LGIH valuation

Investment Analysis Clubs Saul’s Investing Discussions
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I made my projection of 2017 earnings, $4.81 per share. With a forward looking p/e of 10.5 that is $50.51 a share. What the forward looking projection will be at year end, I don’t know. But I think the $50.51 is fair value as of today.

For background, I gathered the following information from my E*Trade account:

5 analysts, FY 2017 estimates:

Revenue, 1.18B mean, 1.28B high, 1.08B low.
EPS, $4.176 mean, $4.90 high, $3.93 low.
Price targets, 12 months, $41.80 mean, $48.00 high, $39.00 low.

The forward p/e is 10.6 and trailing p/e 13.8 which are low, as usual, based on 47% debt to capital and -$292.8% cash operating cash yield.

I am projecting 5,400 closings at $221,000 average sales price for revenue of $1.193B.

I used 73.56% cost of sales, same as last year; 7.6% selling, down from 7.99%; 4.9% G&A, down from 5.15%; and tax rate 4.9%, up from 4.6%.

Net income $107,828K and 22.4 millionl shares and $4.81 earnings per share.

Applying a 10.5 p/e as a trailing 12-month p/e, fair value is $50.51.

But, if analysts catch up to $4.81/share for fy2017, and if LGIH continues to perform, one could expect a forward p/e of 13.5 x trailing 12-month earnings, and that is $64.94 year end price target.

A quick look at Q2 earnings… $1.30. I see the high estimate is $1.36 so that difference is probably average selling price estimate.

Anyway, Friday’s closing price was $47.44 versus the $50.51 and $64.94 values so I am relatively comfortable with LGIH as my top holding. It is 14% of my IRA plus brokerage accounts so I will consider adding some amount.

Comments???

KC

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KC,

I think your predictions for the Q2 results might be close. We will find out on Tuesday.

Regarding the numbers that we might expect for the full year, I created a model which is currently forecasting 5400 home sales for 2017. The drivers of the model are basically taking an average multiple for monthly sales per ASC of 6.3 times the number of ASCs. The 5400 number, though, is assuming they add no more ASCs for the rest of the year. I think it’s likely that 5400 can be exceeded for 2017.

The environment for home buying is still strong. Interest rates have remained lower for longer than many people expected. Employment numbers continue to come in strong. Inflation has remained subdued. Millennials, people who are in LGIH’s target market, in particular, are making strong gains on the employment front. These conditions are very favorable for LGIH selling more homes.

LGIH has guided that they will have 75-80 ASCs by the ned of 2017. They are already at 78. It looks to me like they see these favorable conditions described in my last paragraph and have decided to be much more aggressive in their expansion efforts. Perhaps they decided it would be better to have about 85 ASCs by the end of 2017. We will find out more about what they are thinking on Tuesday.

I expect a substantial beat and a substantial raise in guidance on Tuesday, and I’ve made my bet by buying the Aug $45 calls and selling the Aug $50 calls at a net cost of $2.50. So I’m expecting to double my money on this trade assuming the stock price exceeds $50 in the next 2 weeks.

I think the analysts will likely raise their forecasts and price targets in the weeks after the earnings release.

I am reductant to buy more shares though because I already have a large position. LGIH has very large debt and it is growing every quarter. Barring another huge financial crisis, I think it’s ok for now because the total housing stock is still well below the historical average. This is because not enough homes were built for the last 10 years and a large catch-up is still necessary. I tend to think that LGIH will have another 2-3 years before we may start to see problems.

Chris

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I would encourage you to look at the margins that LGIH is currently having vs the industry average. Why or what would move that towards industry average. If you were to assume average industry margins, what kind of profitability you are seeing.

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Kingran,

I would encourage you to look at the margins that LGIH is currently having vs the industry average. Why or what would move that towards industry average. If you were to assume average industry margins, what kind of profitability you are seeing.

Thanks for the question.

I would only quibble with one word: “currently”. To swing a bit to the other side, I could substitute “always”—even though “always” is the last four years.

Yes, LGIH has the highest gross margin in the industry, 26.4%. Comparing the seven builders that are closest to LGIH in number of houses sold annually, the median gross margin is 18.6% with a range of 16.0% to 22.8% for 2016. So, it is apparent that if LGIH’s margin were 18.6%, the income before taxes would be cut by around 60%.

