LGI Homes, Inc.

Moat: 1/5

Understandability: 2/5

Balance Sheet Health: 4/5

LGI Homes, Inc. is a homebuilder that focuses on entry-level homes in geographically diverse markets in the US, primarily in high-growth areas.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview: LGI Homes, Inc. is a homebuilder operating in multiple states across the United States. Their business focuses primarily on constructing and selling entry-level homes, often targeting first-time buyers. A significant portion of their business is concentrated in high-growth areas. They have a streamlined build process that allows them to build a community at a fast pace. * Revenue Distribution: Home sales account for the bulk of revenue. These are mostly new homes built and sold in their own master-planned communities. There has been a recent shift towards more build-for-rent communities, as they are increasingly in demand. They also sell wholesale to other buyers. * Industry Trends: The homebuilding industry is susceptible to macroeconomic conditions, such as economic growth, interest rates, mortgage availability, consumer confidence, and housing demand. The market has been facing headwinds from high interest rates lately. Demand is highly influenced by demographics and migration. A shortage of housing supply has been a key long-term trend. * The housing market is cyclical, characterized by both boom and bust cycles. * The housing affordability remains a large concern for many new potential home buyers. * Margins: The company’s gross margins are decent but are volatile to various economic factors such as labor costs and materials prices. The cost of land is a major cost in their business model. * Competitive Landscape: The homebuilding industry is very fragmented, consisting of national, regional and local players. LGIH operates in a highly competitive industry where product differentiation is minimal, focusing more on speed of execution and pricing. The real-estate industry also has many private companies who act as competitors. * What Makes LGIH Different: LGIH attempts to differentiate itself with its model of providing affordable homes and building at a fast pace to quickly meet demand. They build entire communities at a time, and provide a “one-stop shop” for the customer. * The company is known for targeting first time buyers and low prices. They also sell in the BTR (Build-To-Rent) market. * They own their land, develop the community, build the homes, and sell them.

Financials in Detail:

  • Revenue: * In the most recent quarter(ending September 30, 2023), home sales revenues were $625 million. In the first three quarters of 2023 (ending September 30), home sales revenues were $1.75 billion.
    • Home sales revenues did slightly increase, despite a 7% drop in closings. This suggests an improvement in ASP (average sales price) driven by higher pricing of new homes. * Total home sales revenues were $3.0 billion and $3.2 billion for the years ending December 31, 2022, and 2021, respectively. There was an 7.8% decrease in revenue from 2021 to 2022.
    • Home sales revenue for the six months ending June 30, 2023 was $1.75 billion. Home sales revenue for the year ending December 31, 2022 was $3.0 billion. Home sales revenue for the year ending December 31, 2021 was $3.2 billion.
    • Total revenues were 2.27 billion, 3.04 billion and 3.21 billion for the fiscal years ended in December 31, 2021, 2022, and 2023, respectively.
  • Margins: Gross profit margins have been hovering around 25%, however, they have been affected by various economic and macro-economic conditions. LGIH’s gross margin has declined due to lower sales volume and higher costs.
    • Gross margin is 24.7% for the quarter ended September 30, 2023, compared with 28.7% in September 2022.
    • Adjusted gross margin was 27.2% and 23.1% for the 3-months ending in June 2023 and 2022 respectively, and 25.4% and 24.5% for the six months ending in June 2023 and 2022.
    • Adjusted gross margin was 26.6% in 2021 and 26.2% in 2022.
  • Profitability: Net income was $157.3 million and $382.5 million in the year ending December 31, 2022, and 2021 respectively. There was an over 59% drop in net income year over year, showing the drop in profitability in the last year.
    • Net income was $102.2 million, for the three months ended in September 2023. That is lower than the prior periods of 2022.
    • Net income was $171.5 million, for the six months ending June 30, 2023.
    • Diluted earnings per share were $2.35, $7.72, and $15.66 in the three months ending September 2023, June 2023, and September 2022, respectively.
  • Balance Sheet:
    • Cash and cash equivalents were $184.9 million, $43.4 million and $50.5 million as of September 30, 2023, June 30, 2023, and December 31, 2022, respectively.
    • Total assets were at $3.25 billion, $3.4 billion and $3.6 billion as of September 30, 2023, June 30, 2023, and December 31, 2022, respectively.
    • Total liabilities were at $1.37 billion and $1.62 billion as of September 30, 2023, and December 31, 2022, respectively.
    • Total equity was at $1.88 billion and $1.8 billion as of September 30, 2023, and December 31, 2022, respectively.
  • Debt: Long term debt was reported as $398.8 million as of September 30, 2023. * Debt to Equity ratio is at 21% and is under management expectations.
  • Stock Buybacks: LGI has a program in place to buy back shares and recently announced an increase to that program to $200 million, showing their belief in current valuations.
  • Other Metrics: Average sales price of homes sold in 2021 was $306,557, in 2022 was $342,176, and in June 2023 was approximately $350,000.

