It looks like someone forgot to tell LGI Homes' (NASDAQ:LGIH) management team that housing starts were down in the third quarter because the company produced another record-setting quarter. On just about every metric that matters for homebuilders -- closings, backlog, new orders, average selling price -- LGI showed improvements.
There are two reasons for these outstanding results today. Let's take a look at them and the company's most recent quarter.
By the numbers
|Metric||Q3 2017||Q2 2017||Q3 2016|
|Revenue||$365.9 million||$324.2 million||$216.3 million|
|Operating income||$50.4 million||$48.5 million||$29.1 million|
|Net income||$33.7 million||$32.2 million||$19.5 million|
It's hard to find fault with any of the numbers LGI posted this past quarter. The 69% growth in revenue came from a 64% increase in total home closings for the quarter. In Q3, the company logged 1,729 total closings, the bulk of which came from its central region (Texas) division. It also helped that the average selling price increased 2.9% to $211,623, mostly from favorable market environments in its various markets.
From the operations side of things, LGI delivered some encouraging results as well. Net orders increased 49% to 4,883 and gave the company a backlog of $308 million at the end of the quarter. The slightly discouraging items in this report are that costs ticked up and gross margins slipped 120 basis points to 25.1% and that its cancellation rate increased 40 basis points to 24.1%. These changes are small enough that they didn't have much of an impact on overall results.
In fact, this quarter's results were strong enough that management raised its guidance for the second quarter in a row. LGI Homes now expects full-year earnings per share to come in between $4.75 and $5.15 per share.
Over the past quarter, housing starts in the U.S. averaged 1.175 million per month. That's still below the historical average rate in the United States, but the number has been steadily on the rise since the bottom of the housing market in 2009. So a lot of LHI's results are a reflection of an improving housing market. In fact, it's hard to find a homebuilder that's not posting outstanding results these days. That said, few companies are posting the revenue and income growth numbers as LGI has in recent years.
We could simply say that LGI is working from a smaller base than the rest of the companies here, which makes growth numbers like that easier to come by, but there are others that have allowed the company to achieve spectacular growth. One is that it has a presence in five of the 10 fastest-growing real estate markets in the U.S. today -- Denver, Portland, Orlando, Seattle, and Nashville -- and has a large concentration in Texas, where real estate growth has outpaced the national average for close to 10 years straight. Considering how much smaller LGI is than many of its peers, having a presence in all these markets is commendable.
Another aspect that is contributing to LGI's growth is its target market: first-time buyers. LGI Homes' offerings today are well suited for the millennial generation that is entering the housing market in droves. About 42% of new homebuyers are in the 18- to 34-year-old age cohort, which means the bulk of them are going into their first homes. LGI's lower selling prices and zero-down payment options make homeownership more accessible for the younger buyer.
What management had to say
After another highly successful quarter, CEO Eric Lipar highlighted the success LGI had filling its development communities and provided the company's updated 2017 guidance.
With a record-setting 1,729 home closings during the third quarter, we continued our trend of strong results and profitability highlighted by above average absorption of 7.6 closings per community per month. These results are a direct reflection of the dedication of our employees and our effective systems and processes that have enabled us to expand and replicate our success.
Based on our solid results during the first nine months of the year, we are well positioned to end the year very strong and are therefore raising our guidance. For the full year 2017, we now anticipate to close more than 5,400 homes and believe basic EPS will be in the range of $4.75 to $5.15 per basic share.
What a Fool believes
LGI Homes' business is hitting the sweet spot in the housing market today by targeting younger buyers in the most desirable real estate markets with more affordable entry-level homes. After almost a decade of lower-than-average housing starts in the U.S., it's clear that there is pent-up demand that could fuel LGI's growth for a while.
The one question that you have to ask when it comes to LGI is, "What happens when tougher times hit?" The company says that its communities are slightly outside the major cities, which were some of the places hit the hardest when the housing market hit last time. Also, courting customers with zero down payments likely means LGI's customers may not have as strong of a credit profile as someone who is moving up from an existing home or can make a down payment. As long as the music keeps playing, LGI is probably going to do incredibly well, but it's not hard to see this company struggling if the market turns.