LGIH Conference Call Notes

Investment Analysis Clubs Saul’s Investing Discussions
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I can’t remember if anyone has already posted this, so here are my notes that I took for myself (edited and paraphrased). The couple of little comments in parentheses are my own comments.

Saul

Our concentration outside of Texas increased during the quarter making 55% of our closings compared to 48% a year ago. We anticipate it will continue to increase.

Company-wide absorption for the quarter average 7.1 closings per community per month, up from 6.8 closings a year ago.

We’re having a lot of success with what we’re calling our wholesale business. Over the last 12 to 18 months, we’ve seen increased interest from the single-family rental business to purchase homes from LGI.

Our team has been working with these investment groups and identifying communities where it makes sense to deliver homes based on available inventory and our land positions. Through these wholesale agreements, we closed seven homes in the first quarter of 2017 and 65 homes in the second quarter of 2017. The 65 homes closed this quarter were spread across 14 communities and five different states. These closings come at a lower gross margin but similar net margins because of the savings we realized on SG&A expense. Although, this quarter our wholesale business made up a small percentage of our 1,511 closings, we’re excited about the future opportunities that may arise as a result of these relationships.

Our average sales prices by division were $206,000 in Texas, $255,000 in our Southwest, $187,000 in our Southeast, $200,000 in Florida and $323,000 in Northwest.

Gross margin was 26.6% this quarter compared to 26.5% a year ago. Our adjusted gross margin was 28% this quarter compared to 27.8% a year ago. Included in this quarter’s results was a one-time reimbursement associated with the community development (whatever that means?)

Our adjusted EPS was $1.39 per diluted share. Shares outstanding for calculating diluted earnings per share are impacted by our outstanding convertible notes. In this quarter our average stock price exceeded the conversion price and therefore the convertible notes were determined to be dilutive. This resulted in a 1.4 million share increase to the weighted average shares outstanding for the diluted EPS calculation for the quarter. (So the comparison was even better than it seemed. EPS this year would have been even higher if they were calculated on the same number of shares as last year.)

Ending backlog was 1,545 homes compared to 887 last year, and the cancellation rate was 22.8%.

At the end of June, we had about 3,000 homes complete or in progress compared to 1,600 homes at December.

The third quarter is off to a great start with 591 closings in July, up 93% from the 306 closings in July last year. To put this in perspective, in July of 2010, the not so distant past, we closed 18 homes.

I can tell you that the demand is continuing in August. In August we expect to close more than 500 homes. We closed 383 in August last year, so we’re looking at a really strong year-over-year comp as well.

We see that trend easily continuing to more than 5,000 houses. But with the inventory constraints, there still is a finite number of homes that we can close this year. We have some communities that we caught up on inventory and now we’re going to be closed out again before the end of the year this year and we’re going to be waiting for that next section to come on board. So, there is always going to be month-to-month and quarter-to-quarter volatility, but we’re very comfortable at the 5,000 plus number this year.

Our average sales price was nearly flat to the first quarter. We see this continuing in the third and fourth quarters resulting in our average sales price for the year remaining within our previous guidance of $210,000 to $220,000. We expect gross margin for the full year to remain within our historical range of 25% to 27% and adjusted gross margin to be within our historical range of 26.5% to 28.5%.

Given our increased closing guidance, similar average sales prices, gross margins, SG&A and taxes within our expected ranges, we are raising our full year basic earnings per share guidance from $4.00 to $4.50 per share to $4.25 to $4.75 per share.

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Thanks Saul.

A few other things that stood out to me (from memory):

They are being conservative on guidance and will have the opportunity to raise guidance again after Q3 results (yes they said this). I think they will probably raise guidance by another 25 cents and 200-300 homes in November.

They are being conservative for the following reasons:

  1. possible supply constraints in the event that they can’t build enough inventory,

  2. demand drivers look very favorable across the board now but I think part of their conservatism takes into account that the demand drivers could change by they end of the year. To me this doesn’t seem likely but it;s certainly possible.

