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Deep Value in Meritage Homes

By Tim Begany on January 6, 2016

A couple tough quarters put the kibosh on Meritage Homes (NYSE: MTH) in 2015. After soaring 39% to almost $50 a share the first few months of the year, the stock of this prominent homebuilder gradually sank back to around $34, ending the year with about a 6% loss.

Still, this makes Meritage one of 2016’s best small-cap values, as Wall Street’s recent pummeling of the firm is a gross over-reaction to short-term obstacles.

One was last year’s unusually wet spring and summer in key markets such as Dallas, Houston and Denver. Because of torrential rains, Meritage fell behind on many new construction projects in these areas. Transient labor shortages have hindered work in some markets, too.

As COO Phillippe Lord pointed out during the third-quarter conference call on October 29th:

Sale-to-close cycle times have stretched out by weeks or months, discouraging some buyers who are not willing to wait that long for a new home to be delivered.

Yet weather and labor-related issues didn’t impede third-quarter performance nearly as much as you’d think, considering the market’s recent treatment of Meritage. While the firm missed on profits, reporting $0.73 a share versus the consensus projection of $0.79, quarterly revenue of $670 million beat forecasts by $30 million.

CEO Steven Hilton had plenty of other good news to report, as well. For example:

Our third-quarter results reflect strong order growth in our east and west regions this year, which drove a 21% increase in our third-quarter home closing revenue. I am pleased we were able to deliver more than 1,700 homes to our customers during the quarter despite encountering headwinds from labor shortages and weather-related challenges in some of our markets.

Hilton wasn’t discouraged that the gross margin on home closings had fallen somewhat in the third quarter, thanks to higher construction costs resulting from labor shortages.

We expect to see our margins increase over the next 12 to 18 months as we improve the margins in our East region, made up primarily of new markets we have entered in recent years, which have not yet achieved anticipated operating efficiencies. We finished the third quarter with 250 actively selling communities—more than we have ever had in our 30-year history, which positions us for additional growth in 2016.

The longer-term also looks promising for Meritage, based on analyst consensus for profits to compound at a solid 7% pace in coming years against the backdrop of a steadfast U.S. economy. Per-share cash flow that exceeds earnings per share is a compelling sign of the firm’s ability to generate robust profit growth. So with a valuation of only around 9 times 2016 estimates, its stock is clearly a huge bargain.

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