be paid with gross margins generated by the other businesses.
How much income is needed : If the investor requires a 10% accrual return on its investment, we are talking about $1.4 per share, or $7 million at the company level. Applying income taxes of 25%, translates into $9 million in pre tax income. Add back $5 million in SG&A expenses (not considering negligible interest expenses), and the company requires $14 million in gross profits, to deliver a healthy return.
The tricky part comes when trying to estimate the company's gross margin on its operations. Using a 30% combined margin yields revenues of $47 million to generate $14 million in gross profits. The 10 year average of land development gross margins is 27%. Reducing the gross margin to 25% yields $56 million in required revenues.
Are those revenues sustainable? : The company currently can generate that level of revenue. In the 1H23 period it generated $27 million in revenues from these two segments. In FY22, $52 million (after subtracting the sale of unrelated property in Florida). In FY21, however, the company sold much less, only $28 million.
The problem is sustainability. In terms of assets the company is completely covered, it has 1 thousand acres of land that can be developed, and has been selling about 60 acres yearly to generate revenue levels of 1H23 and FY22. Further, the company has been acquiring land as well. If the company is buying plots adjacent to the 17 thousand acres that are too sparsely located to be profitable, then it could release even more land for development.
In terms of a homebuilding bubble, the data from the U.S. census bureau does not point to that . New home supplies were depressed after the bubble leading to the 2007 collapse, but are now at more healthy levels.
On the demand side, the 2020 census data indicates that Rio Rancho's population grew by 13% between 2010 and 2020 (1.2% CAGR, more than double the national average), and that housing occupation was 94% at the county level.
Risks
Geographical concentration : Despite the data above does not point to a construction bubble like the one seen before the GFC, AXR has a significant geographical concentration risk. If anything happened in Rio Rancho, Albuquerque or the region, the company will be severely hit.
Low trading volume : It is not easy to build (or close) a position in AXR. Trading below has been below 10 thousand shares (about $140 thousand) daily. This is a general risk of microcap stocks.
Conclusions
I believe AXR could very well sustain a level of recurrent operations that allows it to provide a sufficient return to shareholders. Its geographic market is not saturated in terms of supply, and the company has reached the required revenue even when forecasting average gross margin levels.
The company further provides a margin of safety because its balance sheet is super safe. AXR has $4 million in debt against $12 million in cash, and $70 million in historically priced real estate inventories.
On the upside, the company can continue growing its homebuilding operations, with self generated financing by through asset sales.
For further details see:
AMREP Trading At Value Price Even If The Balance Sheet Is Ignored