  3. Who knows if winter will affect their construction schedules later this year. Most of their communities are in mind temperature zones but they have a few in areas that could be hit by heavy rain (Seattle, Portland) or snow (Minneapolis, Colorado).

My personal feeling from the conference call other factors is that LGIH might be able to sell 5600+ homes in 2017 but the real limitation is not having enough homes to meet all the demand. An open question for me is whether they can scale their operations between and the start of 2018 to meet demand the will likely be there in 2018. Growth may continue to be limited not by demand for their houses in their target markets but by their ability to execute on building enough supply. They ran into this issue in the start of 2017 and I wonder if they will run into similar constraints in 2018 (maybe not as bad as in early 2017 but enough to limit super strong growth).

Chris

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An open question for me is whether they can scale their operations between and the start of 2018 to meet demand the will likely be there in 2018. Growth may continue to be limited not by demand for their houses in their target markets but by their ability to execute on building enough supply. They ran into this issue in the start of 2017 and I wonder if they will run into similar constraints in 2018 (maybe not as bad as in early 2017 but enough to limit super strong growth).

They did say they were aware of this and have emphasized to their teams not to think about closing out the year, but building for the next year, so they wouldn’t have the same problems.

Saul

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They did say they were aware of this and have emphasized to their teams not to think about closing out the year, but building for the next year, so they wouldn’t have the same problems.

In other words: sell less in 2017 so you can have enough to sell in 2018? Sounds like they will continue to be constrained on their supply of available homes to sell…

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sell less in 2017 so you can have enough to sell in 2018?

Hi again Chris,
That wasn’t at all what he said. What I understood was that he was telling them to NOT close down construction and to NOT just sell out at the end of the year to close their books (as some apparently did last year), but to keep constructing and building up inventory.

Best

Saul

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That wasn’t at all what he said. What I understood was that he was telling them to NOT close down construction and to NOT just sell out at the end of the year to close their books (as some apparently did last year), but to keep constructing and building up inventory.

Maybe I misunderstood what he meant, but I still think it’s clear that they could sell a lot more homes if they had more homes to sell. I suspect that demand will continue to outstrip LGIH’s ability to build homes fast enough to meet all the demand that they could have. What this means is that they will continue to have good growth but it would be even greater if they could build more. This is especially true as they increase their bulk sales to property rental companies.

Chris

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Saul: They did say they were aware of this and have emphasized to their teams not to think about closing out the year, but building for the next year, so they wouldn’t have the same problems.

Chris: In other words: sell less in 2017 so you can have enough to sell in 2018? Sounds like they will continue to be constrained on their supply of available homes to sell…

Personally, I like the self restraint. If they push too hard to meet high demand, they will build up momentum that will cause an inventory surplus when demand is lower. Generally speaking, I’d rather see a backlog than a surplus for this type of business. I would also rather see disciplined steady growth than wild abandon fastest possible growth.

Having a backlog in itself is not a problem to me in this company. It only means demand and business in the near future will likely continue to look good. The problem is when they have the buyers (growing backlog) but cannot build homes (supply problems) leading to falling closings in spite of the availability of interested buyers. That is a supply problem, such as was seem temporarily over last winter.

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Sir,

Ending backlog was 1,545 homes compared to 887 last year, and the cancellation rate was 22.8%.

Backlog of orders?

1 in 4 orders are cancelled?

Scary?

Jim

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Jim,

1 in 4 orders are cancelled?

Scary?

No. Always has been that way. It comes with the business model.

