M/I Homes, Inc.

Moat: 1.5/5

Understandability: 2/5

Balance Sheet Health: 3/5

M/I Homes, Inc. is one of the nation’s leading builders of single-family homes, targeting entry-level and move-up buyers with a geographically diversified approach, while also focusing on financial services via its subsidiary, M/I Financial.

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

M/I Homes, Inc. (MHO) is a homebuilding company operating primarily in the United States, focusing on constructing and selling single-family homes, with a core emphasis on urban and suburban communities. They offer a range of homes, from entry-level to move-up homes catering to different segments of the market. They have a highly centralized business with the design, purchasing, planning, and land acquisition functions run from Columbus. They use this standardized strategy to increase their operational efficiencies.

  • Revenue Distribution: M/I Homes generates revenue primarily through home sales, and their subsidiary M/I Financial provides a financial services branch that provides the mortgages which are sold to third-party investors.

    • Homebuilding: The company’s primary revenue driver. Revenue is realized upon the sale of new homes to customers.
    • Financial Services: Generate revenues through mortgage and title insurance origination. They will often package and resell the originated mortgages to a third party.

  • Industry Trends: The housing market is subject to various economic factors and demographic shifts. Recent trends include a high degree of volatility, with a cooling of prices and sales in reaction to rising interest rates in 2023. However, there is a strong demand for housing, particularly among first-time home buyers and from millennials, that is expected to be sustained.

  • Margins:
    • As of 2023, gross margins were 24.3% but they decreased to 22.9% in the fourth quarter and are expected to remain around that range due to promotional activities and increasing incentives to sell.
    • The sales margin, which is calculated as the operating income on home sales divided by revenues, is 10.8% for the full year 2023, and fell to 7.5% in the fourth quarter.
    • The company is hoping to use pricing to drive profitability instead of volume to protect margins.
  • Competitive Landscape: The homebuilding industry is highly competitive and fragmented with several national, regional, and local builders. The industry is prone to consolidation, and it’s also seen increases in build-to-rent strategies. MHO’s ability to differentiate through design, quality, and customer service helps them carve out a position for themselves in their operating markets.
  • What Makes the Company Different: M/I Homes stands out due to its focus on quality construction and customer satisfaction. Their highly centralized model allows the company to have strong control of the entire value chain and increase efficiencies. In addition, they have an on-site mortgage and finance arm which allows the company to streamline the home buying process. The company also emphasizes affordability and has focused on more affordable houses and first-time home buyers.

Financials

M/I Homes’ financial performance is closely tied to the health of the housing market. Their financial statements are complex and need proper analysis to derive conclusions. Here’s a more detailed look:

  • Revenue: For the full year 2023, revenue came to a record $4.9 billion. There is an overall trend of declining revenues in the last quarters of 2022 and all quarters of 2023, however revenues have been higher than the previous year.
    • Home sales represented the bulk of their revenues, with a small but growing share coming from the financial services sector.
*   **Net Income:** MHO’s Net income for 2023 is $461 million. Earnings have also seen a decline in the last quarters of 2022 and all quarters of 2023, despite being slightly higher than the 2022 totals. The company’s focus is now on profitability versus volume, they are trying to focus on increasing the overall value of the homes they sell.

  • Return on Invested Capital (ROIC): There was a high ROIC in 2021 which has seen a decline in 2022 and 2023. The company does not have a strong and consistent ROIC and is prone to being affected by external events and market conditions.

    • ROIC for the full year was around 10%, which is on the low end of the market average and does not indicate a good business model by itself.

  • Other Key Financial Points:

    • Debt: MHO has a highly leveraged business. For example, in early 2024 they issued $450 million in new senior notes. But the company expects to deleverage in the next few years. They are pushing to grow their equity base through retained earnings, and that will help increase their financial resilience.
    • Inventory: High rates of inventory has been negatively affecting cash flows and performance for the last few quarters. They are looking to reduce the cancellation rates, increase closings, and offer promotions to reduce these inventories.

Moat Rating: 1.5 / 5

  • M/I Homes exhibits a weak moat. Its competitive advantages are not as strong as other players in the housing market. The company does show some brand value, but this is unlikely to be enough to protect it from competition. The company does not have any kind of a proprietary product or service that cannot be copied by other players.
    • Brand Recognition: M/I Homes has some degree of brand recognition in its operating regions, however, this isn’t enough to prevent competition.
    • Customer Switching Costs: The housing market is prone to price sensitivity and buyers are very likely to switch to other players.
  • Cost Leadership: The company’s high level of integration from design, purchasing, planning and land acquisition, helps streamline operations and reduce cost. * Economies of Scale: The company’s size and ability to build in multiple states allows some economies of scale which leads to a lower cost structure.
  • The points above do help the company get a slight advantage but not enough to establish a strong moat.

Risks to the Moat and Business Resilience

  • Interest Rate Risk: Rising interest rates can significantly affect housing affordability and demand, directly impacting MHO’s sales and profitability. Increased financing costs can also weigh on their debt. This is one of their most prominent risks.
  • Economic Downturns: A recession can severely reduce demand for homes, leading to falling prices, decreased profits, and an overall collapse in their business. The company’s inventories might also devalue as the properties are now less worth.
  • High Competition: The homebuilding industry is intensely competitive. MHO faces pressure from both large national builders and smaller regional and local players. This can limit its pricing power and market share.
  • Inflation: High inflation especially when combined with high interest rates can impact their costs which will affect margins.
  • Changes in Regulations: Any adverse change in zoning laws or building regulations may hurt their business significantly. The company also has to obtain several permits and approvals to start new locations, which may or may not be granted.
  • Supply Chain Issues: Any disruption to the supply chain, especially raw building materials, can increase the costs for the company. These issues will also limit the amount of buildings the company can complete. * Seasonality: The housing market is often seasonal, which can lead to periodic increases or decreases in revenue.

Understandability: 2/5

M/I Homes’ business model is somewhat easy to understand; it focuses on building and selling homes and providing home financing solutions. This is not unique and many companies have used this business model to operate. The details of their specific strategies, land acquisition, financing, and sales tactics are more complicated, and some understanding is needed for a deep valuation. The number of different financial instruments and the complexities involved in their financials makes it hard to make a detailed valuation.

  • It’s easy to understand the basic nature of homebuilding. But there is some need to learn details of how they operate. A lot of their financial statements and reporting is complex. So it’s rated 2/5.

Balance Sheet Health: 3 / 5

M/I Homes has a relatively healthy balance sheet, but its debt is above the industry average, and the trend of negative cash flows is concerning. Key aspects of the balance sheet show:

  • Debt: A high level of debt relative to equity, especially because they have recently taken on more debt. This increases the risk that negative events could derail the company’s health. This is a major problem for the company.
    • They have also issued Senior Notes, increasing their future debt burden.
  • Liquidity: The company is not cash-flow positive for the moment, and it remains reliant on access to credit.
    • MHO was operating below optimal working capital levels at the beginning of 2023.
    • However, they have been improving their access to capital, liquidity, and are targeting to be cash flow positive in a few years.
  • Assets: There is a risk that their inventory is overvalued in a cooling housing market and they might need to take on write-downs and losses to realize their value.
  • Overall, the company needs to reduce its debts and focus on increasing equity through retained earnings. Hence, a rating of 3/5 is appropriate.