Ensemble Capital Client Call Transcript: Netflix, NVR, and First Republic Updates

17 April 2020 | by Ensemble Capital

We recently hosted our quarterly client conference call. You can read a full transcript HERE.

Below is an excerpt from the call discussing our investments in Netflix, NVR, and First Republic and why we expect them to survive and thrive on the other side of COVID-related economic and business impacts.


Arif Karim speaking:

As the leading streaming video provider around the world with over 160 million paying subscribers, Netflix has seen a huge increase in engagement as a result of global lockdowns. A recent estimate we saw indicated 4 billion people have been ordered to restrict their movement. And what do people do when they stay home? Well, one thing they have been doing is watching a lot more Netflix. In fact, so much so that it’s put a strain on regional internet networks that have also seen a surge in capacity utilization from work at home and school at home activities such as video conferencing.

As a result, in parts of the world including Europe, Netflix has voluntarily reduced video streaming quality to free up bandwidth for other productive uses. This indicates strong user engagement, which is always the first level proxy in value creation in a service that is about consumer attention at its core. And the more valuable a service, the less likely the consumer is to drop the service for any reason and the higher the pricing power the service builds up.

Source: Netflix

So, from our reading, the value of Netflix has gone up tremendously for its users as they stay in and socialize less. In the meantime, with economic pressures on consumers globally, we think it’s reasonable to expect that Pay TV subscriptions like cable and satellite, could see accelerating declines, especially here in the US where that trend has already been in place. This would free up five to 10 times more budget than cancelling a Netflix subscription of $13/month. Netflix is more likely to be near the bottom of costs to cut and near the top of services to add in our view.

Finally, Netflix announced it would spend $100 million to support out of work members of the creative community as a result of the impact of Coronavirus. This is a strong show of support for creative partners and potential partners on the production side of its business but also demonstrates the company’s financial strength and culture. It undoubtedly wins Netflix even stronger sway as the preferred partner for creators to help Netflix fill its growing global audience’s appetite for new content across categories.

Todd Wenning speaking:

We’ve previously discussed our interest in finding idiosyncratic businesses, or companies that aren’t easily compared to others. NVR is one such company. While it is a homebuilder and is impacted by macroeconomic trends in housing, it has a unique culture and business model that is primed to not only survive near-term shocks but thrive on the other side.

Most homebuilders started as land developers and later got into homebuilding. As such, land development is in most homebuilders’ DNA. Owning and developing land has its benefits, especially in boom times when land values are appreciating and property is scarce. This works both ways, however, and as we saw during the housing crisis in 2008/2009, land-heavy homebuilders are often forced to write-down land values and some go out of business. In fact, the largest homebuilders were more land-heavy going into the COVID downturn than they were in the years leading up to the housing crisis.

Source: Ryan Homes

Rather than owning land, NVR’s long-time strategy has been to option its land, providing it with more financial flexibility when times get tough. Further, NVR had over $500 million of net cash at year-end 2019. During the housing crisis, NVR expanded into new territories and in the coming quarters we expect management to once again capitalize on opportunities to both expand and consolidate share of key markets.

When the market gets concerned about homebuilding, NVR often gets thrown out with the bathwater and we believe this has been occurring again. Going into the economic pause, there were several strong tailwinds supporting new home builds including the largest cohorts of millennials moving into household formation and prime earning years, a lack of existing home inventory, low mortgage rates, and low unemployment. Indeed, in February, monthly new home sales hit their second-highest level in 12 years. Though unemployment is a big question mark over the next few quarters, the demographic, existing home inventory, and low interest rate tailwinds remain in place. In fact, the rise of remote work during COVID quarantine may be another tailwind for new home sales (which are typically in suburban and exurban areas) as more workers may find they do not have to live close to companies’ urban headquarters to do their job.

Sean Stannard-Stockton speaking:

First Republic is a bank that caters to high net worth families. They are widely seen as the most conservative bank in terms of underwriting loans and over the long term, including during the housing bust and financial crisis, they have seen a rate of losses on their loans at about 1/5th the level of losses reported by the big banks.

There is no doubt that First Republic will earn less this year than we would have expected them to earn prior to Coronavirus. The main reason for this is the rapid decline in interest rates and thus the rate of return they can earn on the home loans they offer their clients. Yet it is important to note that it is the spread between the amount they earn lending money vs the rate they pay on checking and savings account deposits that drive earnings. While this spread will narrow, part of the decline in mortgage rates will be offset by a decline in the interest the bank pays on deposit accounts. In addition, the drop in rates has triggered a boom in refinancing and as we saw during the refinancing surges in recent years, First Republic is typically a net winner as more people with loans at other banks refinance the loan over to First Republic rather than refinance their First Republic loan to another lender.

Source: First Republic

In making the decision to invest in First Republic years ago, we certainly did not forecast a viral outbreak occurring. But we did assume that there would be deep recessions and ever financial crises that may occur while we owned the stock. Their strong credit profile is important not just from a financial modeling perspective, but in attracting customers. For as long as we’ve been invested in First Republic, the bankers’ desks at the local branch near our office have displayed a one-page summary of the company’s credit ratings, illustrating how they are better capitalized than all the well-known big banks. It is the companies that recognize the importance of being safe and secure all of the time that are best positioned to retain their customers’ trust during a crisis. So when Americans started thinking about sheltering in place and wondering if their cash in the bank would still be there after the crisis, knowing that First Republic has always stood for risk avoidance and high levels of service provides their customers with the confidence they need to keep their assets with the company or even consolidate other loans or deposit accounts they might have elsewhere.

You can read the full transcript here.

For more information about positions owned by Ensemble Capital on behalf of clients as well as additional disclosure information related to this post, please CLICK HERE.

For more information about positions owned by Ensemble Capital on behalf of clients as well as additional disclosure information related to this post, please CLICK HERE.

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