Getting in Early on a Housing Rebound

07/14/2010 11:08 am EST

Focus: STOCKS

George Putnam

Editor, The Turnaround Letter

George Putnam III, editor of The Turnaround Letter, says a small-cap homebuilder is financially stable and poised to profit from any comeback in housing.

Founded in 1976, M/I Homes (NYSE: MHO) is one of the nation’s largest builders of single-family homes. It has operations in the Midwest, Virginia, North Carolina, and Florida.

Like most US homebuilders, sales grew very sharply in the first part of this decade, peaking above $1.3 billion in 2005. Then, sales dropped off even faster as the current housing problems developed. Sales in 2009 were $570 million, or about 43% of peak levels. The stock followed a similar but even more drastic pattern, falling from a high of $61 in 2005 to below $5 in early 2009.

Investors seem eager to invest in a turnaround in the homebuilding sector. Unfortunately, they don’t seem to have the patience to wait for the turnaround to materialize.

MHO stock, which traded below $10 in late January, surged to $18 in April on the strength of what looked like improving housing numbers. Now that investors are less optimistic about the sector (and stocks in general), MHO is back to $10. And MHO is by no means the most volatile stock in the sector.

Within the homebuilding sector, MHO has a reputation for being very well run. [Chief executive officer] Robert Schottenstein is the son of the founder, and he and his family still control more than five percent of the stock. His management team has been in place for quite a while, and they are very highly regarded. While the company has some exposure to Florida, it managed to avoid the boom-bust trouble spots around the country, such as California, Arizona, and Nevada.

The balance sheet is also very solid. MHO has the second lowest amount of leverage among the publicly traded homebuilders, with only $224 million of debt and $157 million in cash. The company was quick to recognize the industry downturn, and they raised a lot of cash, principally by reducing inventories. MHO recently entered into a new credit facility to replace one that expires later this year, giving it plenty of breathing room in case the industry troubles persist.

There are signs that MHO’s fortunes are beginning to improve. Backlog in the latest quarter was up 28% over 2009, and the average sales price rose 14%. The company still posted a loss for the quarter, but it was greatly reduced from the previous year.

We are confident that the homebuilding industry will improve, but we have no idea when. We believe that MHO stock represents a relatively conservative way to play that eventual rebound. Furthermore, we believe that the recent sell-off in both the stock and the sector provides a good entry point for patient investors.

We recommend buying M/I Homes up to $14. (MHO is a small-cap stock, with market value of less than $200 million—Editor.)

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