LGIH closed at $59.04 on Friday. This gave me pause and prompted yet another review of my target price and the two or three year opportunity for LGI Homes. I have several reviews filed away on my computer. I think I have posted one or two here. So this will not be a detailed analysis. Quite simply, I am forecasting $4.81 per share earnings for FY2017. This is based on projected closings of 5,543 (sorry for the false precision). Using a perhaps optomistic $220,000 average selling price, this yields $1,193,400,000 revenue. Without detailing the costs and expenses, I have a net margin of 8.69%, $107,828,000, 22,400,000 shares, and the above mentioned $4.81 per share.
When we first discussed LGIH here, it traded at a 10.5 multiple which was up from 9.5 in previous years. More recently the p/e was 13.0 TTM earnings. Based on 10.5 and 13, the price forecast could be $50.54 to $62.58. The TTM p/e on Friday was 15.2. When I woke up Saturday morning and saw this, I placed an extended hours sell order for 15% of my holdings. I got about 5% executed and then engaged in this “on further review” exercise.
Obviously, there is a great deal more comfort in investing in a growth story at 10.5 p/e than at 15.2. I am targeting that $62.58 to occur between first week of January (after December closings are announced) and second week of April (after March closings and yearend results are accounced). I am left with 6% upside in two to five months.
The 10.5 p/e was not totally irrational. LGI Homes has/had a short history as a public company. Not irrational to discount the growth rate to see if it is sustainable. The 10.5 p/e and the debt/capital ratio put LGIH right on the curve of other home builders. I think that as the market became more comfortable with the growth prospects, the multiple expanded. Right now one could say that 44% growth is accepted (15.1/10.5). That corresponds to the 42.4% revenue increase I am forecasting for 2017 over 2016. Either that or the momentum boys have joined the fray, which is quite probable. Raises the question of whether the easy money has already been made.
Now it is all about future growth. This could be measured by number of active communities. I noted that the increase in number of communities comparing September data is as follows:
2014 54%
2015 35%
2016 18%
2017 47%.
I think that the 2014 number was influenced by the IPO and resulting cash infusion. The low increase in 2016 probably was a forewarning of the low closings in January and February of 2017. The high 2017 increase might be make up for 2016. The average of 2016 and 2017 is 33%. So, the question is (might be) whether LGI Homes can add 30% more communities in 2018, 2019. They had 77 at the end of September. Plus 30% would be 100, and of course another +30% is 130. Financially, they seem able, although I have puzzled over how 9% net margins can finance 40% growth. At least with a p/e of 15 it makes ATM sales more attractive, should that be warranted.
But the question remains as to how many more communities can be added to existing metro markets, and how many more metro markets are available to LGI Homes. LGIH is in 14 of the top 20 markets (as listed by Home Builder Magazine). They are not in Washington D.C., New York, Los Angeles or Riverside. LGI Homes stated a goal of being in the top 50 markets. I didn’t find such a listing now although I recall seeing one within the year. They are in 27 markets overall. 40% of the communities are in 9% of the markets. 84% are in 33% of their 27 markets. Where would those 23 and then 30 additional communities be located? We know they are going into Sacramento. They could enter Riverside. Las Vegas is a top 20 market. Salt Lake City/Provo? Nine of their current markets have just one or two communities at present. Can they add or does this indicate a limit on the lower 23 markets?
Another perspective is their years-of-inventory. It was down to 5.4 years after Q2 with its 1511 closings. Continuing at that quarterly pace is 6044 annually which is only 11% over my FY2017 projection. In other words, we are looking for even larger quarterly closings so it will be interesting to see the lot inventory for the next couple of quarters because I am projecting 1,691 closings for Q3. Will the inventory keep up? Of course there is the issue of the mix of raw versus finished lots, but raw landtakes 3 to 5 years to turn into closings. Finished lots are turned into closings one to two years sooner (I think). I would say it takes 7,000 to 7,100 closings for 2018 to justify a 15 p/e. Say 1800 closings per quarter. To have 5 years inventory requires 1800 x 4 x 5 = 36,000 lots. Last quarter they had 32,689. They needed to add 4002 lots in Q3. We shall see.
Now, I know there has been concern over macro issues, namely interest rates. I am not so concerned. Interest rate increases are supposed to be “data driven” which includes economic activity, inflation, wage inflation and employment. The LGIH buy-don’t-rent thesis is based on fixing the housing cost to avoid rent inflation. The math ought to work out based on higher inflation versus higher interest rate as long as wages of first time buyers increases. I read an intesting article on stagnant wages. Some agency/institution has started to report the increase in median income instead of average income. The data show that the median is increasing noticebaly more than average. Two causes are proposed. One is that the increase in employment is disproportionately scewed to entry-level and lower paying service jobs. Another is the effect of higher paying jobs disappearing as older workers retire. Some of that expertise is replaced by computer-assisted, less experienced, lower paid employees? In any case, LGIH is not so interested in the wages/salaries of entry level employees. Their customers are more established workers making nearer to median wage? Just wishful thinking?
What to do? I think that LGIH shares have a probable floor but I think it is the $50 range, 20% downside. That is just based on where they are now (my earnings projection) and a 10.5 p/e should growth slow noticeably in coming quarters. I see a 25% upside if they track towards more than 7000 closings as 2018 progresses. I think I have talked myself off the ledge. But I have the list of things to monitor: monthly closings, quarterly lot inventory and number of active communities. And of course, average selling price and continued, small increases in net margin.
Am I overthinking this? Maybe just relax. If LGIH disappoints the market, but meets my expectations, just add. If it disappoints the market and me, well, cash in the chips and move on. Don’t have to get out at the very top (it could be $86 in 2019 if it doesn’t run out of room to grow).
Comments?
KC