Homebuilder Meritage Homes (MTH 2.67%) has had an incredible run this year, building and selling more homes through the first three quarters of 2020 than it did in all of 2019. And with interest rates at all-time lows, there's a good chance that demand remains pretty strong for the foreseeable future. But at some point the housing cycle will turn, and demand will soften.
On the Nov 6 edition of "The Wrap" on Motley Fool Live, host Jason Hall explained why that doesn't concern him. The short version is, there's a massive amount of pent-up demand from millennials, and after spending most of the past decade ignoring the entry-level market, homebuilders focusing on starter homes are set for massive demand over the next decade or more.
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Transcript:
Jason Hall: Just like we saw with LGI Homes; massive orders. Seventy one% growth in orders in the quarter. Revenue was up 21%. Home closings revenue was up 21%, that's the majority of the revenue, about $1.1 billion. Net income surged 56%. Earnings per share up almost 60%. Just great job. They sold 10,500 homes in the first three-quarters of the year. That's more than they sold in 2019. They're already at a record year. Last year was a record year. Three-quarters of the way this year, they're already at a record year. So business is so good, the Meritage is burning through its land inventory. They've done a pretty good job of trying to keep about three years worth of land on the books. Sales and orders have gone up so much. They didn't have to, they chose to spend about $300 million to acquire 9,000 new lots. A record acquisition of lots barely got them to three years worth of land at their current sales rate.
Tyler Crowe: That's a big premium for lots.
Jason Hall: Yeah.
Tyler Crowe: Land ain't cheap right now.
Jason Hall: It's not, but here's my guess. My guess is Steve Hilton has done a hell of a job. He's the Founder, CEO. My guess is they probably bought the right lots, so they probably paid the right price. I've yet to see him do anything for the sake of doing something. I think he's earned some trust at this point.
First big takeaway here; the volume is helping the bottom line. We talked about it with the other homebuilders, that lumber prices are skyrocketing. It's getting operating leverage out of that high demand. Sales, general administrative expense fell 70 basis points as a percentage of home closing revenue. A lot of those costs move up or down based on -- its commissions and fees and that sort of thing. Gross margin on home closings increased 170 basis points.
Again, lumber prices are skyrocketing right now, and their gross margins still went up.
They're just really good at building homes at scale, they get margin benefit from that shift to starter homes, just like with LGI Homes. They build it, and they move to the next and build it, move to the next one. I think it's really paying off.
Second, I don't know how sustained this surge and housing is going to prove. We talked a little bit about that. Don't know what's going to happen next quarter, don't know exactly what 2021 is going to look like. Those record low interest rates are helping, that shortage of existing home inventory, but at some point, the cycle is going to turn. Home buyers are going to take a breather. Something is going to happen with the economy that derails things a little bit. Something is eventually going to happen, you just have to accept that.
My third takeaway, and this applies across the board, all three of these home builders; I don't think investors should focus too much on the cycle, especially, if you consider these 10-year investments. Millennials are the largest cohort in the US. There's just nowhere near enough housing to meet that demand.
I think that chart that I showed, home starts over the past 40-50 years versus the population, this is a long tail trend. It's just really a big long tail trend, and I think that's going to continue to prove really for all three of these stocks; LGI Homes, NVR, and Meritage. I think it's going to make them market leading investments over the next decade, even through the cycles.
