DFH Commentary.

DFH Reported 3Q24 earnings last week. As a reminder, they do not have an earnings call and their press release is fairly short. Overall, we do not think this was a particularly eventful quarter.

They are on track for their annual home closing target of 8,250 homes, despite some end market headwinds. Freddie Mac reported that home sales declined 2.9% in August. Existing home sales fell to the lowest since October 2010. This was despite rates reaching their lowest point in two years in September. Additionally, existing home supply reached 4.2 months in October, the highest since July 2019. While this could be a potential headwind for DFH in 4Q, this figure is still at the low end of the historical average of 4-5 months.

The impact of mortgage rates is multifactorial. While higher rates can be a headwind as they increase monthly home payments, the more expensive financing costs also make existing home owners (who locked in much lower rates) more reluctant to sell their homes. This is why new home sales as a portion of total home sales has greatly increased. Furthermore, when rates start to decline, some potential home buyers may defer their purchases, thinking they could drop further. Lastly, there is a lag between lower rates and an increase in purchase activity.

Big picture though home demand remains strong ,“bolster by the demographic tailwind from Millennials and Gen-Z, who are at prime home-buying age” per Freddie Mac.

From our DFH report:

While higher interest rates do make homes more unaffordable, people are not willing to push off a home purchase indefinitely. A 4% versus 8% mortgage is about $1,300 a month more, which is no doubt a considerable amount of money for most Americans. But many who desire a home are likely to cut other expenses or take on second jobs to realize their home ownership dreams.

Ultimately the homes sales will come, it is just a matter of timing, which is why DFH’s capital-light strategy is so important to being able to withstand deteriorating economic environments. Having said all of that, they continue to perform well despite high rates. At $32 a share, they trade around 11x earnings based off of their diluted market cap.

DFH 3Q24 Update.

Home revenues increased +10% y/y to $986mn for the quarter, down 200bps sequentially.

• Noted revenues were partially offset by an increase in sales incentives during 3Q24.

Home closing increased +5%, but net new orders increased +9%.

ASPs increased slightly +3% y/y to $518k, up 100bps sequentially.

• The Crescent Homes acquisition in Feb. 2024 boosted ASPs since those 223 home closings carried an ASP of $554k.

Home gross margins compressed -140bps y/y to 19.2%, but were +20bps sequentially.

• Mostly due to higher land and financing costs, offset by some direct cost savings and an improvement in cycle times.

Backlog slightly shrunk to 3,996 homes valued at $2bn from 4,205 or $2.1bn last quarter.

Cancelation rates improved was 13.8%, a 110bps improvement y/y..

Controlled lot pipeline has increased to 45k from 31k last year.

CEO Patrick Zalupski commented on their performance the following:

Other DFH Comments.

• Repurchased $5mn in shares  
  • “In addition to investing in the growth and scale of our business, we remain committed to our capital allocation strategy, which includes buying back shares when we believe there is an attractive disconnect between the market price and the intrinsic value of the shares”
  • “We will remain opportunistic in all facets of growing the per share returns of DFH.”

• Guidance
  • Reiterate guidance of 8,250 closings for the full year 2024.

• Acquired remaining 40% interest in Jet Home Loans
  • “Deal was immediately accretive, contributing revenues of $16 million and pre-tax profitability of $7 million in the third quarter”.

Axon 3Q24 Earnings.

Results were strong marking the 11^th consecutive quarter of 25%+ growth and 3^rd quarter of 30%+ growth. Total revenue growth of +32% y/y was a 3 point decel sequentially, but is up 8% q/q. For context, this growth rate is still elevated from their high 20s growth rate a couple years ago.

 In their Software & Sensors Segment, Axon Cloud & Services revenue was +36% y/y (y/y growth down 10 points sequentially) and net revenue retention was 123%. Sensors & Other grew +18% y/y (y/y growth rate also down 10 points sequentially). Despite the slowdown in growth, these are still very strong numbers and more than they were doing a few years ago.

The TASER Segment grew +36% y/y, representing a 9 point deceleration from last q, but up 13% q/q. The TASER business is strong with their latest device, the TASER 10, garnering double the interest of their last model at the same point in the upgrade cycle. This was the 6^th consecutive quarter that the TASER segment hit record revenues.

