2023-10-27 12:31:32 ET
Summary
- Tri Pointe Homes has been a beneficiary of the housing inventory shortage despite record mortgage rates.
- The company reported strong Q3 earnings with resilient home sales and a significant beat on top line and gross margins.
- TPH trades at an attractive valuation compared to its peers and has a strong earnings momentum and order backlog. Initiate at Buy.
Investment Thesis
We initiate Tri Pointe Homes ( TPH ) with a Buy rating driven by its strong outperformance amidst a challenging housing market as a result of its strong order backlog and positioning amongst its buyers. The company had a strong run during COVID as with most home builders which reported strong demand growth amidst record low interest rates. Post COVID, the demand remained strong as the significant shortage of inventory made the home buyers turn to home builders to build affordable homes. It reported a stellar set of numbers in Q3 along with strong guidance for Q4 which underlines its strong earnings momentum. Its attractive valuation along with continued share repurchases and comfortable leverage allows TPH to continue growing.
Company Background
Tri Pointe Homes is a leading home builder with presence across 15 markets and 10 states in the US, principally focused in California and Texas. It focuses across a wide segment of home buyers offering single-family attached and detached homes with home prices ranging from $290k to $3.1 mn and average selling home price of over $700k. It has operations of 135+ active selling communities currently across its end markets.
Historical Track Record
The company has reported a strong growth historically driven by robust industry tailwinds with revenues growing at 7% CAGR during 2018-2022 period as a result of record low mortgage rates during the pandemic which spurred new home sales. Gross margins also expanded significantly as a result of growth in average selling prices along with improving product mix as buyers looked for bigger homes. Its favorable leverage ratio and robust gross margins have enabled the company to deliver almost ~2x jump in its book value during the past 5 years.
However, the growth soon stumbled where in the Federal Reserve began increasing interest rates to record highs which pushed the mortgage rates above the 7% mark leading to orders declining by over a third by the end of 2022.
Housing Markets remain Challenging
Housing market continues to remain challenging as the Fed's 'Higher for Longer' mantra continues to dampen demand which has been reeling under record mortgage rates which is nearing 8% mark .
Freddie Mac
September new home sales jumped 12.3% MoM to 759k hitting a 19-month high ahead of the consensus pegged at 680k driven by drop in median home prices. Builders have been offering bulk of incentives and discounts to improve affordability as the bulk of the homes were sold between $150k-$500k range. The sharp demand in new housing is led by a decline in existing resales which dropped to a 19 year low at 3.96 mn units, down 2% MoM, as a result of record low inventories where in home buyers who have locked in at lower interest rates are shying away from the housing market amidst record mortgage rates. Single family home starts jumped 7% in September driven by acute shortage of inventories lower than consensus expectation. The housing markets remains challenging with the mortgage applications declining to its lowest since 1995 as a result of persistently higher mortgage rates.
Builder's confidence continue to decline amidst elevated mortgage rates and rising unaffordability dropping 5 points to 40 having fallen by about 16 points over the last 3 months. In addition, higher cost of construction with slowing demand contributes to the decline in confidence.
Strong Q3 Earnings
TPH report ed a strong quarter w ith top line and bottom line beats as a result of resilient home sales amidst severe shortage of home supply. The company reported new home deliveries of 1,223 down by about 16% with average selling price for home declining by about 7% YoY to $675k resulting in home sales revenue down ~22% YoY to $825 mn, ahead of the consensus expectation pegged at $760 mn. New home deliveries grew to 1,223 up from 1,173 in Q2 and 1,065 in Q1 and still remains resilient amidst challenging macro conditions above the company's expectation at 1,050 (at mid point). This was a second quarter in a row where home deliveries surpassed management's guidance (Q2 expectation was 950 and delivered 1,173 homes) as the company looks to adopt a cautious approach amidst challenging macro environment. Adjusted home builder gross margins declined 430 bps YoY as a result of increase in wage inflation and higher construction costs along with higher incentives and discounts to home buyers, which still came in higher than expectations.
Backlog dollar value continue to improve sequentially with a total of $2.1 bn across 3,000+ units (vs $1.9 bn in Q2 and $1.5 bn in Q1). Average selling price of the orderbook remains robust at $693k (down slightly from $695k in Q2 and up from $680k in Q1). SG&A expenses grew by 5% as the company stepped up its marketing efforts to drive sales growth. SG&A deleverage by 320 bps YoY as higher marketing spends outpaced the significant decline in revenue. In all, it reported a GAAP EPS of $0.76 which came in significantly ahead of the estimates pegged at $0.56 as a result of strong beat on top line as well as gross margins.
The company guided for Q4 home deliveries to be around 1,700 (at midpoint), which represents a sharp improvement sequentially along with stable average selling price of $690 - $700k. We believe given the current demand environment as a result of a crippled supply along with strong order backlog, the company is likely to be around the top of its guidance driven by its strong customer centric single family homes which has remained relatively resilient.
It ended the quarter with cash balance of ~$850 mn and total debt outstanding of $1.4 bn with comfortable debt to capital ratio of 32% and net debt to capital ratio of 15.4%. The company repurchased about $55 mn in shares during the quarter and have so far repurchased about $125 mn in shares YTD with an additional $125 mn shares authorized for repurchase. Continued share purchase activity along with strong cash generation would continue to provide support to the stock price.
Valuation
TPH trades at attractive valuation of 7.5x Fwd P/E, in line with its long term average, however at relative undervaluation compared to its peers (peer average of 8.8x). In addition on a Price to Book basis, the company trades at just 0.8x Book value compared to the peer average of 1.5x which represents a significant discount compared to its peer average as well as its long term average (~1.0x).
Seeking Alpha's valuation grade ascribes a 'A-' rating on the back of attractive valuations compared to its long term averages and relative to sector median multiples. We believe the company has delivered strong earnings momentum and the current quarter proves a testament of its strong portfolio. We initiate with a Buy rating and ascribe a target price of $30 (at 9x Fwd P/E in line with its peer average)
Risks to Rating
1) Affordability challenges amidst persistent record mortgage rates and a looming recession could lead to a significant deterioration in housing activity and decline in order book.
2) Rising construction costs as a result of higher construction loans, wage inflation, higher incentives and discounts to boost demand and adverse product mix as buyers opt for smaller homes with lower prices can lead to a decline in its gross margins.
3) Increasing sales and marketing costs for demand growth can lead to a decline in its operating margins.
Final Thoughts
TPH has reported strong results and remained resilient amidst challenging housing market while maintaining its average sales price. We believe the continued shortage of inventory would lead to a growth in the home deliveries going forward and is likely to stabilize. We remain positive on the company as a result of its strong earnings momentum, history of guidance beat along with attractive valuation. Initiate at Buy with target price of $30.
For further details see:
Tri Pointe Homes: Earnings Topper And Attractive Valuation