MHO - M/I Homes: Shows Financial Strength Through Its Diversified Offerings

2023-03-17 05:37:33 ET

Summary

• M/I Homes shows market-resisting strength through its diversified customer base, increasing market share, and focus on affordability.
• M/I Homes FY2022 revenue increased by 10% YoY to $4.13 billion, improved profit margin of 12%, strong balance sheet, and ROE of 27%.
• Cautious of a double-digit decrease in new contracts, backlog, continued interest rate hikes, and macroeconomic uncertainty.

Amidst challenging market conditions, M/I Homes, Inc. ( MHO ), a small-cap real estate stock with a market cap of $1.6 billion, has reported record revenue, income and solid returns for its full year of 2022. Over the last five years, it has rewarded investors with returns of 83.44%.

We are seeing an improving top and bottom line, a strong balance sheet and an attractively low price-to-earnings ratio of 5.08. Furthermore, although the recent banking instability has created some uncertainty, builder sentiment has increased for the last three months . MHO has indicated improving demand and sales numbers for January 2023. Most noteworthy, MHO is one of the building stocks focused on much-needed affordable and quick housing solutions, with housing options starting from $200,000 . Although cautious of the double-digit decrease in new contracts and backlog, I remain bullish on the stock with a long-term outlook.

Company overview and industry sentiment

MHO is one of the more prominent USA homebuilders offering homes between $200,000 to $800,000, which attracts an extensive range of consumers. It offers high design, quick and affordable solutions with online and offline purchasing opportunities which is leading to quicker sales cycles.

58% of sales in Q4 2022 were to first-time buyers, an increase of 5% YoY. In FY 2022, MHO delivered 8,366 homes across 16 markets. The average sales price was $479,000 for dwellings provided and $541,000 for homes in backlog. The company has produced solid financial results against challenging market conditions.

MHO generates 98% of its revenue through homebuilding, primarily in planned development communities and mixed-use communities, broken up into Northern and Southern segments. A minor part of the revenue is generated through its financial services by selling mortgages, insurance and home-related services. MHO has increased its total revenue YoY by 10% and improved its gross margin to 12%, as shown below. This is primarily due to an increase in average home price, which resulted from a growing consumer demand up to early 2022, later offset by the macroeconomic environment decreasing demand.

While revenue increased, we cannot ignore that in line with the challenging market conditions, new contracts for Northern decreased by 25% to 2,747 in 2022, and backlog decreased by 44% to 1,056. In the Southern region, new contracts fell by 28% to 3,921, and backlog decreased by 29% to 2,081. The reduced backlog has been majorly impacted by increased YoY cancellations due to rising mortgage rates, increasing costs and buyers becoming more cautious as the market uncertainty increases.

The downward trending demand numbers are unsettling, and we should remain cautious. However, the management team signalled demand and sales improvement as of late Q4 2022 going into 2023 in models and online, with 633 homes sold in January 2023. As shown in the graph below for January, February and most recently, March, builder sentiment has improved by a further two points to 44. The general understanding is that it is considered positive if the number is above 50.

Earnings overview and valuation

Although we can see a significant drop in demand in 2022 regarding new contracts onboarded, decreasing backlog and increasing cancellations. MHO has posted strong financial results, improving its top and bottom-line performance. The company generated $4.13 billion in revenue for FY 2022, an increase of 10%, net income increased by 24% to $490.7 million, the profit margin increased to 12%, and EPS rose from $13.64 in FY2021 to $17.60 for FY2022.

We can see that homes delivered decreased from 8,638 to 8,366. However, we see a positive upward long-term trending performance across critical financial performance indicators.

MHO has a strong balance sheet with a cash balance of over $300 million, it has zero borrowings under its $650 million credit facility, and a debt-to-capital ratio of 25%. Year end it had homebuilding inventory of 2.8 billion, an increase of 400 million and homes under construction was 4,700, including backlog and inventory homes, which is a decrease of 12% YoY.

MHO is currently rated as a Strong Buy on Yahoo Finance with a one-year target price estimate of $73, which is well above its current stock price. I have compared MHO to the three largest home-building companies in the USA through Seeking Alpha's Quant rating system. Although its peers provide a dividend program, the dividends all have a rating of D through the Quant system. MHO's stock has outperformed its peers over the last six months and three years regarding price returns. If I compare its valuation to my previous article, the stock has fared better than its peers over the last five months.

MHO has an attractive valuation compared to its larger peers with a low forward price-to-earnings ratio of 5.15, and if we include growth, we can see that it has a PEG of 0.11, which is lower than all its peers besides PHM at a ratio of 0.10. Furthermore, the price-to-book ratio is under one at 0.76, indicating that the stock may be undervalued and worth buying.

Risks

The housing market is still far from recovering, and experts have mixed reviews regarding whether the market will slowly recover halfway through 2023 or whether we could see another collapse as mortgage rates remain high. The recent banking instability has increased market uncertainty, and therefore we should remain cautious when investing in market-sensitive industries such as the housing industry. However, one of MHO's strengths is that it caters to diverse customers who fall within a pressing homebuying demographic across a wide range of areas. Another risk is that some of its key markets are in geographical locations impacted by severe weather conditions, which can delay, increase costs and significantly affect the predicted performance of the business.

Final thoughts

MHO delivered solid financial results in 2022 amidst challenging market conditions. While we remain cautious of the double-digit decrease in new contracts and backlog, the management team has seen demand show some improvement end of Q4 2022, going into 2023, irrespective of high-interest rates. I remain bullish on this stock with a strong balance sheet, increasing top and bottom line performance and a diverse range of offerings at affordable rates across the country.

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