Moat Rating: 1 / 5 LGI Homes, Inc., currently lacks a strong moat. They operate in a highly competitive industry with minimal barriers to entry. There is no significant brand power or technological advantage that makes their product difficult to replicate. While they do have some economies of scale and efficient execution, such benefits are not durable. They can be easily copied and implemented by other competitors in the real estate space. LGI Homes’s differentiation is more operational (faster delivery, lower pricing) instead of strategic, and this is not a durable moat. Therefore, a rating of 1 out of 5 is given.

Legitimate Risks That Could Harm the Moat and Business Resilience

  • Interest Rate Sensitivity: As a homebuilder, LGIH is acutely vulnerable to changes in interest rates, both on their own debt and the impact of mortgage rates on demand. Rising interest rates can significantly lower their profitability and demand for their homes.
  • Economic Slowdowns: Economic slowdowns can reduce housing demand and lead to decreased margins or higher default rates from consumers.
  • Commodity Prices: Increasing input costs (materials, labor, land etc) can significantly affect profits because LGIH works on thin margins already.
  • Competition: The highly competitive nature of the homebuilding industry, with numerous players all focusing on similar offerings.
  • Reliance on Growth: The company’s success depends on having continuous demand growth and a healthy housing market.
  • Low Switching Costs: For a customer, switching to a different home builder is extremely easy, with virtually no switching costs.
  • Limited differentiation: The industry, in general, has a lack of product differentiation.
  • Cyclicality: The housing industry is cyclical and can have wild swings in revenue and profits based on where the economy is in the cycle.
    • LGIH is focusing on expansion into BTR (Build To Rent) market, but this can also come with some new challenges.

Business Resilience:

  • Although LGIH doesn’t have a strong moat, they have an operationally efficient build process which might help in keeping them afloat in tougher situations.
  • They are highly profitable during booming economies.
  • They focus on volume over margin, so lower pricing may help attract more buyers.
  • Their land acquisition and planning process can give them an advantage when land is cheaper during a recessionary environment.

Understandability: 2 / 5

The business model itself is fairly easy to understand: buy land, build homes, and sell them. However, understanding and valuing all the moving parts of real estate and homebuilding companies is quite complex. A deeper dive into their financials reveals some complexities, as there are many non-operating adjustments and the balance sheet has a wide variety of inputs. Also, macroeconomic factors play a larger role which leads to ambiguity, and make it harder to know when a downturn is coming. For this, a rating of 2 out of 5 is given.

Balance Sheet Health Rating: 4 / 5

LGIH has a reasonably healthy balance sheet.

  • Their debt to equity is at 21% which indicates that they are not overly reliant on debt to fund their operations.
    • They have a low long-term debt liability compared to their total asset holdings, indicating good solvency.
  • Their cash flow is decent and is likely to meet their short-term debt obligations.
  • The company has a reasonably strong liquidity position and is able to cover its short-term obligations.
  • Their revenues have been consistent through the years and will eventually pickup in time.

Recent Concerns and Management Commentary

  • The company recently reported a decline in home closings for the three months ended September 2023, but at the same time, their average price of homes has increased by 8%.
  • Gross margins also dropped from 28.7% in 2022 to 24.7% in 2023. This decrease in margins was due to higher costs of operation.
  • Management has expressed confidence in their ability to maintain profit margins through pricing and cost reductions.
  • In their most recent earnings call, management talked about managing inventory and cost, while also being optimistic about long term demand.
  • Management has stated that the current economic environment presents some challenges, including low mortgage applications, high mortgage rates and a difficult economic environment. Despite that, they expect continued demand for their homes and are well positioned to handle them.
  • They are focusing on increasing sales volume, and managing the company through a difficult economic environment.
  • Management expressed their intentions to grow into the BTR market to meet demand.
  • They also emphasized that they are focused on building great communities and not just building and selling houses.
  • Management talked about cost cutting measures and trying to reduce input costs.
  • They recently announced a stock repurchase plan, indicating their trust in the strength of their business at these market valuations.