KC

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Saul,

I’m embarrassed that I haven’t read/listened to the conference call. Did anyone ask if there will be a need to raise capital through issuing shares? I can’t quite wrap my head around the conundrum of having 9% net profits and growing revenue by 30 or 40%. I need to do the detailed calculation again. Cost of goods sold is 73-74%. Say, 35% increase in 73% of revenue is 26% of revenue. This versus 9% net income. Leverage that to 13.5% leaves a shortfall of 12.5%. Now I guess I need a price/sales number to see what dilution would be needed. P/S now is 1.13. Must be doing something wrong. That would require 11% dilution and that hasn’t been happening…

KC

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I’m embarrassed that I haven’t read/listened to the conference call. Did anyone ask if there will be a need to raise capital through issuing shares? I can’t quite wrap my head around the conundrum of having 9% net profits and growing revenue by 30 or 40%. I need to do the detailed calculation again. Cost of goods sold is 73-74%. Say, 35% increase in 73% of revenue is 26% of revenue. This versus 9% net income. Leverage that to 13.5% leaves a shortfall of 12.5%. Now I guess I need a price/sales number to see what dilution would be needed. P/S now is 1.13. Must be doing something wrong. That would require 11% dilution and that hasn’t been happening…

You should definitely read the call transcript especially since you have such a large position in the stock.

Don’t think that was asked. LGIH is financing their growth by issuing more and more debt. Each quarter their debt goes up. They are basically taking out debt to finance more and more land acquisition. I presume that this will continue and they will not start using equity to finance land acquisition when they can continue to do so by using debt.

Chris

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I can’t quite wrap my head around the conundrum of having 9% net profits and growing revenue by 30 or 40%.

KC,

A supermarket chain usually has something like 2% net profits I believe, but that doesn’t stop them from growing at whatever pace.

Percent net profits that a company has is not necessarily attached in any way to the growth of revenue. The rate of growth of net profits probably is!

Saul

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We’re having a lot of success with what we’re calling our wholesale business. Over the last 12 to 18 months, we’ve seen increased interest from the single-family rental business to purchase homes from LGI.

Aha. LGI entered into this contract in December 2016 … now we know why management was so confident they’d hit their 2017 sales numbers, despite an apparent slowdown.

I find this distribution outlet to be interesting. Don’t know yet if it’s good, bad or indifferent … just interesting for now. Selling these homes in bulk to investors who plan to rent them out conflicts with LGI’s core marketing message–buy for a lower monthly payment than your rent. Here are some of my initial thoughts on possible first and second order impacts:

Potential positives:

  • This new “channel” expands LGI’s TAM beyond entry-level buyers (especially, but not exclusively, renters looking to buy) and into single-family home investors
  • Higher net margins from reduced SG&A expense
  • Lower sales volatility as LGI is more likely to sell large blocks of homes earlier in the building cycle
  • Once prospective renters start looking at these homes, maybe they decide they’d rather buy in this community, assuming the monthly payments are similar AND the community is still selling. LGI benefits from a higher flow into their sales funnel without having to lay out additional SG&A

Potential negatives:

  • Lower gross margins as investors negotiate reduced pricing for volume purchases
  • Potentially lower gross margins if these investors are less likely to splurge on what higher-end custom options and finishes LGI offers
  • LGI builds its developments further away from city centers, as this keeps prices low for entry-level buyers. If these investors find it difficult to get the rents they seek so far out, they might sell the houses, putting them in direct competition with LGI’s new construction (and certainly undercutting them on price), if those particular communities are not yet closed

Potentially indifferent:

  • Lots of customers buy products for a reason other than the company’s main marketing message: a home sold is a home sold, no matter they buyer’s objective
  • So far, this is a tiny portion of their overall sales. Maybe it grows to a larger proportion, maybe not
  • Other than lower pricing, nothing limits this channel to LGI. Any brief advantage LGI sees from wholesale could be (quickly) flattened out by competition

Ideally, for all involved, might be using these bulk wholesale orders to close out the last homes in a community. LGI gets to close down a sales office earlier (huge SG&A savings). LGI doesn’t find its new construction competing with the new rentals. The investors don’t have to compete with LGI’s new construction (either in renting or in possibly selling later).

None of these thoughts change my investing thesis yet, but I am intrigued to see where this is going.

Your thoughts? What other potential impacts do you see?

They call me,
MrTBS

Quite long LGIH

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