LGIH's growing pile of debt

Let’s take a closer look at LGIH’s business. Recently Saul posted the company’s revenue and earnings growth over the past 4 years. The numbers seem impressive but they are not without risks. Specifically, we should pay attention to the cash, the debt, the inventory and the share count.


Date	EPS	Sales	        TTM EPS	Unit Sales	Avg Price	Inventory ($M)	Cash ($M)	Debt ($M)	Shares out
12/13	0.34	 $80.9 		        505	        $152 	        $142 	        $54 	        $36 	       20.834
3/14	0.22	 $75.9 		        485	        $157 	        $178 	        $26 	        $49 	       20.863
6/14	0.43	 $106.4 		662	        $161 	        $221 	        $43 	        $94 	       20.869
9/14	0.34	 $92.5 	         $1.33 	557	        $166 	        $292 	        $46 	        $160 	       20.882
12/14	0.34	 $108.4 	 $1.33 	652	        $166 	        $368 	        $31 	        $216 	       22.136
3/15	0.33	 $120.7 	 $1.44 	671	        $180 	        $387 	        $39 	        $230 	       23.809
6/15	0.66	 $158.8 	 $1.67 	853	        $186 	        $407 	        $50 	        $240 	       21.246
9/15	0.76	 $174.0 	 $2.09 	934	        $186 	        $461 	        $37 	        $248 	       20.319
12/15	0.75	 $176.8 	 $2.50 	946	        $187 	        $531 	        $38 	        $305 	
3/16	0.57	 $162.5 	 $2.74 	844	        $192 	        $561 	        $48 	        $323 	       20.461
6/16	0.96	 $222.7 	 $3.04 	1128	        $197 	        $610 	        $50 	        $334 	       21.487
9/16	0.86	 $216.3 	 $3.14 	1052	        $206 	        $677 	        $46 	        $355 	       22.674
12/16	1.01	 $236.8 	 $3.25 	1139	        $208 	        $718 	        $50 	        $401 	       22.879

Now in looking at the above data, you will see great growth in EPS, revenue, and homes sold. You will also see that they cash balance is really moving, the inventory and the debt are ballooning. The share count is slowly going up. So what is happening is that the company is taking out more and more debt to finance the purchase of more and more inventory. Let’s look at the inventory in closer detail.


Date	TOTAL Inv	Land/lots	Sales Offices	WIP	Homes
12/13	 $142 	        $82 	        $4 	        $28 	 $28 
3/14	 $178 	        $101 	        $4 	        $41 	 $30 
6/14	 $221 	        $126 	        $7 	        $45 	 $42 
9/14	 $292 	        $191 	        $8 	        $34 	 $59 
12/14	 $368 	        $245 	        $7 	        $56 	 $60 
3/15	 $387 	        $267 	        $13 	        $58 	 $48 
6/15	 $407 	        $263 	        $9 	        $96 	 $40 
9/15	 $461 	        $282 	        $8 	        $112 	 $59 
12/15	 $531 	        $320 	        $8 	        $109 	 $93 
3/16	 $561 	        $337 	        $10 	        $123 	 $92 
6/16	 $610 	        $381 	        $10 	        $139 	 $80 
9/16	 $677 	        $425 	        $11 	        $146 	 $95 
12/16	 $718 	        $477 	        $14 	        $95 	 $132 

The sales offices are considered inventory by the Company; they are growing slowly as LGIH increases the number of Active Selling Communities. WIP (homes being built) and Homes are going in line with the business growth. These two inventory items are less of a risk because they can be cleared fairly quickly. The land and lots are inventory that will take more time to clear; this is the item that is ballooning. Essentially what is happening is the company is using all (most) of it’s revenue plus additional debt to finance the purchase of land and lots. Specifically, from the Dec 13 period through the Dec 16 period the company increased (net) its lots and land inventory by about $400M and increased its debt by about $375M.

