I last did a “don’t miss the forest for the trees” post on Big Lots. That company went on to rally from when I posted it (not because of me, but because the reaction was way too negative). Unfortunately, supply chain concerns have created new pressures on BIG. In a similar vein, supply concerns are now pressuring LGIH stock, but I remain unfazed and take comfort in the long-term story.
LGIH just posted September home closings were 793 vs. 811 last year, which is a miss for a company “growth” company and I believe this is below expectations. They didn’t report earnings, but investors closely watch these reports for signals of how the quarter will shape up.
We’ve seen other builders also lower their guidance already:
Pulte (PHM) lowered closings 6%
DR Horton (DHI) lowered closings 9%, but raised GM target, so net / net EPS impact was margins
Lennar (LEN) lowered closings 5%
KB Homes missed closings by 7%
Hovnanian just lowered guidance for closings and lowered EBITDA expectations (see yellow line below).
So clearly the homebuilders are all aligned here.
But you need to understand why they are all guiding down: tight supply. To me, this firms the thesis.
LGIH is a largely spec builder at really attractive price points. While they are selling lots very quickly and now need to reinvest, I am comfortable that this model will continue to do very well in the long run. Absorptions are still running at 7.7 (compared to average pace of 6.5) so again, this isn’t really a demand issue, but more so a supply problem. I like it when demand outstrips supply.
Interest rates have also increased modestly, so can’t help but think that is pressuring the stock. That could have a severe impact on the price, but again, I’d likely be unfazed given the long-run story here.
At ~8x forward PE and 2x TBV, I also think valuation is undemanding (DHI trades at 1.6x TBV).
I think LGIH stock is potential multi-bagger. Well, it already has been one, but I think it can do it again. When you add in solid growth, good demand fundamentals and a high ROIC business model, it spells opportunity for long-term investors.
Take a look at some of its growth metrics over time. It does around $480MM of EBITDA now, which is about 2.2x from 2 years ago, and 4.0x from 4 years ago. Also… it was the only homebuilder among the 200 largest U.S. homebuilders to report closings & revenue growth from 2006 to 2008 when the housing market experienced a significant decline. So management clearly is focused on growth.
LGIH did $12.8 in EPS for 2020, but I see the path to $23.3 in EPS by the end of 2023 (discussed more below). Therefore, shares are trading at just ~7.25x my 2023 estimates.
LGIH is interesting too because they provide monthly home closing cadence. The May 2021 was up 42% Y/Y and YTD is up 44%. On one hand, easy comps with April/May, but on the other hand, I think they will keep this strong cadence going for a decent period of time.
LGIH also generates a really strong ROIC, but it doesn’t rely solely on options, as you can see below (controlled = options). It’s split ~55% owned / 45% optioned.
As you can see, LGIH’s ROIC not only is solid for any company, it is improving with scale.
So how has LGIH stock done versus NVR’s? LGIH stock is now officially crushing NVR
However, LGIH still has a unique model. Let’s break it down:
Very sales focused:
Whereas NVR focuses on the land strategy (a big thing for builders, no doubt), LGIH’s core competency comes from focus on sales and marketing
A sales office typically has 2-5 people in it with one loan officer.
The main goal is to convert renters to buyers. They even send direct mailers to apartment complexes pitching renters on buying a home.
Now, in talking to some folks about LGIH’s process, it’s clear some people think LGIH is akin to a used-car salesperson (i.e. pushy). However, as we’ll discuss more, the model appears to work really well. Consumer reviews are also pretty solid.
Spec homes – big contrast from other builders
LGIH is 100% spec homes. Almost the opposite of NVR
“Spec” means they build the home without the buyer already secured. NVR only builds on the optioned land once it has the buyer.
Everything is typically included, so there are not specific options that each buyer needs to select. They have 4 to 5 home plans in each community that allows LGIH to build and sell faster and drive on.
Now, clearly LGIH seems more risky, though in a tight inventory market, the market needs spec homes. Its model is also still low cost.
Also, LGIH was the only top 200 builder to grow from 2006-2008
Focused on entry-level:
Average price point is around $250k, which is square in the entry level price point (meaning first time home buyers).
Given lots are expensive these days, LGIH is typically acquiring lots outside of city centers, but also targets areas where there is some retail anchors to attract consumers.
This segment of the market should have demand for years to come, given millennials deferred purchasing homes post-GFC and have been renting for longer.
Still earns strong returns
The average & median builder earns around a 12% EBIT margin, with DR Horton and Lennar near the top given their massive scale (16.1% and 15.5% respectively) and the smaller builders near the bottom, such as Beazer and Taylor Morrison around 10%
LGIH earned a 18.3% EBIT margin
Another interesting thing to note, going back to strategy, is LGIH’s absorptions blow competitors out of the water. Again, 4 is the average absorption rate per month in 2020. LGIH is around 7. The gap was even wider pre-COVID (i.e. before the buying boom).
This means LGIH is selling almost double the amount of homes in a period of time as competitors.
So what drives LGIH’s high returns on capital?
Dupont formula: profit margins (high for LGIH), asset turns (high for LGIH), and leverage (actually low for LGIH).
As LGIH gains size, I think ROIC will continue to grind higher. Now, they’ve gotten pricing, which helps ROIC and margins, but look at ROIC as size has scaled.
As a quick aside, it’s funny to contrast everything we’ve talked about so far with New Home, a luxury builder I wrote about a few months ago that still trades below book value. New Home is small, so its EBIT margins are low. It’s also a luxury builder which just given the nature of the product is slower moving. However, I still think it’s cheap and it’s likely a take-out candidate in a market thirsty for inventory.
Ok – back to LGIH. To my knowledge, only a couple firms cover LGIH. I only could find JP Morgan and BTIG.
Here lies the opportunity. I think LGIH will be a long-term compounder and it’s relatively undercovered. Based on my estimates, I think LGIH will do about $23 in EPS in 3 years (from ~$15 LTM). So with the stock trading at 7.4x that forward EPS today, that seems too cheap to me.
Sure, I’m looking 3 years out on a cyclical business, but I’d rather have LGIH stock than buy a questionable SAAS name for 20x sales.
The risk to the thesis is, can they keep up the growth? Well, 2020 will definitely be a tough comp. Right now, we are still lapping the easier part of 2020.
However, the risk to LGIH’s growth is not the same as NVR for example.
Recall, NVR uses solely options on lots and those don’t exist in every market. LGIH’s risk is acquiring lots at attractive prices and selling them in high demand areas – lot prices are going up, but so is entry level demand. I think LGIH will just pass that through.
There are other obvious risks to homebuilders. Interest rates, the economy, etc. etc. But I think this cycle is going to last awhile. Sure, we could have a buyers’ strike like the end of 2018 as rates were rising, but I think we actually need several years of housing starts >2MM (vs. new cycle high of 1.5MM right now) to sustain demand.
I watch the builder stocks from time to time. In some ways, they’re HODL’ers. They are so volatile. But a few are worth grabbing on to and just taking along for the ride.
So bottom line: LGIH stock may not be a straight path up, but I think it will compound earnings for a long period of time.
