An Undervalued Builder In a Booming Sector
One of the hottest markets in the world right now is the U.S. housing market. Home prices surged across the country last year, and it looks as if this trend will continue in 2022.
To understand the roots of this trend, we have to look at the world as well as the domestic U.S. market. Housing prices haven't just been rising in the U.S. They have been rising internationally as well.
A decade-long issue
International housing markets are not all interlinked, but they lean on each other via the credit market as well as the materials market. Low interest rates in the U.S. and Europe have made it easier for buyers to borrow money to fund home purchases, which has led to an uptick in bidding wars, raising the prices all around. At the same time, quantitative easing "created" a considerable amount of wealth (much of it speculative or inflation-based), especially in the most affluent section of society.
It is not just demand factors that are contributing to the current environment, either. In the run-up to the financial crisis, homebuilders worldwide could not build properties fast enough - not just because of high demand from those needing houses, but also because of the demand from investors and speculators as well as the incentive to package mortgages for mortgage-backed securities. When the crash came, builders were the ones who bore the brunt of the decline. Tens of thousands of businesses collapsed under huge debts and a lack of customers.
In the years after, builders did not rush back into the market. For much of the past 12 years, builders have taken a cautious approach, wary of repeating the same mistake they made pre-2008. As a result, construction volumes have remained below pre-crisis levels, constricting supply in the face of rising demand. Even though homebuilders have to deal with rising input costs, high levels of demand and high prices offset this headwind.
Growth potential
Against this backdrop, Meritage Homes (NYSE:MTH) looks appealing compared to other homebuilders. According to Wall Street analysts, the company is on track to report normalized earnings per share of $19.20 for the 2021 financial year, rising to $23 for the 2022 financial year. In comparison, in 2020, the company reported earnings per share of $11. Based on these growth targets, the stock is trading at a forward price-earnings ratio of 5.5.
One of the interesting things about the home building sector is that it is easy to project future growth due to the long lead time between the initial conception of the development and the final sale.
We can build some idea about a company's future potential by looking at its landbank, although a landbank can be both a headwind as well as a benefit if property prices suddenly fall off a cliff.
Meritage invested half a billion dollars in land acquisition in the third quarter, and at the end of September, it had 70,000 lots in the pipeline, an increase of 46% year-over-year. With output averaging around 13,000 homes per year, this locks in several years of revenues for the business and provides significant headroom for output expansion in the years ahead.
Considering the market environment, one could argue that the demand for these properties will remain elevated. Across the country in December of last year, buyers had 19.5% fewer homes to choose from than a year earlier. Compared with December 2019, they found 40.5% fewer homes available for sale. Against this backdrop, it appears as if Meritage looks cheap considering the value of its development pipeline.
Management is also returning cash to investors. It has been buying back stock and had $153 million remaining on its latest authorization at the end of October. Over the past five years, as the company has grown its balance sheet and reduced the number of shares outstanding and book value per share has grown at a compound annual rate of 15%, signifying a solid rate of value creation.
This article first appeared on GuruFocus.