Here is the latest (as of 12/31/2017) information on what the debt is:

$322.3M under their $375M revolving credit facility maturing on 5/27/2019. Interest rate (paid monthly) is LIBOR + 3.50%. The company has been increasing its credit facility frequently. One 12/31/16 LIBOR was 0.72% while today it is 0.93%.

AND

$78.2M under a 4.25% convertible note due on 11/15/2019. Interest is paid semi-annually.

So while the sales and earnings have been growing fast, the debt is growing at a similar rate. This method of growth adds a number of risks including interest rate risk, inventory holding risks (and cost), market risk (should home sales slow they could be stuck with), financing risk (should LGIH not be able to continue issuing ever increasing debt), land/lot price declines.

When you compare LGIH’s earnings to other rapidly growing companies’ earnings, they are not apples to apples. Take Shopify for example. SHOP is not showing much in earnings while LGIH is. But the difference is that SHOP’s cash balance is soaring while LGIH’s debt balance is soaring. Both companies are investing in future earnings (LGIH by buying land/lots and SHOP by improving its offering to customers and “buying” and ever increasing customer base.

26 Likes

But the difference is that SHOP’s cash balance is soaring while LGIH’s debt balance is soaring.

if it matters, shop’s cash flow from operations was about 32m in the past 27 months which trails PPE and acquisition spending and most of the CFFO is coming from stock based compensation. Where’s SHOP’s cash has increased has come from a share offering which added 224m.

course, shop is a growth company…

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if it matters, shop’s cash flow from operations was about 32m in the past 27 months which trails PPE and acquisition spending and most of the CFFO is coming from stock based compensation. Where’s SHOP’s cash has increased has come from a share offering which added 224m.

You are right. SHOP was a bad example to make my point.

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Chris, you are referring to that debt as if there was nothing balancing it, but there is. They have all that land inventory that they are carrying on their books at cost even though it is probably worth much more at present. In addition they probably made a calculation that the interest they pay is well worth it, because if they had to buy the same lots a year or two later the price would have gone up much more than the few percent of interest that they are paying. It’s a simple, and in their eyes, sensible business decision.

Saul

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The land and lots are inventory that will take more time to clear; this is the item that is ballooning.

Instead of looking at the $$ value, look at the lots in numbers and look at it as # of years of supply. That is in the TTM (trailing twelve month) LGIH had sold 100 houses and they owned (including options) 1000 lots then they have 10 years of supply. If you look at it that way, the land growth should also be tracking similar to the sales growth.

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Chris, you are referring to that debt as if there was nothing balancing it, but there is. They have all that land inventory that they are carrying on their books at cost even though it is probably worth much more at present. In addition they probably made a calculation that the interest they pay is well worth it, because if they had to buy the same lots a year or two later the price would have gone up much more than the few percent of interest that they are paying. It’s a simple, and in their eyes, sensible business decision.

Yes they have all that land, but if you are investing in LGIH because you expect the land to increase in value then you are a real estate land speculator. Don’t you want to see the company throwing off cash?

The land they currently own or control is 29,460 lots. Their unit sales in 2017 might be 4700. Do they really need 5 years worth of land inventory (we’re not talking a year or two here)? The carrying cost of that land is $18M per year, but this is minor compared with the risk of leverage. Also, if they continue to grow that inventory indefinitely there will likely be a time when there is another real estate downturn or another financial crisis (at some point). BTW, they are now growing debt and land inventory at more than $50M per QUARTER. This is not sustainable unless the real estate boom to continues.

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GauchoChris,

First, we are seeing no indications of a demand reduction in entry level single family homes.

So excpecting a continuation of the building is a reasonable expectation.

Also, this is a growing campany, and is why it is on Sauls radar at all. In this case they have roughly 25000 lots in inventory but are selling only about 5000 a year, but this is a double from 2 years ago. If they are going to continue to grow at this rate they will be selling 10000 homes a year in two year. At that rate they only have 2.5 years inventory.

If they quit borrowing for inventory for even one year, their debt starts dropping rapidly and their profits go way up.

The question is: Is the management flexable and smart enough to work outside their original Southwest culture?

