M/I Homes (MHO): Long-term housing shortage guarantees growth
Interest rates have risen significantly this year, and there is uncertainty about their impact on the economy. Higher interest rates increase the cost of mortgages and could slow the number of people who are likely to buy a home. It had a negative impact housing construction companies on the stock exchange. One such company is M/I Homes Inc. (MHO), noted as the thirteenth largest home builder in the United States. While MHO has delivered EPS surprises for the past three consecutive quarters, beating EPS expectations by $1.01 to reach $4.79 per share in the previous quarter. At the same time, the share price has fallen by 36.85% since the start of the year. However, one thing we do know is that the demand for housing will not go away. Statistics show housing shortages in more than 50% of US metropolitan areas. MHO is an extremely cheap and highly undervalued stock in the industry. Although historically, management has failed to provide shareholders with good value.
The company has been on the rise in terms of revenue and earnings for the past eight consecutive years, and the forecast is that revenue and number of homes will continue to grow in the coming years. With a one-year target price estimate of $83, more than double the current stock price, and an incredible backlog, I think there is still plenty of upside potential, and while there is there is uncertainty in demand, this stock is currently undeniably cheap. and therefore, I would recommend that investors take a bullish stance on this company.
MHO, formerly known as M/I Schottenstein Homes, Inc., is a full service home building company founded in 1976 in Columbus, Ohio by Irving and Melvin Schottenstein. The company builds single-family homes in 16 markets across the United States. It operates in three segments: Northern Homebuilding, Southern Homebuilding and the Financial Services segment, and has built more than 140,000 homes. It also provides additional services such as reviews, mortgage solutions, title insurance policies, and closing services to homebuyers.
The company sells under the M/I Home brand and targets a wide variety of consumers, from first-time single-family homeowners and young individuals moving up the career ladder to those seeking luxury. In the previous fiscal year, MHO closed 8,638 homes and generated $3.75 billion.
Finances and evaluation
Although the housing market felt the impact of gradually increasing interest rates, MHO still delivered a strong performance in Q2. The first two quarters saw a significant reduction in home deliveries, fewer new contracts and an increase in contract cancellations, which investors should be aware of. Homes delivered fell by 6% to 2,133 homes in Q2 2022. Looking at it over six months, the drop is even more significant, by 8% year-on-year to 3,956 homes delivered in the first half. Contracts fell further, with a 20% year-over-year reduction to 2,267 contracts in the second quarter of 2022 and a 19% decline in the first two quarters of this year to 4,334 new deals. However, revenue grew year-over-year by 8% to $1 billion in the second quarter of 2022, and net income rose 27% to $137 million. The company also still has an order book valued at $2.7 billion.
The company is financially strong, has no borrowings on its $550 million credit facility, and has a debt-equity ratio of 28% and $189 million in cash. In addition, revenue is expected to continue its upward growth over the next few years, regardless of the challenges.
I wanted to compare MHO to the four biggest home building companies in the United States through Seeking Alpha’s Quant Rating System to better understand the value this company could offer to potential investors. As shown in the table below, MHO has a significantly lower market cap of $1.12 billion compared to its larger peers. We can see that, with the exception of NVR, Inc. (NVRs), as a whole, these companies are currently worth more than they sell for.
Although MHO does not pay dividends to its shareholders, most large construction companies do. It is currently much cheaper than all of its peers except PulteGroup, Inc. (MPS), and at the same time, it shows a firm valuation in Seeking Alpha’s quantitative rating system if we look at the chart below.
If we compare the valuation of these companies, MHO is incredibly undervalued.
The market is not ideal for home buyers, with rising interest rates and inflation. Mortgage rates have risen significantly over the past ten months, and this has already been felt by the company in the reduction in new home contracts signed in the previous six months and an increase in contract terminations. There is uncertainty as to the duration of these market conditions.
While we should be cautious about market conditions, these are not ideal for homebuyers who are heavily impacted by soaring interest rates and their impact on potential mortgage costs. On the other hand, a significant shortage of available housing and a demographic always willing to buy. MHO is positioned in financially affluent communities and is confident in its fundamentals, has low debt levels and has an incredibly large order book and diverse offerings to succeed in these less than ideal economic times. We can see much more potential by comparing MHO to its high profile peers. With a much lower market capitalization, it is currently undervalued and has much greater upside potential. For this reason, I think investors may want to take a bullish stance on this company.