Commentary on new products, particularly AI, is optimistic. They wil launch an AI bundle next year with DraftOne as a marquee feature. Axon President Josh Isner noted he was “very, very bullish on Draft One”. The AI bundle, called “AI Aero”, will be $199/mo, giving them another important growth lever to push ARPU higher.

Drones is another future growth vector. Currently local law enforcement cannot intercept drones, but that could change soon. This is especially important as the availability of drones has led to some incidents, like someone attaching a pipe bomb to a drone in Pennsylvania. Axon’s Dedrone can locate drones and in the future give law enforcement the ability to intercept them.

Overall, the call was brimming with optimism and as President Josh noted, “Part of what’s informing that confidence is just tremendous execution across all four segments of the business. state & local, enterprise, federal, and international.” They are gaining adoption with all of their end markets and across both their product segments.

Such optimism was quickly mirrored by the market though, which sent Axon shares up +28% the day, seeming to reflect much of the optimism conveyed on the call. At a $46bn market cap today, Axon trades at 22x sales or, assuming a 40% mature margin, 71x earnings.

CSU 3Q24 Update.

3Q24 revenues grew +20% y/y to $2.54bn for the quarter. This is a slight drop from last Q’s growth of +21%.

Organic growth was +1% y/y, down from +3% y/y last quarter.

As a reminder the “Maintenance & other recurring” revenue segment is the best barometer of health for Constellation. This is because this segment has the highest margins and is recurring in nature. This segment represents 74% of total revenues, up about ~300bps y/y and grew organically +6% y/y, same as last quarter.

Their Licenses revenue fell -20% y/y and is expected to shrink as legacy VMS offerings move to a SaaS mode. Shrinkage here should be thought of as helping the Maintenance & Other Recurring revenue line item.  While it is a minor point, we see that their organic Maintenance revenue growth has been steady despite Licenses revenue shrinking at a faster rate over the past 2 quarters. This suggest that without the transferring of legacy revenues over, which is a one-time boost in nature, organic revenue would have been lower (estimated to represent about 1 point of organic revenue growth in 3Q24).

Professional Services, which represent about 20% of revenues, have shrunk a bit too recently. However, this is a lower margin revenue source.

The 1% overall organic revenue growth rate is more in line with what we originally expected when we wrote our 2023 report. As Mark Leonard noted at the last AGM, the increased organic growth seen in ’22/’23 was largely due to inflation, and it appears we are seeing that dynamic pass.

Because of all of their acquisitions, acquired intangibles, and consolidated financials of partially owned companies that run through the P&L, we’ll move right to their FCFA2S metric.

FCFA2S was slightly down y/y to $362mn vs $367 in the same 3 month period last year. However, we think it makes the most sense to adjust out the IRGA liability increase (see the original report for our rationale). After this adjust FCFA2S incrases ~$3mn y/y to $395mn.

In 3Q they acquired about ~$200mn worth of business, putting the total at ~$870mn YTD. If we adjust for cash acquired and post-acquisition payments, they have deployed just under 80% of their FCF YTD. We show LTM below (without the post-acquisition payment adjustment).

FCFA2S is now run-rating over $1.3bn and has grown at a ~16% CAGR since 2021. Generally they have continued to deploy capital towards the high end of the range we would have expected a few years ago. Larger acquisitions and the use of some debt has helped them deploy over 100% of FCFA2S.

CSU Valuation.

We re-ran our Reverse DCF below for Constellation’s Updated market valuation of ~$68bn. (As a reminder, they consolidate revenues from businesses not wholly owned so a revenue multiple can be misleading). On a FCF multiple they trade at 51x LTM, which is up from 39x when we published our report in September 2022 (although it was arguably closer to a low 30s multiple because of temporary operating cash flow factors).

Below are the original assumptions we used in our Reverse DCF.

We used the same assumptions shown above, but with an updated FCF figure and an updated market valuation. We also only ran a 1% organic growth scenario, instead of a 0% and a 2%. (If you are Members Plus and need help with Excel, feel free to reach out. This one is a little less straight forward than the others).

Below we see the range of outcomes or discount rates, which can be thought of as the investor’s return should they own the entire business and received all excess cash flows.