The gross margin for LGIH has been 24.2%, 26.8%, 26.5%, and 26.4% from 2013 to 2016. So, the question becomes, why are gross margins so high, and what could cause them to fall to the mean? The two suspected reasons for high gross margins are 1) the business model where (I suspect) the land value is a lower percentage of the sale price, and 2) the hot real estate market due to high demand (read low supply).

Where is the larger margin, converting raw land to residential lot or converting raw materials to a house? Where is the higher pricing power, entry level homes or custom/luxury homes? I don’t know the answer to that question, but the answer the to why the high gross margins is in the in the answer to the second question.

An additional reason the the gross margin could be the relatively standard designs for the house models across many of the active selling communities. The exteriors change a bit, but the floor plans are very similar. Is there more uniformity in doors, windows, appliances and higher purchase volumes, that is they negotiate lower prices.?

Then, what could cause the margins to fall to the mean? The primary reason that I can think of is a lowering of demand which would lower average selling price. I think it would come off the top line and not the cost of sales. This is the cyclicality of the market and, along with the debt/equity of LGIH, is why this fast grower has a 10,5 forward p/e (13.5 trailing). This is a medium term concern but, IMO, not a worry for 2017 results or a twelve month price target.

By the way, I read in either the Home Builders 100 or the Reuters analysis that LGIH needs an absorption rate of 3 in order to cover the interest payments right now. And, as to what can happen to home builders, this from the Home Builder 100 write ukp on Hovnanian Enterprises:

“For Hovnanian Enterprises (NYSE: HOV), 2016 was a tough year. Saddled with debt and hamstrung by a nonexistent junk bond market, Hovnanian did a joint venture deal with GTIS in June that took some prime land off its books but generated cash. “We grew revenues by 28%, reduced our SG&A ratio by 250 basis points, paid off $260 million of public debt at maturity, and returned to profitability,” says Ara K. Hovnanian, chairman and CEO.”

Comments/Questions??

KC

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As to the business model, I gave short shrift to the overall business model. I am sure their description is normally hyped, but:

“We developed our unique operating model based on our belief that there is a more effective and efficient method of constructing and selling homes. We are focused on maintaining an appropriate supply of move-in ready homes to fuel our dynamic sales force, maximizing our return on capital through efficient build-times, our even-flow or continuous construction methodology, and steady inventory turnover. We believe that the key competitive advantages of our operational business model include our sales and marketing expertise; recruiting, selection, training and development of our people; our disciplined land acquisition process; and our quality assurance and quality control procedures.
Our unique operating model has been refined over the last 20 years through the experience of our management team. We believe our operating model will be effective with respect to homes across all price points, including in our new markets and in communities in which we are the developer, and with respect to sales of home sites. We believe that the business model can be adapted as needed, for the requirements of the individual communities.”

It is not exactly Levittown. Something between manufactured homes, 1,000 identical houses and the regular subdivision. I think the consistently high gross margins do point to the competitive advantage that LGIH claims. Not a “current” or short term transient situation. Consistent not just over the years but in all the added geographic market areas.

KC

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Consistent not just over the years but in all the added geographic market areas.

How do you determine margins for different geographic areas? or is it more like the margins have not deteriorated with new geographies?

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How do you determine margins for different geographic areas? or is it more like the margins have not deteriorated with new geographies?

Yes. Small sample size as the %-age of sales from new geographies is small. But, I am taking the position that the gross margins survived the expansion to Arizona and the combination of Florida, Southeast, addition of Colorado and a small amount of Seattle. Using just Texas as the base geography, the percent of Texas has gone from 84% to 75%, 49%, 29% for 2013 to 2016 (2015 and 16 numbers from a quarterly, not fy, 'cause that’s what I have).

A more correct statement would have been that the gross margins have remained about the same over the years as the number of geographies has expanded.

KC

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As to the business model, I gave short shrift to the overall business model. I am sure their description is normally hyped, but:

"We developed our unique operating model based on our belief that there is a more effective and efficient method of constructing and selling homes. We are focused on maintaining an appropriate supply of move-in ready homes to fuel our dynamic sales force, maximizing our return on capital through efficient build-times, our even-flow or continuous construction methodology, and steady inventory turnover.

