An Improving Homebuilder's Shares Look Cheap

I haven't found a lot to like about homebuilder stocks over the last several months. That's pretty unfortunate for me, because many of these companies have had quite a run. As tracked by the Homebuilders SPDR (NYSE: XHB) ETF, the sector has actually put in about a 30% gain since the beginning of September. With home prices still falling in most major cities, and an overabundance of housing inventory, I have remained bearish on the sector. My Foolish colleague Morgan Housel also expects home prices to stay flat or fall this year.

We can credit some of the homebuilder bounce to the low bar set for these beaten-down stocks. Already this year, KB Home (NYSE: KBH) and Lennar (NYSE: LEN) have walloped Wall Street analysts' low expectations. Last month, Toll Brothers (NYSE: TOL) even reported a quarterly gain after 11 straight losses. However, while others want to cheer more homebuilding, I believe that less is more with regard to improving the dreadful housing market. Sure, more homebuilding will create job opportunities, but I don't believe building more houses in an already oversaturated market will help raise prices.

Whatever my opinion, the trend in homebuilder stocks is clearly upward. Instead of fighting it, I screened the entire sector for cheap ways to invest. Surprisingly, I found one stock that has enjoyed some of the sector's price appreciation, remains relatively cheap, and provides a nice margin of safety should the rally fizzle.

Strength in the Midwest
Based in Columbus, Ohio, M/I Homes (NYSE: MHO) builds and sells single-family homes mainly throughout the Midwest, and in the Mid-Atlantic, Florida, and now Texas. Just as with its competitors, the last couple of years have been about survival for the company, but its competitive position as the leader in the Midwest region has helped the company draw whatever buyers remained during the recession.

Its financial performance and balance sheet are also on the upswing, even though the sales environment is has been anything but robust. In the company's most recent quarter, it posted a loss of only $2.1 million or $0.07 per share. That beat analysts' expectations, and it was also a huge improvement from the prior-year period, in which the company's $21.1 million loss worked out to $1.14 per share. This past quarter, M/I Homes also impressively managed to increase its operating margin to 18.1% -- its highest level in three years.

While I believe that M/I Homes is outperforming many of its peers, it's also trading below its net tangible asset value, which discounts its stock significantly to many of these same peers.

While the $16.92 NTA value does not necessarily represent a floor for the stock, as the stock has dipped well below that number in recent months, trading at below net tangible asset value prices in a housing market with no future growth. At this valuation, I can begin to get comfortable with holding the stock, especially as it continues to enhance its reputation in its non-core markets.

More than just value
On the company's recent conference call, CEO Robert Schottenstein said that the Midwest market is actually becoming less competitive. Many of M/I's competitors have gone out of business, or simply exited the market. This bodes well for M/I Homes, which can further build upon its leading market share in the region.

In addition, the company also recently received its highest J.D. Power rankings ever in terms of home quality and customer satisfaction in its markets. The homebuilder ranked first in both of these categories even in Washington D.C., one of the most competitive markets in the country.

In addition, there were only two analysts on this conference call, so the company still flies under most of Wall Street's radar. That creates a good opportunity for astute investors, should the company begin to show signs of growth again.

In my opinion, investing in homebuilders at this stage of the housing "recovery" is all about finding value. At current prices, it's tough to get excited about the majority of these stocks. M/I Homes is intriguing because of its leadership in the Midwest region, its operating improvement, and a valuation that provides some margin of safety for investors.  I don't believe that now is the time to jump aboard the homebuilder train, but on a pullback, M/I Homes might be a good place to look.