Is $MTH Still a Good Buy?

Federal Reserve Chair Jerome Powell told investors on Friday "time has come for policy to adjust."

In response, stocks finished the week near record highs. The $S&P 500(.SPX)$, $NASDAQ(.IXIC)$, $DJIA(.DJI)$ all rose more than 1% on the week. The S&P 500 is now within 1% of a record closing high. The best-performing concepts is Homebuilding.

Considering the different perceptions of the stock, this time TigerPicks chose $Meritage Homes(MTH)$ to have a fundamental highlight to help users understand it better.

$Meritage Homes(MTH)$

Meritage Homes Corporation, together with its subsidiaries, designs and builds single-family attached and detached homes in the United States. The company operates through two segments, Homebuilding and Financial Services.

It acquires and develops land; and constructs, markets, and sells homes for entry-level and first move-up buyers. The company also offers title and escrow, mortgage, insurance, and closing/settlement services to its homebuyers.

Meritage Homes Corporation previously (May 2024) was given a buy rating as there were no signs of demand weakness, and pricing also remained high above the historical average.

We still give a buy rating for MTH as the macro situation and demand outlook are favorable towards MTH. Although rates are likely to be cut in 2H24, MTH's focus on building move-in-ready inventories and its ability to step up on incentives should sustain demand.

Demand strength continues

MTH reported a strong EPS beat, the strength behind the beat was driven from the top of the P&L, where orders and absorption rose 14% and 15%, respectively, leading to revenue growth of 8.2%. Combined with a strong margin performance, where gross margin expanded by 190 bps, which led to a core EBIT margin expansion of ~200 bps, EBIT grew by ~21%.

Demand momentum remains strong for MTH, and the results speak for themselves. The monthly sales pace continues to stay at a very healthy level of 4.5 per month in all regions. With the conversion ratio sustaining at 136% (1Q24 was 138%), this suggests that the new supply of home inventories is quickly being converted into sales.

This is crucial because it shows that there is strong demand for MTH quick move-in inventory, and so long as MTH can keep churning out such inventories, it can still compete effectively against resale homes (there has been a slight tick up in resale inventory over the past few months). My opinion is that resale homes allow homebuyers to move in quicker, so if MTH is able to release more quick move-in inventory, it is able to level the playing field against resale inventories.

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As such, We wouldn’t see the increase in supply of resale homes as a big threat to MTH's near-term earnings outlook. In fact, if we look at the chart over a 20-year period, the current level of inventories is still very low relative to history. Major macro indicators continue to be in favor of MTH (i.e., demand for MTH new home builds). For instance, (1) existing home prices surged to a new high in June; (2) mortgage rates remain near 7%; and (3) the housing affordability index continues to be low.

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Points (1) and (2) push homebuyers to seek new homes because there is simply a lack of existing home supply. In order to address the need for quick move-in and affordability, MTH has stepped up its focus on building move-in-ready homes and also using incentives to sustain volumes. The point of having the capacity to offer incentives should be well noted because it means that MTH still has a strong lever to pull to sustain demand. MTH certainly has the balance sheet to support this, as it has no maturities until 2027 and has just recently issued a $575 million convertible debt.

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Margin upside potential

The common narrative when mortgage rates fall is that it is a super negative for MTH because existing home supply will come back online, which impacts demand for its home inventories. There is truth to a certain extent, but I note a few things.

Firstly, mortgage rates are unlikely to fall sharply back to below 4% (which is the rate that most existing home owners have financed their home at). Secondly, even when rates start to fall, existing home prices are still extremely high.

On the other hand, lower interest rates in the near term is actually positive for MTH’s margin because the incentives provided will come at a lower cost. MTH could either reinvest this cost savings to step up incentives (to sustain demand) or let it flow through the P&L to drive up margins.

What could also drive up margins is further improvement in cycle times. Cycle times have continued to improve, now touching 130 days (vs. 140 days in 1Q24). Historically, MTH cycle times run at ~120 days, which means there is still room for improvement. Faster cycle times indicate higher margin potential because of fixed cost leverage (labor costs are fixed).

All in all, considering these factors, I see potential for MTH to beat 3Q24 gross margin guidance of 24.75% at the midpoint (a step down from 2Q24 of 26.3%).

Valuation

While MTH has traded up to 9.5x forward PE, above my previous expectation for it to trade at least in line with its historical average of ~8x forward PE, We don’t think the stock is trading at an expensive level yet.

In fact, removing the COVID period (where multiples traded down to ~3x forward PE), MTH's current valuation is just in line with its historical average. The current macro situation and demand outlook are a lot more favorable than pre-covid (where rates were 0% and existing home inventories were high); hence, I think it is justifiable for it to trade at this level.

Risk

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Lumber prices have surged sharply in the past few weeks, likely because of the typical home building season in summer and spring. If lumber prices continue to surge throughout the remainder of this year, it could deeply impact margins, as management guidance expects flat lumber prices.

Conclusion

We give a buy rating for MTH as 2Q24 results continue to be very positive, reinforcing my bullish stance. MTH’s strategic focus on building move-in-ready inventories and its ability to provide incentives have helped in sustaining demand.

The macro environment is still a positive for MTH, so there should be no issues for it to achieve FY24 guidance easily. Improving cycle times and potential cost savings from lower interest rates could also potentially lead it to beat its 3Q24/FY24 guidance.

Stock Price Forecast:

Here are the target price forecasts for the next 12 months from analysts.

Based on 10 Wall Street analysts offering 12 month price targets for Meritage in the last 3 months. The average price target is $211.13 with a high forecast of $257.00 and a low forecast of $153.00. The average price target represents a 2.52% change from the last price of $205.94.

Resource:

https://seekingalpha.com/article/4707931-meritage-homes-corporation-staying-buy-rated-as-demand-outlook-remains-positive

What are your thoughts on $Meritage Homes(MTH)$ ?