LEGH - Legacy Housing: Still Among The Best Despite Industry Headwinds

2023-05-18 08:27:26 ET

Summary

• Legacy Housing recently reported Q1 2023 results that have revealed the company is not immune to the housing crisis.
• Legacy Housing's top-line, alongside those of its peers, has declined markedly as high home prices, high mortgage rates and a weak economy take their toll.
• Long-term investors should wait for the company's next report and check whether the industry will have started recovering from its slump.

A couple of years ago, I gained serious interest in the global energy transition since it was becoming evident that this was another secular megatrend that would be around for decades. I started by looking at the obvious candidates including wind, solar, hydropower, geothermal sectors before later delving into niches like hydrogen, ammonia, synthetic fuels, carbon capture , nuclear fusion/fission and, more recently, tiny homes. Although my interest in tiny homes was initially triggered by the ecological aspect (I first realized they had become a thing thanks to reality TV show Tiny House Nation ), the deepening American housing crisis has brought the sector into sharp focus. I have been following tiny home builder stocks and have found that Legacy Housing Corp. ( LEGH ) and Skyline Champion Corp . (NYSE: SKY ) tick a lot of the right boxes for a long-term investor. I have kept both companies on my radar for more than a year, and have decided to look further into Legacy Housing because it recently returned its quarterly scorecard which gives some useful insights into the state of the industry.

Legacy Housing is a builder of mobile homes, and the fifth largest producer of manufactured homes in the United States with current operations focused primarily in the southern part of the country. The company’s homes range in size from ~395 to 2,667 square feet consisting of 1 to 5 bedrooms while prices range from ~$33,000 to $180,000.

On the business side of things, Legacy Housing has a pretty good track record of steady and consistent growth. Over the past three years, the company has delivered revenue growth of 14.9% CAGR; EBITDA has grown at 21.0% CAGR while EPS has expanded at 21.1% CAGR. Meanwhile, LEGH shares have nearly doubled since it went public in 2018 for a decent 14.2% annualized return. Of its peers, only Skyline Champion tops those numbers , including 19.6% annualized share return over the timeframe. In its defense, Legacy Housing’s founders and management seem to be excellent capital stewards: During the company’s latest earnings call, Legacy Housing President and Chief Executive Officer Duncan Bates revealed that the business was started with less than $10 million and has managed to grow into a $550 million market cap company in the space of 18 years, thereby delivering an impressive >25% CAGR capital growth.

However, the latest earnings report has made me revisit my bull thesis.

Last week, Legacy Housing reported Q1 net revenue of $52.9M, good for a 11.7% Y/Y contraction and $9.93M less than the Wall Street consensus while product revenue (revenue generated from actual sale of houses, the rest comes from the company’s financing business) decreased to $43.3 million or 16.4%Y/Y. The company does not divulge information on number of units sold or ASPs (Average Selling Prices). However, the company revealed that shipments have been improving as the months roll on but remain well below 2022 numbers. GAAP EPS of $0.65 was in-line with expectations; basic earnings per share was $0.67, a 1.0% Y/Y increase, income from operations for the first quarter clocked in at $18.4 million, a 0.5% Y/Y increase while Q1 net income came in at $16.3 million, good for 1.1% Y/Y growth. Meanwhile, book value for the quarter was $397.9 million, representing 4.1%Y/Y growth while book value per share was $16.32, good for a 4.0% Y/Y increase.

You will notice that Legacy Housing managed to keep its income and margins steady despite the large double-digit revenue decline, thanks in large part to the company’s integrated business model as well as the flexibility to cut costs. Indeed, Legacy Housing’s management said that whereas the company’s top focus remains on sales, it’s also looking at ways to reduce SG&A and warranty costs. Last quarter, the company was able to lower selling, general, and administrative expenses by an impressive 29.3% to $5.4M.

But let’s first investigate and find out why this company is experiencing revenue contraction in the first place after 15 consecutive quarters of top-line growth.

Legacy Housing Corp. Revenue Growth

Housing Affordability Hits Record Lows

During the company’s earnings call, Bates told shareholders that the big revenue decline ‘‘… primarily resulted from a reduction in shipments across all three plants. Also, we did not convert any independent dealer consignment agreements to floor plan financing agreements during this quarter, as we did most quarters last year.’’

In other words, demand for the company’s houses has suddenly plummeted with Bates pointing out that the manufactured housing industry has slowed. Although Legacy Housing’s management did not provide Q2 2023 or FY 2023 guidance, Wall Street estimates the company’s full-year revenue will fall 10.8% to $229.2M.

We can glean some useful insights into the general health of the industry by looking at Legacy Housing’s peers. Two of the company’s closest peers, Skyline Champion and Cavco Industries, Inc. (CVCO), are yet to report results for the March quarter; however, both companies are expected to record revenue declines in the current fiscal year to the tune of 13.6% and 2.3% Y/Y, respectively. Both companies sell manufactured homes with ASPs below $200,000.

