Five Homebuilders with Turnaround Potential

05/29/2020 5:00 am EST


George Putnam

Editor, The Turnaround Letter

Like most consumer industries, residential housing construction is declining sharply in the wake of the Covid-19 shutdown, observes George Putnam, editor of The Turnaround Letter.

New demand will continue to drop and contract cancellations will surge in April, particularly with 26 million job losses. The industry’s recovery, which was accelerating at the beginning of the year, is now reversing rapidly.

However, is the recovery derailed, or just delayed? The demographic tailwind from Millennials reaching the traditional home-buying age remains in place.

Single family housing starts, at 1.04 million units in February, was only about half the pace of the peak of the last housing bubble and even below levels of the 1980s and 1990s, when the U.S. population was much smaller, leaving plenty of potential for higher volumes.

The stay-at-home restrictions may incentivize many to move out of crowded cities into spacious new suburban homes.

Affordability, long a concern for home buyers, is being helped by historically-low interest rates, and could be boosted further if financial market conditions begin to improve.

And, if inflation returns, demand for homes would likely rise significantly, especially if interest rates remain low, as consumers rush to buy before the next price increase.

Listed below are five homebuilders whose valuations appear to overly discount the industry’s recovery prospects. Their shares sell close to or below tangible book value, a useful valuation metric as most of a homebuilder’s assets (primarily land and in-process homes) are recorded at approximately market value.

Green Brick Partners (GBRK)

Green Brick has a unique strategy: rather than operating as a single company, its local subsidiaries and affiliates to run their businesses with considerable autonomy, on the logical assumption that they know their markets better than centralized management.

Administrative functions, risk management and financing are provided by the main office. Conservatively capitalized Green Brick builds suburban townhomes, first-time and second-time moveups, age-targeted and urban housing in Texas (its home state), Georgia, Florida and Colorado.

Another unusual twist is that Greenlight Capital has long-held nearly 50% of the company’s shares, as the hedge fund’s manager David Einhorn co-founded the company in 1986.

M/I Homes (MHO)

M/I Homes (gains of 75% and 92%) is a Columbus Ohio-based builder founded in 1976 by the locally-renowned Schottenstein family. The company focuses on affordable, empty-nester and luxury homes to buyers in the upper Midwest, Texas and southeast regions of the United States.

M/I Homes is conservatively run, reflected in its low-risk balance sheet and land acquisition strategy that emphasizes controlling lots with options rather than outright ownership.

MDC Holdings (MDC)

MDC builds homes for first-time and move-up homebuyers in the western United States with a smaller presence on the east coast. Chairman and CEO Larry Mizel, who founded the company in 1972, still controls 15.8% of the company’s shares.

MDC’s balance sheet is conservative, with $450 million in cash, plenty of untapped credit line capacity, and no senior note maturities until 2024. MDC raised its generous dividend by 10% in January, although this was before the downturn started.

Meritage Homes (MTH)

Meritage concentrates on entry-level and first-time move-up homes primarily in the southwest, west and southeast United States. The company is simplifying its roster of home plans and customizations with a strategy first deployed by car makers.

This has helped Meritage expand its margins while making it easier on customers who don’t want to be overwhelmed by hundreds of choices. Complementing this strategy, Meritage is emphasizing speculative home-building (without a buyer in advance), which has now reached over 60% of closings.

This may lead to higher near-term unsold inventory as buyers wait-out the virus, but over time may help Meritage meet a demand recovery and boost its margins further. The company has plenty of liquidity and a reasonable amount of debt.

Toll Brothers (TOL)

Toll Brothers is the country’s largest luxury homebuilder, even as it is expanding upon its wide range of price points in more affordable categories. The company operates across 24 states. In addition to the downturn, Toll has struggled with cost over-runs at its Metro Crossing project, but we expect this issue to fade over time.

Overall, the company has a quality reputation, reflected in its ranking as the #1 Most Admired Homebuilder by Fortune magazine for six consecutive years. Its balance sheet and financial flexibility remain capable of carrying them through the current downturn.

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