LGIH - My thoughts

They make a very clear distinction between closings and sales

I think LGIH is the only company that doesn’t disclose sales. FWIW, between sale and close there are healthy cancellation. I think the 4Q had more than 25% cancellation.

The closing comes 6-8 weeks later, when it is finalized and that’s when they get paid by the mortgage bank, and the money goes into revenue. There’s really no ambiguity about it.

So January sales should have been closed in late Feb or March? This Feb 3 press release asserted that January sales were “strong”:

http://investor.lgihomes.com/releasedetail.cfm?ReleaseID=101…

But March closings were down vs last year. (Feb too, though I suppose you could blame that on weak December sales.)

Something doesn’t add up. What do they mean by “strong?”

Bear

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With earnings growing at 25%, if they attain a PE of only 11 their stock price would be $46.75, up 47.6% in just one year. (And imagine if they beat their estimates by 2% instead of 1%!)

Saul,

That scenario is possible and probably likely. Nevertheless, I sold a partial position (25% of my position) today because I think that the stock will likely continue to fall until the market believes their sales are not declining in 2017. I intend to buy back once I think the shares have bottomed.

Chris

Bear,

One thing to keep in mind is that normally closings come 6-8 weeks after sale. But, they had low inventory. I take it as “falling behind”, or finishing homes was/is not keeping up with sales. I may be reading too much into it (or maybe not enough?), but it seems like if sales in January that normally would take 6-8 weeks to close could pretty easily slide into April. I could be way off base on this, but trying to look at all angles with open mind. Sold out of LGIH a while back, but have been watching and considering getting back in.

Kevin

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Saul,
good analysis. I still feel home builders do not have a very good business model. LGIH has very nice valuation now due to their credibility may be in danger. I guess the April close has to be strong, otherwise, there will be a lot downside. I feel if you already hold it, just hold it for another month. But I will be very careful to initiate new position now, even means I will miss possible big upside.

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it seems like if sales in January that normally would take 6-8 weeks to close could pretty easily slide into April.

I think the issue here is cancellation. Sales are only contracts which gets cancelled all the time. In the last quarter Q4 the cancellation rate was something like 25%. Perhaps LGIH is suffering higher cancellation. BTW, rest of the industry is not having the challenges like LGIH.

Interesting a lot of luxury home builders are doing fine. One possibility is LGIH’s focus on entry level home, may not be best when people have more secured job and general economy is doing fine. People will always want to live a little bit better if possible, they may skip entry level home and instead buying a better home at better location, even the price may be higher.

One other point: let’s not forget they have already missed their own guidance, albeit for a single month. They said just a few weeks ago:

As we have previously stated, our goal is to close more than 4,700 homes in 2017. We believe we will close 375 – between 375 and 425 homes in March, surpassing last year’s March closing number of 367 and gaining momentum to reach our closing goal in 2017.

Their midpoint for March was 400 and they closed 365. If they can’t predict just a few weeks in advance, why do you think they’ll be able to hit their prediction for 2017?

Bear

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Certainly cancellations is an issue. It’s true that contracts get canceled for any number of reasons, and with first time buyers (who are not trading their house up or even down for that matter) cancellations tend to be higher than someone who already owns a house.

But, it’s not the only reason that a sale might not close when expected. Some percentage of buyers will want a certain model house built on a certain lot. So the contract is signed before construction has even begun. That can push closing out 3 months or more.

There’s really no way of knowing why a sale did not close in the normal 6 weeks. We don’t have all the information the builder has.

Some percentage of buyers will want a certain model house built on a certain lot. So the contract is signed before construction has even begun.

LGIH model is not that. They built spec and sell it. If they don’t have inventory then they don’t have inventory to sell. It is not the execution, i.e., ability to deliver the house that is sold, is the issue.

One other point: let’s not forget they have already missed their own guidance, albeit for a single month. They said just a few weeks ago:

As we have previously stated, our goal is to close more than 4,700 homes in 2017. We believe we will close 375 – between 375 and 425 homes in March, surpassing last year’s March closing number of 367 and gaining momentum to reach our closing goal in 2017.

Their midpoint for March was 400 and they closed 365. If they can’t predict just a few weeks in advance, why do you think they’ll be able to hit their prediction for 2017?

Great point Bear! After re-going thru everything, I don’t know how I missed it. For now, I will probably stay on the sidelines depending what the share price does.

I think as a company, it is good value where it is now with upside. But seeing how market acts/overreacts with this one, we could see a pretty big drop if April numbers aren’t impressive.

Of course, should go right back up if numbers are strong and support guidance.

Time will tell.

