It is common knowledge that the U.S. housing market is booming. Nonetheless, in this inflationary environment, it can be difficult to pick a reasonably priced company to take advantage of this trend. Nonetheless, these stocks exist. LGI Homes Inc. (LGIH, Financial) is a Texas-based builder of housing developments, with its projects mostly focused in the southwestern corner of the United States. Founded in 2002, LGI has built over 23,000 homes and is present in six different regional groupings: Central, Southwest, Southeast, Florida, Northwest and Midwest. The stock is currently trading around $57 per share and has a market capitalization of around $1.3 billion.
The company divides sales between two brands: LGI Homes and Terrata Homes. The latter sells homes to more affluent buyers, whereas the former supplies the first-time or entry-level demographic. The stock has been through some ups and downs over the course of the last year; nonetheless, we believe there will be growth on the cards for LGI going forward. In this article we lay out the bull case for this value stock.
Financials
LGI’s financial performance for the first quarter of 2018 has been exceptional. Revenue from home sales were $279 million, a 71.3% increase from the first quarter of 2017. The average sales price was up 4.8% year over year due to a combination of product mix and a favorable pricing environment. Despite this, expenses have been brought down. Selling, general and administrative expenses for the quarter were 13.8% of home sales revenue, down from 16.8% for the same period in 2017.
Pre-tax income for the quarter was $31.2 million (11.2% of home sales revenue), an 85% increase in pre-tax income compared with the first quarter of 2017 and the strongest first-quarter earnings in the company’s history. Management has said they expect to close between 6,000 and 7,000 homes this year, and based on this they project full-year basic earnings per share to be between $6 and $7, which would be a significant improvement on last year’s earnings of $5.24 per share.
Positives
Positive macroeconomic trends are buoying up the housing market as a whole. Unemployment is at historical lows, wages are growing, spending is up and interest rates remain very low. This combination of economic growth and cheap money has made homeownership available to a much wider range of people, hence the boom in the sector.
Specifically, these people are millennials who came of age during and after the 2008 financial crisis and who for a long time were shut out of the housing market. As this demographic has aged and accumulated financial capital, we have seen them become first-time property owners in increasing numbers. Where LGI has an advantage over larger developers is in its LGI Homes segment, which caters more to lower-income individuals and families taking their first step on the property ladder. This makes the company’s homes particularly attractive to this consumer segment.
Risks
As the health of the housing market is linked very closely to the health of the overall economy, any general slowdown would be a blow to the sector. Geopolitical risks like the brewing trade war with China, as well as increased tensions with Canada and the European Union could boil over and have more serious consequences. Furthermore, as LGI is a small company (for a real estate developer), it will be hit comparatively harder than its larger competitors. This may be particularly dangerous as the company has a relatively high net debt-to-capitalization ratio (approximately 50%).
Verdict
Overall, we see a stock that is poised to do well off the back of a strong economy, historically low unemployment and interest rates and increased spending and wages. In particular, its homes should be more attractive for the millennial demographic. However, high debt and vulnerability to a sudden economic downturn do not make this a low-risk investment by any means.
Tread carefully and keep an eye on the headlines.
Disclosure: I/We own no stocks discussed in this article.
(This article was co-authored by Stepan Lavrouk, an investment analyst with Almington Capital - Merchant Bankers.)
