DHI: Nuggets from the 10-K: Higher Inventory in the West, Acq. in Indy, and Express Market Share

Dan Oppenheim
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Dan Oppenheim, CFA

(415) 889-5617

doppenheim@ssrllc.com

November 18th 2018

Nuggets from DHI’s 10-K: Higher Inventory in the West, Acq. in Indy, and Express Market Share

  • Higher inventory and slowing trends likely to create margin pressure in the West. We expect pressure on margins in the West (had been the highest of all regions, with pretax margins of 13.9%, above the 12.5% company average) based on Horton’s rising level of inventory (completed homes and homes under construction rose 7% year/year) while the value of Horton’s backlog in the region fell (down 8% year/year). In addition, we expect the ongoing slowing in the region will also impact margins. We think a slight portion of the higher inventory is related to more attached communities (townhomes and condos), but the 7% increase in work in progress despite an 8% year/year decline in community count in a slower market likely signals higher incentives ahead. We also think this could create competitive challenges for other builders in calendar 4Q. For Horton, the West represents only 27% of pretax homebuilding pretax income, well below the levels of William Lyon, MDC (Mountain and West regions), KB Home, and Toll, with those builders all generating more than 70% of homebuilding profit from California and the West.
  • Acquisition of Westport Homes to boost scale (and margins) in Midwest. Horton acquired Westport Homes in early November for $190 million, and we think this fits well with Horton’s recent entry into Indy, as Westport operates in Indianapolis, IN and Columbus OH, while also having a presence in Ft Wayne, IN. This will boost Horton’s scale in the Midwest (by far the smallest region at just 5.5% of fiscal 2018 revenue) as the scale has likely impeded margins (pretax margins of 9.0% in fiscal 2018, below the 12.5% company average), although Westport represents 1.5% of Horton’s revenue.
  • Express Homes continues to capture share, now up to 30% of revenue. Horton’s lower-priced brand continued to grow at a faster pace than its other brands, with the division now representing 30% of revenue, up from 24% in fiscal 2017, and 18% in fiscal 2016. We continue to expect the brand to grow at a faster rate than Horton’s other brands, given both the livability and the financial appeal of these efficient homes to consumers.
  • Curious to hear more on share repurchase activity. Horton noted that it repurchased 640,000 shares in July and 560,000 shares in August (in both cases at average prices just under $44/share), but didn’t repurchase any shares in September. There was no comment in the 10-K about repurchases subsequent to the end of the fiscal year, whereas the company had explicitly noted that it had not repurchased shares subsequent to the end of fiscal 2017 in its 2017 10-K. Share repurchase has not been a significant part of Horton’s past financial strategy, but we’d be curious to see if the company chose to step up the activity, given the recent decline in the share price (down 17.5% since the end of the quarter).
  • Premium valuation suggests expectation of raising capital for Forestar. As Horton trades at 1.5x 2018 book value, a significant premium to the group’s 1.0 average, we believe that the stock incorporates some expectation that Forestar (Horton’s 75% owned land developer) will be able to raise capital in the coming year (consistent with Forestar’s September shelf offering). We think Horton’s entry-level position is a positive in the current slowdown. However, we believe it may be a challenge to raise capital for a land developer absent significant improvement in housing demand in the coming quarters, which we do not expect.
Exhibit 1: SSR’s Preferences Among Housing-Related Sectors
Source: SSR Analysis

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