Top residential homebuilders have been outperforming expectations this earnings season, but the market has generally seemed unimpressed with their results. Few of their share prices have moved by more than a couple of percentage points in response to their reports, despite big year-over-year earnings gains and favorable market conditions for the foreseeable future.
So it was with M/I Homes (MHO -1.74%), which reported earnings last week that missed analysts' forecasts. Traders immediately sent the shares down by about 12%, but then, the stock price promptly began to rise again. By the end of the day, it was only down by about 1.8%.
Here's why investors decided to jump back into the homebuilder.
M/I Homes, a top Midwestern homebuilder, posted strong margins but underperformed the stock market's expectations. Image source: Getty Images.
By the numbers
| Metric | Q4 2019 | Q3 2019 | Q4 2018 | Change (YOY) |
|---|---|---|---|---|
| Revenue | $742.2 million | $653.3 million | $722.5 million | 2.7% |
| Net income | $41.8 million | $38.8 million | $32.4 million | 29% |
| Earnings per share (diluted) | $1.44 | $1.32 | $1.15 | 25.2% |
| New contracts | 1,677 | 1,721 | 1,173 | 42.9% |
| Homes delivered | 1,921 | 1,651 | 1,825 | 5.2% |
YOY = Year over year. Data Source: M/I Homes earnings releases. Chart by author.
Excluding some after-tax impairments, earnings per share came in at $1.57, which was still lower than the $1.68 per share that analysts had been predicting. However, other investors may have viewed the drop as a buying opportunity, considering net income and earnings both rose by more than 25% year over year.
M/I Homes reports fewer geographic divisions than most of its peers, dividing its sales into Northern and Southern regions. Northern includes the upper Midwest, primarily in big cities like Chicago, Minneapolis, and Cincinnati. The Southern region is more far-flung, including metropolitan areas in North and South Carolina, central Florida, and Texas. In terms of the number of deliveries, the Southern region is clearly outperforming its Northern counterpart.
Sales in the company's southern region shot up 12% over the prior-year quarter, while its northern region saw a 3% decline. Data source: M/I Homes earnings release. Chart by author.
Highlights from the quarter
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Many homebuilders have seen stronger sales growth in their lower-tier offerings, and M/I did too. The company's most affordably priced homes -- which it calls its Smart Series -- grew as a percentage of its overall sales to just over 25%. The percentage of Smart Series communities also grew. At the end of the quarter, M/I was offering Smart Series homes in just over 25% of its communities, compared to about 10% of communities at the end of Q4 2018. These homes comprised an even slightly higher than 25% of total sales. Management says the margins are good on these homes and expects to see further growth at this price point in 2020.
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The company saw strong growth in terms of both orders and sales in its four major Texas markets (Austin, Dallas/Fort Worth, Houston, and San Antonio), as well as in Charlotte and Minneapolis. Orlando, Tampa, Columbus, and Cincinnati were also cited during the Q4 earnings call as strong performers. Management reiterated its previously announced decision to exit the Washington, D.C., market, noting that as of the end of Q4, it had substantially ceased operations there, with "merely a handful of homes remaining to close in 2020."
- The average backlog sale price of $396,000 was 3% lower than a year ago, but adjusted gross margin improved 100 basis points to 19.9%.
What management had to say
In a statement, CEO Robert Schottenstein highlighted the homebuilder's impressive 2019 performance, which has driven the stock up by 46.9% over the past year:
"2019 was a banner year for M/I Homes with record revenue, record new contracts, record homes delivered and record pre-tax income. Revenue increased 9% to $2.5 billion, new contracts increased 16% to 6,773 homes, homes delivered increased 9% to 6,296 homes, and pre-tax income, aided by improved operating leverage, increased 18% to $166 million. The strong performance of many of our homebuilding divisions along with another very good year from our financial services business contributed to our record results. We also reached the highest year-end sales backlog in Company history with a value of $1.1 billion, an 18% increase over 2018.
...
Housing market conditions remain strong and, given the strength of our record backlog and our solid competitive position across each of our 15 markets, we are well positioned for a very good 2020."
Margins, Midwest, and markets
Overall, M/I Homes looks to be in a relatively strong position within its industry. Its adjusted gross margin of 19.9% is one of the best in the industry, although many homebuilders feature gross margins in the high teens.
Meanwhile, the Midwestern market is one of the weakest in the country, as evidenced by the company's year-over-year decline in sales in that region. However, the housing market in the South -- especially Florida -- is one of the strongest in the country. Other homebuilders have a better market mix working in their favor, but M/I's isn't particularly bad.
All this assumes, though, that the cyclical housing market -- already in its tenth straight year of growth -- continues to grow. Any hint of a potential recession -- however small -- is likely to send homebuilders' stocks downward, fast. Only those bullish on the housing market and the overall economy should consider buying into this industry now.
