LGIH and the new tax code

I’m going to try to evaluate impact of the new tax code on LGIH. One part of this is relatively easy. LGIH paid $38.6 million tax on $113,672 pre-tax income in FY2016, 33.99%. I believe that Texas has 5% corporate tax and the U.S. average is 4.7% (ref, some Houston Chronical piece). Using 5%, that leaves 28.99% for federal corporate tax. The new rate is 21%—but the effective LGI Homes rate would be less(???) as they were not paying the top rate previously. Anyway, use 21%. This lowers the total tax burden from 34% to 26%, lowers the tax from $38.6 million to $29.6 million and raises after tax income from $75.0 million to $84.1 million, or 12.1%.

This is sort of the tip of the iceberg. But, first let’s look at possible impact of this simplified number. I have become comfortable with a p/e of 13 based on recent preformance. If forward net income were 12% higher due to tax reduction, a current p/e of 14.7 is equivilent.

However, there are other provisions. See: https://hbr.org/ideacast/2017/12/breaking-down-the-new-u-s-c…. This an interview with Mihir Desai and one of the few discussions of the new tax code that appears (to me) based on facts over rhetoric. It mentions provision that at least limits deduction for interest payments (not the mortgage interest for individuals) for highly leveraged corporations. LGI Homes is highly leveraged within the homebuilder community, but maybe not compared to all industries, start ups, etc.

I think it is likely that most of the addlitional profit would be reinvested, because LGIH is in a high growth phase. Certainly there will be no share buy back. I think the housing market is sufficiently robust that competitive pressures will not result in lower ASP across the industry. Growth has been limited by capital. Assuming that there are sufficient market for new communities, the new tax rate should support continued or increased growth rate, i.e., investment in the business.

Although the 2017 earnings will not be affected by the new code, the forward looking market will take it into account. LGIH hit $76.64 as I write this. My $5 ($4.99) projected FY 2017 earnings makes that a 15.4 p/e. Projecting lower tax and assuming a boost to growth, I still rate LGIH as a hold as my #4 position. As always, I suggest checking my math.

And, I re-recommend the interview. There is much in it about positives and negatives and possible disruptions to the international business relations as a result of the new corpoate tax provisions.



Two more comments.

  1. As best I understand it, interest deduction is limited to 30% of EBITDA. LGIH interest in 2016 was $18.5 million, taxes were $38.6 million and net income was $75 million. Depreciation was negligible, I think. Anyway, by inspection interest is less than 30% so this probably does not affect LGIH.

  2. Federal plus state tax rate would have been 35% plus about 4.7% = 39.7%. Actual rate was 34.0% due mostly to two provisions: Domestic Production Activity Deduction of 3.3% and the state income taxes were only 1.9% “net of federal benefits”.

Whether these “loopholes” survived the new tax code is knowledge beyond my pay grade. But the 35% to 21% = 14% reduction could be offset by any number of provisions. The two mentioned above amount to almost 6%. One might want to model based on 27% effective, down from 34%.

Market closes in less than two hours. Thanks to Saul and all who post for the sharing which certainly helped my returns this year.

Happy New Year,


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