Meritage Homes Corp Earnings: Cracks in the Foundation, or Building Something Great?

Top-10 homebuilder Meritage Homes Corp (MTH 3.15%) reported third-quarter financial results on October 29, with relatively positive 21% home-closing revenue growth. However, profits came up short, and actually declined from last year.

Let's take a deeper look at Meritage's results for the quarter. On the surface, things look mixed, but a deeper dive should uncover what's going on. 

The numbers 

What happened in the quarter 
Meritage, like many homebuilders, continue to struggle with labor- and weather-related challenges, despite relatively strong demand for new homes in most major markets. 

• Home closing revenue increased 21% over the prior year's quarter, with a 12% increase in home closings, and an 8% increase in the average closing price.
• Closings in Central region only increased 3% due to the impact of this past spring's torrential rains in Texas. Closings in Houston and Dallas markets continue to be affected by the delays in many building projects in this market. 
• General and administrative expenses decreased to 4.3% of total closing revenue, down from 5.2% in the prior year. 
• Gross margins fell to 19% in the quarter, down more than 100 basis points, from 20.4% the year before. The company said that material costs were down in the quarter, but labor costs continue to increase. 

Meritage isn't the only homebuilder dealing with rising labor costs. PulteGroup (PHM -2.66%) reported earnings recently, and profits were down 23% on a 5.5% revenue decline. On its earnings call, PulteGroup management mentioned restraints on the available labor pool for construction numerous times as a key constraint to the company's efforts. The third-largest homebuilder in the U.S., PulteGroup reported its backlog of new home orders grew 13% in the quarter, similar to the 12% increase in backlog units that Meritage reported. 

What management said 
CEO Steve Hilton started his earnings call comments making it clear that he sees the market for new homes is still strong, and likely to remain so:

Market conditions remained generally positive through most of the third quarter. Job growth is still strong, household formations are up, interest rates remain low, and the inventory of homes for sale is tight. So pent-up demand for housing units has remained largely unmet. 

Hilton also addressed the pressures on the company's margins and profitability:

Rising construction costs driven by labor shortages have pressured our home closing gross margin this year, which was 19% for the third quarter. However, we expect to see our margins increase over the next 12-18 months as we improve the margins in our East region, made up primarily of new markets we have entered in recent years, which have not yet achieved anticipated operating efficiencies.

While it should be expected that management would have a relatively upbeat view, the data seems to back it up. Macroeconomic conditions are largely positive across the markets where Meritage operates, with the biggest pressures on the business being weather and labor challenges, which should be short-term in nature, as well as some rising real-estate prices, which the company should be able to recoup in the sale price of completed homes.

Looking ahead 
Meritage continues to report strong sales growth and gains in average selling price, but the impact of extreme weather, and a serious labor shortfall across the industry, are weighing on short-term profits. In summary, there are likely to remain some short-term pressures on the business, but the big picture and longer-term outlook are strong.

There aren't enough new homes being built. There's plenty of demand. A relatively steady economic and employment picture should support steady returns in the years ahead.