Top-10 homebuilder Meritage Homes (NYSE:MTH) announced fourth-quarter and full-year financial results on Jan. 29, beating Wall Street estimates for net income by 15%, but coming up a little short on sales, with revenue less than 2% below estimates. Revenue and home closings grew strongly, but earnings per share was flat, and margins continued to fall.
Let's peel back the layers and take a look at the details. There are some good things happening, but also a couple of things investors should watch closely.
Growth in expanding markets, but concern in Texas
Meritage Homes has expanded its presence in Texas and the Southeastern U.S. over the past couple of years, a smart move as its business in the Western U.S. matures. The largest source of expansion has been in Texas so far, with the 713 homes sold in the state last quarter representing a 37% increase from 2013, and more than 38% of total homes sold.
The strong growth is good, but there is reason to be concerned about the impact of falling oil prices, especially in Houston, a key market for Meritage. CEO Steve Hilton, from the release:
While there is uncertainty surrounding the potential effects of lower oil prices on the energy industry and some housing markets like Houston, other industries and markets should benefit from lower energy prices. We are confident in our market position and believe there will be opportunities as the U.S. economy continues to grow despite a decline in a single industry.
In short, management is acknowledging the risk to one of its key markets, but sees falling oil prices as a net benefit for economic stimulus. Time will tell how this plays out.
Falling margins expected to improve in second half of 2015
Closing margin of 20.3% was down from 23% in 2013, but management expected some contraction. The reason is that 2013 saw some margin expansion based simply on market timing and price escalation in key markets like Southern California and Arizona. However, prices have stabilized, returning margins to more normal historical levels. The recent purchase of Legendary Homes is also having an impact on margins, and management said that will continue into early 2015 before improving in the second half of the year.
Growing backlog and properties, but also growing share count
Meritage entered 2015 with a backlog 23% higher than a year ago, and 20% more communities, both of which bode well for continued sales growth. The company continues to do a solid job of acquiring new properties -- and in some cases regional builders -- in order to continue future growth.
However, the share count also continues to increase:
Using secondary offerings as a source of capital isn't in and of itself a bad thing, as long as the return is greater than the cost of the dilution to shareholders. That wasn't the case last quarter, with the reported $1.19 in earnings per share exactly the same as the year before, even though total earnings grew 8%.
However, looking at the long-term trends, management has been able to grow earnings per share even with notable dilution in recent years:
The point? One or two quarters probably doesn't give us enough information to measure the impact of dilution, but over time we can get a better sense of the impact. The historical data says the capital raised does more good to shareholder returns than the impact of dilution does harm.
Management is being cautious with their outlook going forward, and expects margins to further compress early in the year, partly as a result of the Legendary Homes acquisition. However, they also expect to see improvement in the second half of the year, with full-year margins being similar to the 20.3% in Q4.
Based on the larger economic trends in the U.S of falling unemployment rates and improving wages, coupled with falling energy costs, there's a high probability that Meritage Homes' management will be right. The big question will be whether home sales grow enough to make up for the lower margins. Only time will tell.