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One of the things that I love most about home building companies is that they tend to provide plenty of financial metrics that show not only where they are today, but also where they seem to be headed. When you pair this up with economic data and make sure that you buy the stocks at a cheap enough price, upside is very difficult to avoid. One firm that I believe does offer some really great upside at this point in time is Meritage Homes (NYSE:MTH). Since initially writing about the company in January 2022, I have become quite a fan of the business. Its emphasis is on single family properties, which might not be as popular as the multifamily properties that some have come into favor. But overall financial health of the firm is robust and shares seem to offer some nice upside potential.
When I last wrote about the business back in November of 2023, I used all of this rationale to conclude that shares made for a solid ‘buy’ opportunity. But there was more than just those data points that helped me make that decision. Orders were coming in stronger and cancellation rates were on the decline. For the most part, those trends continue to this current day. So even though shares are up 12.3% since then, slightly worse than the 13.8% rise seen by the broader market, and even though shares are up 39.4% since my initial ‘buy’ rating on it in June of 2022 at a time when the S&P 500 is up only 6.2%, I would argue that additional upside is on the table. In fact, given how cheap shares are, I would even go so far as to upgrade the firm at this point to a ‘strong buy’.
This is not to say that the road moving forward won’t be bumpy. There are obvious economic risks, especially if interest rates remain high and when factoring in the prospect of an eventual recession. But the good news is that new data is about to come out that will detail for investors like you and me just how healthy the picture is. That data will cover the first quarter of the 2024 fiscal year, and it’s expected to come out after the market closes on April 24th. Leading up to that time, there are some important things that investors should be paying attention to you. But even though financial performance for the business has been, in some respects, weak, in recent quarters, analysts expect some encouraging signs of stability.
The picture keeps improving
When I last wrote about Meritage Homes, we had data covering through the third quarter of the 2023 fiscal year. Today, data now extends through the final quarter of that year. So it’s my view that we would be best off tackling results for that final quarter. During that time, revenue for the company came in at $1.66 billion. That represents a decline of 16.9% from the nearly $2 billion generated in the final quarter one year earlier. Considering I just spent the prior three paragraphs touting the overall health of the company, you might be scratching your head right about now. But don’t worry. We will get to the good news before long.
According to management, this decline in revenue was driven largely by a drop in home closings. The company went from closing 4,540 homes to closing 3,951. In addition to this, however, the company also saw a reduction in the average sales price of homes closed. This figure dropped from $437 thousand to $415 thousand. Some of this decline can certainly be chalked up to easing economic pressures. However, there is also no denying that firms are having to drop prices because of what was a temporary decline in demand thanks to inflation and high interest rates aimed at combating said inflation.
With revenue dropping, it should come as no surprise that profits and cash flows worsened. Net income went from $262.4 million in the final quarter of 2022 to $198.9 million in the final quarter of 2023. Other profitability metrics followed suit. Operating cash flow took the biggest hit, plunging from $575.1 million to negative $104.5 million. But if we adjust for changes in working capital, we would get a drop from $274.4 million to $215.1 million. Meanwhile, EBITDA for the company fell from $345.9 million to $253.7 million.
No matter how you stack it, this picture was undesirable. And this was not a one-time blip on the radar. Though from a revenue perspective, it wasn’t as bad, 2023 in its entirety was more painful than 2022 was. This much can be seen in the chart above, which shows financial results covering both fiscal years as a whole. Revenue, profits, and cash flows, all took a beating. And this was because of the same two factors. The number of home closings fell from 14,106 to 13,976. Over the same window of time, the average selling price of those homes dropped from $440 thousand to $433 thousand.
Author – SEC EDGAR Data Author – SEC EDGAR Data
Over this window of time, backlog for the company also fell, dropping from 3,332 homes to 2,549 homes. When added to all of the other data points I discussed already, it may seem odd that I would be so bullish. If anything, you would expect me to be bearish about the situation. But this is where the good data starts. You see, pretty much every company in the homebuilding industry keeps track of the number of new orders coming in. And Meritage Homes is no exception. In the most recent quarter, the company reported 2,892 homes that were ordered. This happens to be 60% above the 1,808 homes ordered the same time one year earlier.
