wf on lgih

I was curious - he had downgraded before - these are my notes

1 - GM was surprise for Q
2 - they are concerned about 2017 guide
3 - says that 2016 metrics came in lower range of guide
4 - they are not as optimistic about closings (“However, with backlog conversion consistently well above 100%, we are not as optimistic, given closing trends are +29%, +8%, -26%, and -9% the last 4 months”)
5 - they see 4453 closings vs. 4700 management guide and they are expecting ASP to be lower too
6 - they said last year this company predicted 26.5-28.5% GM but ended with 26.4%; lower current guide of 25-27% suggest to them to use lower end; they think the company may have to offer incentives
7 - there is some general stuff about rising rate risk and that stuff

if it matters, this analyst agrees with CM - they value it based on book value (at 1.3 to 1.4x BV). T

my 2c

  • I know zilch about homebuilder’s but I’m glad you folks have made a profit. That said, it seems (seems because I am guessing!) clear that this analyst is a) following trends, and you follow the latest trends which means if the trends change so will the opinion (so I would call his analysis more numbers oriented than business oriented, which means it is inherently lower quality - again, my guess), b) his focus is very short-term oriented (which is typical for reports like this - the narratives focus on upcoming months vs. years, and you can trade around opinions like this cause years are much, much different than quarters), and c) he might be right or wrong (and who knows this person? not me). The stock shows he is “wrong” of course for now and he might end up being wrong wrong but given my lack of knowledge here I have no clue if the market is rational or not on this stock (or many others for that matter), but I for one like to hear divergent opinions - it keeps me sane but it doesn’t mean he or me is right, but…there you go…

Nishu Sood is a long-term housing analyst with Duetsche bank and he has buy rating on the stock. He raised questions that shows there is a concern.

since you’ve been public, two months in a row being affected by inventory shortages…Especially it seems to contrast with the statement about the fourth quarter where you had a terrific gross margin and you mentioned management of construction, managing construction well. if you’re managing construction well, how does that end up with an inventory shortage that is enough to affect two months as opposed to the typical one?

Your model is pretty different than pretty much every other builder out there, much quicker turnaround, the vast majority of your homes are – 100% are – close to 100% are spec. So, the idea of stacking up demand across two weak months of closings whereas demand was still stronger, how are you folks managing that because I think you’ve told me the past 60% of your customers buy on their first visit.

your guidance seems to imply a huge improvement in SG&A about 80 bps, Charles if I calculate it correctly, but you mentioned some additional expenses this year. Am I in the right ballpark there that that’s a great performance that’s implied there?

Nothing earth shattering, however, I see there is a concern the guidance may be aggressive. Especially if you see the commentary around their Texas communities inventory not available to meet the demand, etc.

The company is breaking ground in new territories and they may face some bumps along the way. They had two months of lackluster closings. The management is saying we had great sales. But January was down 14% and Feb was up 24%. That is a big swing. I think WF analyst was correct in being skeptical that the closing are going to be weak. The first quarter results are not going to be good because of low closing their margin’s are going to be impacted. And the company is already talking about adjusting their offering to meet the demand (i.e., customers impacted by rate increase) in reducing the plan size (for ex: from 1800 to 1400, etc). The plan on meeting ASP increase is due to expensive areas getting in the mix (like Seattle, which is more expensive than Texas). While they can address the ASP increase but it is not clear how it will help them with margins.

Also, in my view the company will be increasing the investments not only in higher community count, and they are going into a model of slower absorption that is they are going to have some spec inventory on the book. This is something new for the company because they have traditionally turned over in 30 days so there is very little scope of inventory mistakes now there will be some learning and adjustments.

Again, the guidance is strong. The stock price move today is strong. There are some new challenges like rate increase, new territories. It needs to be seen the company can execute. On hindsight, the wells fargo downgrade was an opportunity for a quick profit. No guts, no glory I guess.

On the valuation or the potential for further gain…

Here is ML summary on their valuation for MTH. Of course this is just an example they have rated DHI, TOL, PHM between 11x to 13x PE and 1.5x P/B. The reason I am posting this is to show the shares are not terribly undervalued but not overvalued either.

Meritage Homes Corporation (MTH)
Our $31 PO on MTH shares is based on a 2017E P/E mult. of roughly 8.5x. We are using
later cycle multiples to value the homebuilders, despite our view that the current US
housing recovery has at least several more years of upside. In determining our $31 PO
for MTH, we considered the group average P/E mult. at the last two peaks in housing
starts and new home sales as general bookends. We then looked at MTH’s individual, as
well as the group average P/E mult. from 1992-1997, which we view as the most recent
period of normalized US housing starts and new home sales. Using a combination of
these periods we derive POs that imply a group P/B to ROE matrix R-squared of roughly
99%. The 8.5x 2017 P/E mult. and implied 0.8x P/B mult. supporting our PO on MTH
shares are both within historical ranges.