Cheers
Qazulight

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GC, you make great points. Thank you. That was a very helpful post.

Massive leveraged ownership of land is quite obviously a high risk, high reward tactic.

IMO, it would not be analytically correct to dismiss the risk (as opposed to explaining or evaluating it) by saying that the company expects the land price to go up. The existence of potentially high reward does not reduce the risk, it just explains why the company is taking that risk. And “high risk” is not the same as “wrong” or “loco,” it just is a factor to consider. At least it is for me – everyone is free to make his or her own judgment.

Of course the company expects the land to increase in value, and it could be right; there could be great benefits to speculating like this (and make no mistake, speculation – albeit informed speculation – is what this is).

But if we call a duck a duck here, and allow ourselves to use the term “land speculation,” if may well set of alarm bells for people. It certainly does for me. After all, land speculation has a long history of making and breaking fortunes. I have already made mine, so I am only eligible now for the “breaking” half of that formula – which, all in all, I would prefer to avoid.

And so, for now, I will avoid LGIH.

If I miss a home run, who cares? I have missed so many home runs over the years; this is just one more.

And despite all those misses, here I am, still standing, because I have also never been that rabbit that pokes his nose out of the burrow because he just KNOWS that fox must have wandered away after all this time. I am the rabbit that stays in the burrow an extra hour. So I miss the succulent green shoots, but I also do not get eaten.

Your Moose May Vanish!

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Also, this is a growing campany, and is why it is on Sauls radar at all. In this case they have roughly 25000 lots in inventory but are selling only about 5000 a year, but this is a double from 2 years ago. If they are going to continue to grow at this rate they will be selling 10000 homes a year in two year. At that rate they only have 2.5 years inventory.

They have 29,460, lots. They expect to sell 4700 homes, but the growth rate is slowing.

In 2014 they sold 2356 homes.

In 2015 they sold 3404 homes. Up 44.5%.

In 2016 they sold 4163 homes. Up 22.3%.

In 2017 they expect to sell 4700 homes. Up 12.9%.

Unit homes growth has been about cut in half every year. There’s no way this company can afford to build 10,000 homes per year in 2 years without taking on massive amounts of additional debt or issuing a ton of new shares. They don’t need 29,460 lots right now or for a long time.

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They don’t need 29,460 lots right now or for a long time

That is 6 years of inventory and I would say very much in-line with other homebuilders. I would encourage you to benchmark other industry peers to see how these numbers compare before deciding the company is carrying excess inventory or that is an issue.

2 Likes

but the growth rate is slowing.

That is a valid Saul type warning.

Thanks
Qazulight

That is 6 years of inventory and I would say very much in-line with other homebuilders. I would encourage you to benchmark other industry peers to see how these numbers compare before deciding the company is carrying excess inventory or that is an issue.

Kingran,

I think you missed the point. Their inventory level is rising in spite of the home that they are selling.

At the end of 2015, LGIH had 23,915 lots and they sold 3404 homes during 2015.

At the end of 2016, LGIH had 29,460 lots and they sold 4163 homes during 2016.

We also need to account for homes that were being constructed and homes that were completed but not sold.

At the end of 2015, they had 716 homes (partially constructed or finished) in inventory.

At the end of 2016, they had 1564 homes (partially constructed or finished) in inventory.

So the simple math is that for 2016 their inventory grew by 5545 (lots) plus 848 (homes) IN EXCESS of the homes that they sold during 2016 all while the growth rate of units homes sold is shrinking. So in just looking at those 2 years (2015 to 2016), we have a situation where they are increasing the years of inventory by at least one additional year. Why do they need to add 10,556 when they only consumed 4163?It’s something to keep an eye on going forward.

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GauchoChris: The land they currently own or control is 29,460 lots.

Chris, here

Keep in mind that 13,167 lots are either raw land or still under development. I do not see details for LGIH specifically but in general, development of raw land takes 6 - 24 months until it reaches “finished lot” status and is ready for construction of the house. They also buy land when they find a good deal, not when they are immediately ready to begin developing a new community. I highly suggest reading the 10-K section describing their land acquisition policies.

