Introduction

Skyline-Champion (SKY) is the second-largest manufactured home company in the US (the largest is Berkshire Hathaway's (BRK.A) Clayton), so I was surprised to find sparse coverage on SeekingAlpha, with the most recent article published nearly two years ago in January 2018.

Since then, Skyline merged with Champion to form Skyline-Champion and a chronic labor shortage in the construction industry is beginning to create longterm favorable tailwinds for off-site construction companies such as Skyline. As I build out an investment thesis for playing the growing housing and labor shortage, it seems appropriate to initiate coverage of the newly-minted Skyline-Champion on SeekingAlpha.

Skyline-Champion was formed by the merger between Skyline and Champion in June 2018 to create the second-largest US manufactured home company with 17% share of the market, according to the most recent investor deck (see slide pasted below). For reference, the largest is Clayton Homes with 47% (owned by Berkshire Hathaway), and the third is Cavco (CVCO) with 13%.

Slide from 20Q2 Investor Presentation

Skyline's business is organized into three reporting segments: "manufacturing and retail", "commercial", and "transportation". The manufacturing and retail segment is by far the largest, representing 93% of revenue. Manufacturing and retail is primarily HUD code manufactured homes. Transportation (i.e. shipping / logistics of manufactured homes) makes up 6%, and commercial (i.e. multi-tenant wood frame buildings such as hotels) makes up the remaining 1%. The product mix can be seen visually in the slide below taken from Skyline's most recent investor presentation. The mix of products cover a range of price points, but in general are well below the median US new-build price of $101/sqft. This positions Skyline to grow with the increasing unmet demand for more affordable housing.

Reporting Segments from FY19 10K

Slide from 20Q2 Investor Presentation

A snapshot of Skyline Champion's earnings breakdown (quarterly revenue, gross profit, EBITDA, Net Income, and FCF) is shown below to provide a quick visualization of growth and margins. For the most recent quarter, Skyline brought in $354M revenue and $31.4M EBITDA, corresponding to an EBITDA margin of 8.85%. Free cash flow was $20.5M. The balance sheet overall looks healthy with a 0.099 debt to equity ratio and $139M in working capital. Looking forward, analysts are estimating $1.54 EPS for FY2021 and $1.31 for FY2020, which represents 26% and 18% year over year growth respectively. This growth is expected to be driven partly by top line growth and partly through margin expansion. On the most recent conference call, CEO Mark Yost estimated that EBITDA margins can grow to 10% over the next 18 months.

Data by YChartsData by YCharts

Earnings Breakdown and Balance Sheet Breakdown.

The stock price is currently $31.45 following a tremendous 114% rally year-to-date. This gives a P/E ratio of 24 based on FY2020 earnings and 20 based on FY2021 earnings. These valuations are very high, especially considering that the manufactured home market is only expected to grow at a 6% CAGR over the next year and much of the earnings growth will be due to margin expansion resulting from cost synergies.

Despite the high valuation, there are some growth opportunities that could represent a substantial upside to current earnings estimates. These growth opportunities stem from the fact that an ongoing labor shortage in the construction industry is constraining the housing supply and driving up home prices. This creates a significant opportunity for Skyline Champion to leverage its existing national network of factories and distribution to meet some of this unmet demand. Factory-built housing is more insulated from the effects of national labor shortages because the factories are typically located in communities with ample labor, whereas on-site construction is at the mercy of the local labor dynamics near the job-site location. For example, factory labor in a rural setting costs $15-$20/hr vs. potential $50-$100/hr in more urban settings.

Light commercial (3-5 story apartment buildings or hotels) developers are beginning to adopt modular construction, which is an early proof point that the traditional industry is ready to transition toward factory-built buildings. The benefits for commercial construction are the aforementioned cost savings on labor but also shorter construction times which reduces carrying costs associated with the land / job-site and accelerates property revenue. Skyline-Champion has a small commercial segment (1% of revenue) that focuses on this type of construction. Most famously, Marriott has been strategically pushing the use of modular construction for its hotels with Skyline-Champion one of their preferred vendors. Despite the potential to scale this commercial business, Skyline-Champion has not put a lot of emphasis on this segment during recent conference calls, suggesting that this will not be a strategic growth area for the company.

It appears that Skyline-Champion is more focused on expanding into the single family home market, as it is starting to target builder-developers as a customer segment. This strategic effort is being conducted in earnest through Skyline's Genesis brand line of products scheduled to launch in early 2020. This product line is intended to be an off-site construction solution for builder-developers looking to target the gap between traditional site-built single family homes and traditional HUD homes. Single family home starts are approximately 10x higher vs. manufactured homes, creating a potentially huge new market for Skyline-Champion. If Skyline-Champion captured just 1% of the single family market (which is roughly equivalent to 10% of the manufactured home market), that would grow Skyline-Champion's top line by almost 60% (Skyline-Champion currently has 17% share of the manufactured home market). Single family homes also sell for a higher price per square foot creating further upside.

Finally, Skyline-Champion is experimenting with automation, which if successful could increase factory capacity and margins. This could also help insulate Skyline-Champion from the effects of the industry labor shortage by directly reducing Skyline's reliance on manual labor and also expanding the potential labor pool by reducing the physical strength required to work in the factory. It is hard to quantify the potential impact of automation as the technology is relatively new in the context of construction, especially for US manufactured homes. To this end, Skyline has deployed automation only at a single factory: it's new Leesville factory. From the most recent conference call, management views the deployment of automation at Leesville as an experiment, presumably which if successful would then be scaled to more of Skyline's legacy factories. Investors have relatively little data by which to judge this experiment other than recent conference call comments from Mark Yost saying that the "learning's gone phenomenally well" and that the "takeaways from that had been monumental and [Mark is] very impressed".

Skyline-Champion's stock is currently quite expensive based on earnings estimates (P/E of 24 based on FY2020, P/E of 20 based on FY2021) especially given that the manufactured home industry is only anticipated to grow at 6% year over year. This high valuation likely indicates that investors believe that some of Skyline's growth experiments will pay off--most notably entering the single family home market through its new Genesis product line aimed at single family home builder-developers. Other experiments that could result in new growth are Skyline's experimentation with automation and Skyline's experience with commercial modular construction. Ultimately as many of these experiments are in early stages I would recommend a wait and see approach, closely monitoring Skyline-Champion for positive developments on any of the above growth experiments.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Potentially Transformative: Skyline-Champion Experimenting With Off-Site Construction And Automation - Seeking Alpha