Here's How This High-Growth Homebuilder Keeps Building Bigger Profits

Small homebuilder LGI Homes (LGIH -1.61%) has delivered well for investors, with shares up 60% so far this year due to record levels of demand for new homes. Home sales have grown by double digits every quarter, while orders surged an incredible 80% last quarter. On the Nov. 6 episode of "The Wrap" on Motley Fool Live, host Jason Hall and Motley Fool and Millionacres contributor Tyler Crowe discussed why LGI Homes should be able to continue growing its profits -- and helping deliver market-beating gains for investors -- for years to come. 

Transcript: 

Jason Hall: Let's shift over to home builders. You want to kick things off with LGI Homes? What happened?

Tyler Crowe: LGI Homes is probably one of the fastest growing home builders in America. They focus mostly on entry-level homes, low price. Their entire strategy is, let's get people who are currently renting into a home, where mortgage rates are comparable to rent rates in their areas. It's been a huge success for the past several years.

This has just been a continuation of that, where net sales, actually this quarter, were up, comparatively, to a lot of the other home builders who reported weren't up as much as you've seen for other ones. They were up 10% year-over-year to $534 million. But the real number for them was the increase in net income, which was actually up 80% to $89 million for the quarter. The big thing for them that was really surprising was that their average home sales price increased about 5.9%, which is considerably high for somebody who really tries to keep the price point low -- their average sales price was about $255,000 per home sold.

One of the things that I always follow when I talk about LGI Homes is gross margin. Being the low-cost seller, I guess you could call them, of the home builders. They have to be super cost conscious of what they're doing, and one of the things that was most surprising is they actually saw an increase in their gross margins to 25%. Home building is never going to be a huge high-margin business; there's a ton of labor involved, ton of capital tied up with land and stuff like that, so a gross margin of 25% is a really really good number.

Jason Hall: That's very, very good.

Tyler Crowe: Typically, you're seeing gross margins somewhere in the 18%-21% range, so 25% is really blowing it out of the water here.

Jason Hall: It's interesting. We saw some similar stuff, we'll talk about with some of the other companies we get into. But I think to me it says this is where their scale really pays off. When demand is this high, they're really just able to leverage having crews on the ground and just churn through houses. Also, it's part of their model. They're not building custom homes, they're building a lot of these homes on spec. They're following specific floor plans. They build them and they move on to the next one.

That helps, that can help their margins. Even if the average selling price is lower, it's good for margins. Tyler?

Tyler Crowe: Yeah. It's part of the reason why they've been able to grow so fast. There's still a ton of room for them to grow. Because if you look at them, they're home closings were about 2,000 in the quarter, which when you compare it to the big names in this industry like a DR Horton or a Lennar or somebody like that, it's not even close, it's maybe like 10%, 15% of total home sales on these big players.

Having that finger on the pulse of the low entry-level market and having an affordable option, that is what they're wholly focused on, it has really been a huge win for them and gives them a massive runway going forward. One of the things that's obviously going to be a little bit scary in the coming quarters, and we'll have to see how it plays out is labor and construction costs are going up. I shared a chart with you guys a little bit earlier showing lumber future prices right now, and they have just absolutely skyrocketed in the past several months. Whether that is some sort of combo of housing construction and a little bit of extra plywood being used for boarding up stuff lately, who knows? I can't really say if that's going to be some sort of speculative movement on lumber prices.

But if you really look at it, the truth is, lumber demand is going up. Lumber prices are really high right now, and it will be interesting to see if LGI Homes and all the other home builders are able to maintain margins when things like lumber prices really start to eat into them.

Jason Hall: So far, I think just the sheer volume has been enough to offset that. Plus demand, they've been able to raise prices. Then with interest rates falling, affordability has been still better in some ways. So it's interesting how this has played out. Any other big takeaways as far as how you see LGI right now and their prospects going forward?

Tyler Crowe: Well, one of the things that you always have to look at when you're talking about home builders is where they're building.

Obviously, one of the things that LGI Homes has focused very much on is Texas Southeast and the Southwest Arizona area. These have been their heart, their geographic core for a very long time, especially Texas.

Being in those particular markets, if you look at average population growth per state, the states that they are working in right now are some of the fastest growing right now, and so it gives the company a big runway in those particular markets. They don't even have to try to stretch themselves going into the Mid-Atlantic or somewhere else where it's a much more competitive market, and you start running up against these big players like DR Horton or something like that.