LGIH growth

Investment Analysis Clubs Saul’s Investing Discussions
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As noted, LGIH sales growth is slowing without considering January sales. I am curious as to why management has chosen to grow so quickly. There has been a strategic decision to grow beyond the rate that net income would allow, beyond the rate that leveraging the income by borrowing would allow, and to a rate that requires issuing new shares at the market price.

This is not a tech company that is grabbing market share to become dominant. I don’t see them being in a race for market dominance in home building, or home building for first time buyers, or home building for first time buyers in Texas, or …… Does anyone see a strategic business reason to pursue maximum growth?

I believe slower growth is good, or would be as long as it is by choice and not by soft market conditions. What I wanted to look at was how much growth they can obtain by just reinvesting net income, and therefore, what are the ramifications of pursuing 30%, 20% 10% growth. I used Q3 2016 and Q3 2015 information. Cost of goods sold, sales expense, and general and administrative expense increased nearly in proportion to sales revenue. Sales decreased from 8.6% of sales to 8.1%, and G&A decreased from 5.5% to 5.2%, so there were efficiency gains to some extent. But for the analysis I assumed a linear relationship. The $602 million sales for three quarters cost $524 million in CGS, sales, and G&A. The after tax net income was $51.8 million. They can increase spending by %51.8 million, from $524 million to $576 million or by 9.9%. By using leverage they can increase by almost 15%. Growth beyond 15% requires issuing more shares.

For 30% growth, they need another $52 million above and beyond levered net income. I think the market cap is about $635 million so dilution of about 8% is need to fund the extra 15% growth.

For 20% growth dilution of 2.5% is needed to fund the extra 4.7% growth. 15% growth would require no dilution. 10% growth would require no leverage and the debt to equity ratio would begin to fall.

I would appreciate feedback on the method and accuracy of this analysis. I don’t believe the market is rewarding LGIH for its growth. In fact, the p/e is depressed due to high debt needed for the fast growth. I would be content with sub-15% sales growth and improved balance sheet. As a core, longer term holding, 10 to 15% share price appreciation through slower growth and p/e expansion would suit me just fine.

KC

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I can think of at least one good reason to pursue a high growth rate. Housing is very cyclical, and go great guns (like it is now in certain locales) and then drop of to nothing for a period. It’s a sort of make hay while the sun shines strategy. But you’ve got a point about the debt load when the rains come. If they don’t see it coming and back down before everything gets wet, they can be in trouble.

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KC, That’s a good question. Why don’t you modify it and send it to Investor Relations, or to the CFO.
Saul

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Brittlerock,

Cyclical, for sure. However, the last up cycle was 15-years long, followed by a massive crash to 50-year low in new home sales. Now just recovered to 60’s, 70’s average number of sales. On the demand side, seems there should be a long runway–macroeconomic conditions permitting. As a side note, I received two emails from my property manager this week. The first was regarding legislation pending in Oregon to cap rent increases to 5% per year. A second is before the Portland city fathers proposing a “relocation assistance payment” from landlord to tenant if rent is increased more than 10%. For a three BR unit they payment is… $4,500 as I recall. These are signs that shortage of rental units is resulting in rent increases, which of course is the LGIH sales pitch. Renters are feeling the pinch and seemingly complaining to city hall. So there is a dual shortage, rental units and owner occupied single family dwellings.

Saul,

I might do that, and throw in a question about sales cancellations, too. We’ll see.

KC

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