Profile: The Ryland Group Inc. (RYL) is a residential construction company that focuses on home building for first-time, second-time, and move-up home buyers. The company, additionally, operates its only mortgage financing arm. The company offers detached, town homes, condominiums, and some mid-rise buildings. Ryland was founded in Calabasas, California in 1967.
Thesis
We all know the story on the residential construction sector. It has been one of the toughest industries in the economic times. A lack of new home demand, which is brought on by the high levels of unemployment and economic uncertainty, has plagued the entire sector. Recent rises in home sales in late 2009 and early 2010 were mostly fueled by tax credits. Now that those have disappeared natural demand has reappeared and sales have dropped off again for homebuilders. Real demand for homes may not appear again until 2013 – 2014, and until then, these companies will continue to struggle. Those companies that can do the best job of keeping down debt, remaining financially healthy, and liquidating inventory will be able to remain above water and play the waiting game for demand to return.
One company that has maintained one of the cleanest balance sheets is Ryland Group Inc. (RYL). The company operates in the Southeast region and West region. They operate in the mid-level home with an average selling price in the mid-$200,000 levels. They appeal to first-time, second-time, and move-up homebuyers. The company has been able to maintain a very financially healthy balance sheet over the past three years, keeping a current ratio above 4 and improving it over 6.5 in the latest quarter. The company is doing a great job of covering their liabilities and figuring out great ways to keep their head afloat during these tough economic times. Their current ratio is far better than competitors Pulte Homes, D.R. Horton, Lennar, and KB Homes – with the top competitors ratio at three.
The current outlook does not look promising for homebuilders. Since the expiration of the tax credit for new homebuyers, the housing market has significantly collapsed. The administration, in July, extended new credits, but the new homebuyer pool has dried up to a certain level. What the industry truly needs is new demand, which comes from movement in jobs and a fluid job market. That is anything but the case. Unemployment may not significantly drop until 2012, and it may be more time till these companies can see that actual demand come back to normal levels.
In the meantime, therefore, Ryland Group appears to be the leader of the pack as far as the health of its balance sheet, and it is looking to turn to profitability for the first time in FY 2011. A positive for the company comes from the fact that these stocks have been plagued by such bad news that it does not affect these stocks as greatly anymore. Much of the expectations for more hard times ahead has been priced into these stocks to certain levels. Good news, therefore, will have a much greater impact on RYL and can really give these stocks a positive movement. Therefore, downside risk is there, but it is much less significant than the upside potential now.
When that movement will start to take place still does seem some time away, however. Most homebuilders and analysts have seemed to stress that unemployment won’t begin to really dip until next year, and new orders won’t be able to get going until next summer. Therefore, the next nine months it may be a tight range to the downside that many of the housing stocks trade within.
On the positive side, many believe that the number of homes on the market is in significant oversupply, which is true to an 
extent. There is, however, not an oversupply of new homes. In fact, currently, there is only around 200,000 new homes that are on the books for all new homebuilders total. It is the lowest level since 1968. Homebuilders are actually attempting to bring up the price of homes. Further, private employment has actually shown signs of growth with over 600,000 jobs added thus far this year. It is one of the signs that some companies are finally starting to put employment back into their radar.
extent. There is, however, not an oversupply of new homes. In fact, currently, there is only around 200,000 new homes that are on the books for all new homebuilders total. It is the lowest level since 1968. Homebuilders are actually attempting to bring up the price of homes. Further, private employment has actually shown signs of growth with over 600,000 jobs added thus far this year. It is one of the signs that some companies are finally starting to put employment back into their radar.Looking at the financial side of things can help to provide more perspective into where this company is headed in the future. One of the first positive signs that has been mentioned is the company’s very solid financial health. The company’s current ratio is above 6.0. They have also seen a significant increase in gross margins over the past year and a half from -6 in 2009 to 4.5 in the TTM. The company’s ability to turn positive margins in this climate is a very good sign. The company should continue to see margins increase as they reduce their costs from less homebuilding
Additionally, the company is seeing a decrease in its price to tangible book value. The stock has a current PTBV of 1.35. The company’s low price to tangible book value is very low even for its industry, which does not truly match up with the health of the company. Among its four top competitors, KB Homes’ PTBV is 1.5. DR Horton’s is 1.43. Pulte Homes’ is less than 1. While Lennar’s is 1.2. The company’s PTBV is well below companies that have weaker financial statements, and over time, this should bode very well for Ryland.
The company’s P/E ratio is not really too discernible because of the negative EPS. Even FY 2011 EPS estimates show a P/E ratio of 100, but it is not a good measure of the stock. Most of the companies in the industry do not have any P/E ratios, so an industry average is not discernible either. Another positive is that the company has seen very strong free cash flow throughout the past three years. The company has a lot of cash to use to develop once demand returns. Its FCF margin is at 23%, which is well above a healthy FCF margin above 10-12%..png)
Ryland Group is a very financially responsible company that is stuck in an industry that lacks the necessary demand for it to be profitable. Until that occurs, the stock’s upside is limited. On a five year outlook, however, there are brighter days ahead for this company.
Valuation
The Oxen Group’s fair value estimate for Ryland is $20 per share based on a discounted cash-flow analysis. The company will remain stagnant in growth through at least 2011 to 2012, but the future ability for growth is enticing. The company should see growth in operating income through 2015. Growth should increase each year in percentage year-over-year into 2015. The company has a WACC at 5.2%.
The company is a buy below $15.25 and a sell above $22. Currently, the company, therefore is a hold at $16.85 but nearing a buy.
Risk
Risk is medium-high with Ryland Group Inc. The company, in the last year, has been able to improve and near profitability, but until it actually happens and is sustained, worry about more bad news is always going to be prevalent. The company is very financially healthy and has prepared itself to deal well with the current economic situation. Once demand returns, Ryland Group should be off to the races. When that will happen, though, is anyone’s guess.
Good Investing,
David Ristau