In the chart above, you can see that while this is the lowest number of orders the company has seen in a year, the year-over-year increase over the past four quarters is higher than any other periods of time shown. This means that the picture is getting progressively better, which makes a lot of sense when you consider what else is going on in the homebuilding market. As the image below illustrates, the number of single-family starts in March of this year totaled 1.32 million. While this is lower than what was seen in February of this year, and it was below the 1.38 million reported in March of last year, the number of building permits increased 1.5% year over year, climbing from 1.44 million to 1.46 million. This shows that, nationwide, there has been some improvement.
Another positive to consider is that cancellation rates continue to improve. While the cancellation rate of 13% seen in the final quarter of 2023 was above the 11% seen in the third quarter, it’s significantly below the 39% cancellation rate reported for the final quarter of 2022. Over the last two years, that 39% was the worst reported by Meritage Homes. And ever since this year began, cancellation rates have been plummeting. This shows that, in addition to the company landing new orders, customers are following through on their own commitments to have new homes constructed.
So far, this covers just the short term. But when we shift to the long term, we have a lot more to be bullish about. The fact of the matter is that, between 2012 and 2023, there has been a consistent shortage when it comes to new single-family properties. According to one source, household formations have outpaced new home constructions significantly, creating a gap that translates to a 7.2 million home shortage during that window of time. It is worth noting that while multifamily home construction is currently weak, it has made-up for a good portion of this spread. But even with it, there has been a shortage of about 2.5 million homes nationwide.
You would think that, with data like this, Meritage Homes and other companies like it would be expensive. But that’s not the case either. In the chart above, you can see exactly how cheap shares are using results from 2022 and 2023. In the table below, meanwhile, I then compared the company to five similar firms. On a price to earnings basis, only one of the five companies was cheaper than Meritage Homes. And when using the other two profitability metrics, our candidate ended up being the cheapest of the group.
| Company | Price / Earnings | Price / Operating Cash Flow | EV / EBITDA |
| Meritage Homes | 7.4 | 6.9 | 6.0 |
| Beazer Homes USA (BZH) | 5.2 | 20.5 | 9.4 |
| Century Communities (CCS) | 9.9 | 61.4 | 9.8 |
| Legacy Housing (LEGH) | 9.1 | 44.3 | 7.1 |
| Dream Finders Homes (DFH) | 12.2 | 9.7 | 8.4 |
| Landsea Homes (LSEA) | 15.1 | 16.0 | 19.1 |
Of course, this picture could change. If bearish data comes in when management reports financial results in the first quarter, this situation could go from being rather attractive to being unappealing. But at the moment, analysts don’t believe that will happen, and I have no reason to think it will either. For starters, analysts believe that revenue for the quarter will come in at about $1.28 billion. That’s only marginally lower than the $1.29 billion reported one year earlier. They also anticipate earnings per share of $3.54. This would match what the company reported the same time last year, meaning that net profits should remain more or less unchanged at around $131 million. In the table below, you can see some other profitability metrics that matter. Between now and the time management reports, you should familiarize yourself with them and, when data does come out, you should see how these numbers stack up against the new results. While profits look set to remain flat year over year, there’s always some risk that cash flows could worsen.
Takeaway
Fundamentally speaking, I really like Meritage Homes. The stock is cheap, and the industry looks set to recover nicely. Yes, fundamental performance has been weak as of late. But when you look at pent-up demand for housing, combined with how cheap shares are on both an absolute basis and relative to similar firms, and when you consider just how strong orders have been while cancellation rates have been on the decline, it’s difficult to not be bullish about the picture. Because of this, I have decided to upgrade the stock from a ‘buy’ to a ‘strong buy’.
Editor’s Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.