The major fortunes in America have been made in land. – John D. Rockefeller
Residential real estate has emerged as a brighter trend during the pandemic as many people who are stuck at home decide they want a different home. Homebuilders are capitalizing on that trend, booking orders for new homes at a record pace. I looked across the homebuilders and found one attractive way to benefit from this trend is to buy M/I Homes, Inc. (NYSE:MHO).
M/I Homes, Inc. builds single-family homes in 10 states and 15 markets, including Houston, Dallas Fort Worth, Austin, Charlotte, Orlando, Raleigh, Tampa, Minneapolis, San Antonio, and Indianapolis. The company is in the top five builders in seven markets and the top 10 in 11 markets. MHO earns additional revenues from buying undeveloped land to develop and by originating and selling mortgages.
Trends in MHO’s markets are currently extremely favorable. Consumers spending more time at home are looking for larger homes. According to a Redfin survey from July, 21 percent of buyers want more space to work from home, and 21 percent want more outdoor or recreational space. Also, mortgage rates are at historic lows, as shown in the chart below, allowing consumers to increase loan sizes to afford larger homes.
MHO is capitalizing on these positive trends. For the third quarter of 2020, new contracts of 2,949 rose 71 percent higher than the same quarter in the prior year. Backlog of 4,503 homes in September 2020 is up sharply from 2,915 at the end of September 2019. Homes delivered during the first nine months of the current year have already surpassed the amount delivered over twelve months in 2019.
Source: Company materials
Strong fundamentals drove a record high quarterly revenue in the third quarter for MHO of $848 million, up 30% year over year. Pre-tax income of $95 million also notched a record quarter and almost doubled the prior year’s quarter. MHO continues to translate positive fundamentals to the bottom line as profit margins continue to climb, as shown below.
I expect residential real estate trends to continue to benefit MHO post-vaccine as people are expected to spend more time working from home than did so pre-pandemic, driving continued demand for larger houses. Also, the Federal Reserve’s commitment to keep rates low for the foreseeable future will help keep mortgages affordable. As such, while earnings for 2021 and 2022 will likely be below 2020 levels, both are expected to top 2019 levels with estimates shown in the chart below.
MHO stock remains reasonably priced, given an improved outlook. Looking at the stock’s PE ratio over the past five years, as shown below, multiples were closer to 12-16 times in prior years, though, more recently, have fluctuated closer to 8 times. The current PE ratio of 6.8 times is attractive, given demand for the products is stronger than ever. Year to date, MHO’s stock is up only 7% compared to a 21% rise in the S&P 500 over the same period.
Risks to ownership
- If regions within the United States shut down to slow virus spread, sales activity could slow for MHO. However, it seems unlikely shutdowns will revert to as broad of levels as we saw in the spring. Partially offsetting, MHO has undertaken actions to adapt, including virtual appointments and hygiene protocols.
- Prolonged unemployment and lack of further fiscal stimulus could hurt consumer’s abilities to buy new homes. Ideally, we will eventually receive additional fiscal stimulus and, in the meantime, accommodate monetary stimulus does support consumer spending.
Demand for MHO homes is at records highs, as measured by metrics, including new contracts and backlog. These positive fundamentals will continue to propel the company’s earnings higher, and with a reasonable PE valuation, the current stock price offers an attractive opportunity to buy in now and reap gains later as higher earnings result in price gains.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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