The number of lots also seems inline with the rest of the industry. Here is a comparison to KBH and MHO (chosen at random) pulling numbers from the most recent 10-K.


Company  Closings   Inventory
LGIH     4,163      29,460
KBH      9,829      44,825
MHO      4,482      23,064

No clue if any of those numbers are good or bad but it seems LGIH is at least following industry norms for land acquisition!

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GauchoChris:
At the end of 2015, LGIH had 23,915 lots and they sold 3404 homes during 2015.

At the end of 2016, LGIH had 29,460 lots and they sold 4163 homes during 2016.

Interesting calculation:


2015: 3404 / 23915 = 0.1423
2016: 4163 / 29460 = 0.1413

Looks like lots owned is grew at the exact same rate as lots sold.

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Interesting calculation:

2015: 3404 / 23915 = 0.1423
2016: 4163 / 29460 = 0.1413

Looks like lots owned is grew at the exact same rate as lots sold.

That’s not the calculation that you want to make. Please read my post again as it accounts for all inventory, not just lots. Also, you want to use the prior year’s lots and the next year’s homes sold so it would be…

4163 / 23,915 = 0.174

4700 / 29,460 = 0.160 but you need to add the additional partial and completed homes (848 homes added to inventory) that were added which makes it 4700 / 30,308 = 0.155

so as I said, you have a increasing inventory relative to future sales:

1 / 0.174 = 5 years, 9 months

1 / 0.155 = 6 years, 6 months

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I think you missed the point

I don’t think so. Like I suggested if you do the lot inventory as years of supply you will see there is no significant variance from the industry when you adjust for LGIH growth. In your lot supply you have to separate optioned lots vs owned lots, just to understand how much they really invested on land inventory. Also, as they geographically expand there could be short-term spike on the lots as they build inventory in a new geography.

Next, their wip or homes under development inventory, typically LGIH does spec build but closes the sales very fast. Therefore there inventory used to be 3 months of closing and now the sales process is slightly getting drawn out (takes more than 3 months to close the sale). They had a bit of absorption issues in their southern communities but that will fix itself over time, but the sale to close will get drawn out and slowly gravitate towards industry norm of 5 to 6 months. The good rule of thumb for the WIP inventory should be about 4 to 4.5 months of closing. For ex: this is 6 months for DHI excluding express homes and use to be 8 months for Toll brothers.

In a nutshell I am not worried about LGIH inventory, debt levels. The company is experiencing mild growing pains (which shows slightly lower absorption rate) and given time, management will make necessary adjustments. The growth slowing is a natural and the valuation (price) will either stagnate or gently decline towards the book value. I would say 1.0 to 1.3x price to book value is a good level and currently LGIH is trading at a premium.

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Why do they need to add 10,556 when they only consumed 4163? It’s something to keep an eye on going forward.

Chris, could it be because they are rapidly expanding, and thus for every new community they have to buy an adequate supply of lots before they open, but have no past sales as of yet for you to balance against.

Saul

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Chris, could it be because they are rapidly expanding, and thus for every new community they have to buy an adequate supply of lots before they open, but have no past sales as of yet for you to balance against.

LGIH breaks down their lot information by region.

12/31/2015:
Texas: 12,894
Southeast: 5886
Southwest: 2692
Florida: 1928
Northwest: 515

12/31/2016:
Texas: 16,653 (net addition of 3759)
Southeast: 6723 (net addition of 837)
Southwest: 2847 (net addition of 155)
Florida: 1933 (net addition of 5)
Northwest: 986 (net addition of 471)
Midwest: 318 (net addition of 318)

So 2/3 of the new lot additions are in Texas.

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Just want to give a shout out to this board for discussions just like this one. A couple different opinions, really investing strategies in a single company, but great research and perspectives.

Well thought out answers from varying experiences are exactly what makes this board so great. Oh, and the % value increases :slight_smile:

I will try to post my own experiences more, as time allows, but wanted to let everyone on here know that your opinions are appreciated.

Rob

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