Anytime a company posts a 75% increase in earnings per share, investors have to sit up and pay attention -- at least a little bit. This past quarter, homebuilder M/I Homes (MHO -1.74%) did just that on the back of strong sales, higher home prices, and a lower federal tax rate. These kinds of results and M/I Homes' low valuation metrics might have you wondering whether the market is overlooking this stock.
So let's look at M/I Home's most recent results and try to figure out whether they give this homebuilder investment potential.
A row of M/I townhouses. Image source: M/I Homes.
By the numbers
| Metric | Q2 2018 | Q1 2018 | Q2 2017 |
|---|---|---|---|
| Revenue | $558.1 million | $437.8 million | $456.9 million |
| Operating income | $38.5 million | $31.1 million | $28.9 million |
| Net income | $27.9 million | $18.0 million | $15.8 million |
| Diluted EPS | $0.96 | $0.60 | $0.55 |
Data source: M/I Homes earnings release. EPS = earnings per share.
M/I's second-quarter sales and revenue numbers were impressive. The company grew revenue by 22% from a 16% increase in homes delivered and a higher average price per home delivered. Even more important, though, was that new contracts were up 17% to 1,631 at the end of the quarter, and net new contracts outpaced deliveries by 16%. New orders growing faster than deliveries is always a good sign.
Data source: M/I Homes earnings release. Chart by author.
What continue to be concerning from an investment perspective are the low margins that M/I Homes continues to post. Selling, general, and administrative costs were 12.6% of revenue, and pre-tax operating margins were a paltry 6%. Compared to other homebuilders that have reported recently, that number stands out -- and not in a good way.
| Company | Q2 2018 Pre-Tax Income Margin |
|---|---|
| M/I Homes | 6% |
| NVR | 13.8% |
| Lennar | 7.2% |
| KB Home | 7.1% |
Data source: Company press releases.
The only explanation that can justify these lower margins is that the company is investing heavily in new developments to grow sales, and that its high revenue growth rates prove that this is the right idea. But revenue growth at the other companies on this list isn't that far behind, so M/I Home's isn't exactly unique with this sales growth trend.
What management had to say
As part of his press release statement, CEO Robert Schottenstein gave a quick overview of the company's successes in the quarter and some hint at what is to come for the rest of the year.
Our second-quarter new contracts of 1,631 increased 17% over last year, and despite margin pressures, our pre-tax income for the second quarter increased to $33.5 million. The increase in pre-tax income, combined with a significantly lower tax rate and improved operating expense leverage, resulted in a dramatic increase in net income to common shareholders from $15.8 million in last year's second quarter to $27.9 million.
We ended the quarter with record-high shareholders' equity of $816 million, an increase of 18% from 2017's second quarter, book value per share of $28.56, and a homebuilding debt to capital ratio of 47%. With the strength of our backlog and planned new community openings, we are positioned to have a very good 2018.
Riding the tailwinds of a strong housing market
It's hard to deny that M/I Homes had a good quarter. For investors, though, the challenge is separating good business performance from favorable market trends. In the case of M/I Homes, it looks like most of these gains are from a robust housing market, as evidenced by its low margins.
One thing that stands out, in particular, is the underperformance of its Mid-Atlantic division. It has operations in only three metro areas in this particular area, and sales have been declining in this region for some time. Unless it can turn things around in the region, it may be in M/I Homes' best interest to sell its stake there to a developer with significant Mid-Atlantic operations, and focus on the two markets in which it performs best.
Aside from the low valuation that the market has assigned M/I Homes (it trades for 11 times earnings and is the only homebuilder trading for less than its book value), there aren't a whole lot of reasons to get excited about this stock. Sure, you might be able to capture some of the gains from the rising housing market, but there are plenty of other companies in this industry that let you ride those same trends, and some of them are much better positioned than M/I Homes.