I mentioned once before about my friend Bill in Phoenix, he does quarterly surveys of home building inventory and in process, etc. He was somewhat amazed how quickly LGI Homes put up finished homes compared to others in the west Phoenix area he covered.

JT
Seems to be working after they kicked it in high gear post Q1.

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The backlog was reported as 1,545. Note that the backlog at 2016 Q4, when they were short of houses, was 446. They were building rapidly and ended up selling 761, 1.7 times the beginning backlog. That was from a small base. At Q1 the backlog was 1087 and they sold 1511 for Q2 (1.4 times the beginning backlog). What does that indicate for Q3? I don’t know. But if they close, say, 1.3 times the backlog, that is 2,009.

My forecast was/is for 1,584 homes closed. Is 2,009 possible??? Not likely, but June was 8.8 absorption rate. Even at 9.0 and 77 communities that is 693 closings for August and September, or 1,977 for the quarter (591 in July). Anyway, I need to increase my year end forecast, even though my $4.81 eps (fully diluted) exceeds high guidance of $4.75. That most bullish analyst might be right.

Anyway, I think that somewhat hidden backlog number is significant.

KC, looong LGIH

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GauchoChris and Oforfive -

Excellent work on your diligence around LGIH the last several months - the insight and data driven analysis has made buying and holding LGIH a real pleasure. It is quite an accomplishment to precisely call the companies results and guidance - it is very rewarding when you feel your analysis of a company and its cooresponding stock performance directly correlate!

My own back of the napkin (which aligns with your previous posts) points to an FY17 finish of ~5,300 Homes Sold for ~1.14B Revenue and ~4.65eps. If the valuation holds at ~13PE (or ~1.25 P/S) we would see a price in the $57-$60 range by end of year assuming guidance remains strong.

Anyone have thoughts on what PE you expect going forward (the ultimate Magic 8 Ball question, I know)? LGIH is currently at the top end of its historic valuation (using these metrics) in the last several years. However, compared to its peers LGIH is still “cheap” on the surface (other publicly traded home builders PEs range from 14-23).

I’ll admit I haven’t done as much research on LGIH’s peers, but the only real explanations I have seen about why LGIH trades at a discount is the high debt / inventory levels and that sometimes their guidance is not believed by analysts. The catch 22 is that these “negatives” are what is allowing LGIH to grow so rapidly (along with its unique business model).

I am a happy hold right now, but if we start approaching ~$60/share I will need to get comfortable on the catalysts for LGIH taking that next step in valuation.

Erik (first time poster, long time lurker)

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Regarding the backlog:

I checked to see if there was seasonality looking at previous Q2 ending backlog versus Q3 closings.

Data: 2014, Q3 closings were 75% above Q2 backlog; 2015 we 55% above, 2016 was 29% above. Obvious downtrend. Certainly many factors specific to those years so perilous extrapolation. My model was for 1595 closings for Q3, this compared now to 1545 backlog. If this year the actual closings are 10% above Q2 backlog, that is 1,700. I note that the average house price in the backlog is $228,183 and my asp for 2017 was $221,000. Adding the extra closing for just Q3 and the higher ASP for two quarters adds $0.31 per share to year end. I think I was at $4.81 so plus $0.31 is $5.12.

I’m observing this, not predicting it. I think there is upside potential, quite a bit, to the LGIH guidance.

KC, long LGIH

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I had a 10% trailing stop on about 1/3 of my LGIH, just to trim in case things go sideways. Well with this morning’s selloff, it triggered the stop, and when I went to see why, I saw a wire headline that JP Morgan downgraded, but no explanation of why.

I don’t think I’m going to get a good answer from the folks on this board, seeing as there’s been a ton of DD and excellent analysis from its posters, for which I’m grateful.

Are the big investors sneezing?

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Access,

Thanks for the downgrade news. I had a plan to increase my holdings by 25%. With today’s drop I did add 8%, not wanting to use up too much cash in case this reversal lasts more than two days. But if the larger drop for LGIH is a gift from J P Morgan, I may add some more if the market giveth.

KC

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