One of the concerns of the market regarding LGI Homes is the debt level. This and “valuation” are “sell” level according to S&P. Valuation would be a topic for another post. What interests me now is the debt burden. I did an amateur stress test and would appreciate feedback.
What is LGIH’s debt burden? They have convertible notes and a revolving credit facility. The convertibles carry 4.25% interest payable semi-annually and are in the amount of $85 million. Every quarter they need to generate $903,125 to service this debt. The revolver carries variable interest rate of 3.5% “plus LIBOR” which was 0.53% at September end. There are many U.S. LIBOR rates, but the one that matches September end is the 1 month LIBOR. The revolver is in the amount of $360 million and as of September end required $3.627 million per quarter to cover interest. The total interest for a quarter totaled $4,530,125.
So one part of the question has to do with the variability of the one month U.S. LIBOR rate. I looked back as far as 1998 and noted the September rate for even numbered years (I know, lazy note taker). Anyway, the rate cycled a couple of times, being high in 2000 (Bernanke throttling irrational exuberance?) and 2006 before the real estate bubble burst. The highs were 5.625% and 6.629%. After 2008 the rates were under 1% and we are now at 0.8%, I think—I didn’t write it down.
My purpose is not to predict the U.S. 1 month LIBOR for 2017-2018. I don’t really see an overheated economy needing the application of economic braking. But, this is a “what if” stress test, so I looked at 5%. Assuming many things for a first cut analysis, including the same level of debt, the quarterly interest burden increases to $8,553,125 (let’s say $8,5 million and get rid of the 7-place approximation).
The second part of the question looks at the sales level LGIH would need to generate the $8.5 million. Assuming they could maintain about the same margins (which the likely could not) and assuming that the sales and SG&A expenses remain the same, I believe that need a bit more than $135 million revenue which would be about a 37% drop from their Q3 sales. It is a “little” more complicated than that. The provisions for tax would drop 3 million but if margins are squeezed those $3 million disappear in a hurry.
But of course, for the LIBOR to go to 5%, mortgage rates would also be high. There is no linear relationship between the 1 month U.S. LIBOR and the 30-year fixed mortgage. The 1 month has changed rapidly, I assume in response to reserve bank overnight changes, whereas the 30-year moves slowly. There has been no “normal spread”. All that can be said is that the 30-year fixed mortgage rate has been higher than the 1 month LIBOR, not less than 1.2% higher, not more than 4+% higher (based on these bi-annual, September data). Don’t know what happened in intervening 23 month periods. I suppose that one could get data on new home sales for these same Septembers. Almost 11 p.m., I don’t think I need to do that right now.
I’ve just deleted a section on cash flow which anyway ended up inconclusive. And other stuff on continued growth through geographical expansion even if the pool of qualified buyers in existing markets shrinks due to higher interest rates. Conclusion…., don’t know. As compared to other homebuilders, I don’t think that the LGIH’s higher debt/equity justifies the p/e disparities.
I didn’t add yesterday, don’t plan to do so today (though I haven’t checked the market yet). My LGIH tank is full.
KC, who wishes he could convert his thoughts and research into a more useful post. Sigh.