Kevin

<<FWIW, between sale and close there are healthy cancellation. I think the 4Q had more than 25% cancellation.>>

Since I have been around the construction and real estate business for a good number of years I do have some knowledge of the industry although it’s been a few years since I have been active being semi retired and I also don’t have much direct experience with new homes sales so beware.
I am not sure where the heavy cancellations are coming from especially 25%. Did the company provide that number? I can’t imagine in the real estate business a 25% rate. In a tight real estate market it is hard for me to picture that one out of four mostly families I assume choose a home they like sign all the paperwork, place a deposit (I assume) and then back out before closing. In existing home sales the deposit is not refundable, believe me a lot of behind the scenes work has gone on to complete all of the details of the sale. The family on the other hand had their hopes high on a brand new home. Something doesn’t seem right here, are the salespeople not doing their jobs by “selling” homes to tons of prospects that aren’t following thru to closings. If they are losing 25% of the customers between the sale and the close that ain’t just ain’t right as we say in Missouri.
long LGIH

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Since I have been around the construction …I am not sure where the heavy cancellations are coming from especially 25%.

The 25% cancellation rate is par for the course. I don’t want to question your real estate experience but clearly you don’t have an idea about what you are talking about.

the cancellation rate for the fourth quarter was 27.7% and for the year, our cancellation rate was 24.5%

https://seekingalpha.com/article/4052900-lgi-homes-lgih-ceo-…

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soycapital: I am not sure where the heavy cancellations are coming from especially 25%. Did the company provide that number? I can’t imagine in the real estate business a 25% rate. […] The family on the other hand had their hopes high on a brand new home.

Soycapital, while I certainly don’t have your experience in real estate sales, the 25% cancellation rate makes sense to me. What you may be missing is that LGIH customers often did not have their hopes high on a brand new home.

I agree with you that if a family is looking for a home and happens to find one they like being sold by LGIH, everything from sale to close is mostly formalities with a low cancellation rate.

However, this is not the LGIH business model. They are marketing directly to first time home buyers with the argument that home ownership will save them money compared to renting (and all the other benefits). Many of those potential customers will not have considered buying a home. By making the deposit fully refundable for any reason (no risk) they likely attract many customers who would otherwise not have taken the time to seriously pursue the option.

The fact that they have this 25%+ cancellation rate and have been growing revenue as fast as they have and have run into inventory shortages (demand is higher than available finished homes) tells me this marketing strategy is working great.

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I am not sure where the heavy cancellations are coming from especially 25%.

Especially given that these are starter homes, is it not likely that a fair number of the hopeful homeowners fail to qualify for a mortgage?

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FWIW I got out of LGIH yesterday, but it was primarily conviction related as I used that money to buy more UBNT and TWLO. I plan on continuing to follow LGIH and that certainly won’t be difficult with the multitudinous posts on the company.

I will say that I’m not pleased with the trajectory of LGIH against their stated goals. That said, I’m inclined to believe the downside to LGIH is pretty limited due to valuation and increasing home prices. So, while I believe it is a fairly safe investment, I have more conviction in the other two names and both are in the range where I want to be a buyer.

I had trimmed LGIH previously and it was a relatively small position. I’m trying to limit my small positions as I seem to do much better with my higher conviction positions (go figure).

Take care,
A.J.

AJ

I had trimmed LGIH previously and it was a relatively small position. I’m trying to limit my small positions as I seem to do much better with my higher conviction positions (go figure).

I always let my portfolio lead me. I try to stay neutral and eliminate the bad guys and add to the good guys.

b&w

B&W,

I always let my portfolio lead me. I try to stay neutral and eliminate the bad guys and add to the good guys.

I tend to agree with you, but have questions about how you allow your portfolio to lead you. First, let me discuss my instance. I sold LGIH to purchase two other stocks, UBNT and TWLO. I listed those two names as high conviction for me. However, that wasn’t necessarily because my portfolio was leading me in that direction. For instance, I’ve made money in LGIH. However, am about even in TWLO and have been a buyer around $28. UBNT fits with the “let your portfolio do the talking” theme. I have held it for several years while it floundered. I’m a buyer again today especially after the drop last quarter which I believe is unwarranted. While TWLO has been relatively flat, I believe their future potential is large.

To summarize, my decisions are based on what I feel about each company, their valuation and their future prospects. My questions about your decisions are as follows. How do you evaluate closed end funds and MLPs and BDC type of companies? Your staggering statistics cannot be achieved by tax deferred distributions alone. They have to be spurred by price appreciation as well.

You’ve written a lot about how you let your portfolio steer your decisions. However, you’ve written little about how you make the initial decision to invest in a specific equity. That is what I’m interested in.

I should have taken this to another board or another thread maybe. Therefore, I’m sending this to you personally as well in case it is better replied to one on one.

Take care,
A.J.

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“But, it’s not the only reason that a sale might not close when expected. Some percentage of buyers will want a certain model house built on a certain lot. So the contract is signed before construction has even begun. That can push closing out 3 months or more.”

I think you guys are also forgetting that it’s still not that easy to get a loan. I’m sure lots of these entry level applicants are not able to get financing, therefore the contract is void, sale doesn’t happen.

Chris

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I sold real estate many moons ago. My experience at the time was that spec builders loved pre-sales. The business may have changed, or LGIH may not do pre-sales. I don’t know.

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