The latest results from Legacy Housing’s bigger peers have so far been mixed, but the full-year outlook appears murky across the board.

Landsea Homes Corporation (NASDAQ: LSEA ) reported a huge 18.9% Y/Y revenue contraction for Q1 2023 and also issued weak FY 2023 guidance that points to a massive 27.9% revenue decline at the mid-point of its guidance range. Landsea sells suburban and urban single-family detached and attached homes with home sizes spanning from 1,706 to 3,427 square feet and ASPs above $500K last quarter.

Beazer Homes USA, Inc. (NYSE: BZH ) reported FQ2 revenue of $543.91M (+7.0% Y/Y). However, net income from continuing operations clocked in at $34.7 million, or $1.13 per diluted share, compared to net income from continuing operations of $44.7 million, or $1.45 per diluted share, in fiscal second quarter 2022. EBITDA of $62.1 million was down 19.7% while homebuilding gross margin was 18.7%, down 480 basis points. Beazer Homes has recorded revenue contraction in 3 out of the last 5 quarters, with full year FY 2023 expected to fall 10% to $2.1B, the first annual revenue decline since 2019.

Dream Finders Homes, Inc. (NYSE: DFH ) actually reported solid quarterly results. Q1 2023 revenue clocked in at $767M (+15.9% Y/Y) while net income attributable to DFH increased 12% to $49 million, or $0.49 per basic share. Even more impressive, the company increased ASPs by 4% to $490,553 from $470,218, usually a sign of strong demand and good pricing power (Legacy Housing last increased ASPs in June 2022). Unfortunately, that outperformance is not likely to be repeated, with DFH expected to record a 14.8% drop in annual revenue to $2.9B for the current year. Dream Finders sells single-family entry-level, and first-time and second time move-up homes with sizes ranging from 1,388 to 4,431 square feet and ASP above $400K.

The residential housing industry is going through one of its roughest patches in recent times. According to technology-powered real estate company Redfin, housing affordability in the United States has hit all-time lows, leading to a massive decline in home sales. Redfin has reported that the percentage of affordable homes for the typical household in 2022 was down to one in five from two in five in 2021. Affordable listings fell 53% from a year earlier in 2022, marking the largest annual drop in the company’s records thanks to higher mortgage rates making listings less affordable (A listing is considered affordable if the monthly mortgage payment does not exceed 30% of the local county’s median income).

Mortgage rates have more than doubled from the all-time low of 2.65% in 2021. Low mortgage rates during the pandemic fueled the COVID-19 pandemic homebuying boom , which in turn led to surging home prices. Although home prices are not increasing at the blistering clip they did a few years back, they still remain elevated: the median home sales price in Q1 2023 was $436,800, less than a 1% increase from a year ago but 32% higher from 2020. Meanwhile, whereas the housing market has slowed significantly, home prices continue being propped up by low supply especially for the non-luxury category. With high mortgage rates, many homeowners have been unwilling to sell because it would mean giving up their relatively low rates.

A combination of high home prices, elevated mortgage rates, a frail economy and ongoing inflation has contributed to the housing crisis.

*Luxury homes are those in the top 5% based on market value while non luxury homes are those estimated to be in the 35th-65th percentile.

Unfortunately, judging by the latest set of results by these companies, these negative trends have infiltrated the low-end of the manufactured housing market which companies like Legacy Housing serve.

Thankfully, it’s not all doom and gloom.

About half of Legacy Housing’s business involves selling through dealers to retail customers while the other half involves selling homes directly at wholesale prices to community owners and developers aka regional entrepreneurs in Legacy Housing’s parlance. Whereas business on the retail side has dwindled, a lot of developers who have been in the industry for a long time and are familiar with boom and bust cycles have now started deploying capital, a trend that is likely to gain momentum as the quarters roll on.

Even better, just like CPI inflation fell below 5% in April for the first time since June 2021, mortgage rates appear to have hit an inflection point and are beginning to edge lower. Last week, the average 30-year fixed rate mortgage fell from 6.39% on May 4 to 6.35% on May 11, marking the second consecutive week of declines.

“ While inflation remains elevated, its rate of growth has moderated and is expected to decelerate over the remainder of 2023. This should bode well for the trajectory of mortgage rates over the long-term,” Sam Khater, Freddie Mac’s chief economist, has said.

With U.S. Recession Probability currently at 68.22%, compared to 57.77% last month and 3.71% last year, it’s possible we’ve already hit the peak of this rate cycle. Of course, interest rates are notoriously fickle and could change trajectory at the drop of a hat. However, I’m willing to wager that they are quite unlikely to tick up to the March peak of 6.73% and rates will either continue to drop or at least moderate.

We’ve still got a month and a half left of the spring homebuying season with March through June typically the busiest time of year. Long-term investors should probably wait for Legacy Housing’s report for the June quarter before pulling the trigger on this one, though the shares don’t seem to have a lot of downside that would give a more favorable entry point.

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