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Meritage Homes (MTH) Looks Resilient in 2H'20: Here's Why

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Meritage Homes Corporation’s (MTH - Free Report) second-half 2020 prospects look resilient on the back of solid homebuilding fundamentals. Although the industry grappled with coronavirus-led government restrictions, particularly in April, it bounced back impressively since May. In-fact, the industry posted some of the new highs in July.

Building permits and housing starts rebounded to the pre-pandemic level in July, according to the U.S. Census Bureau and the U.S. Department of Housing and Urban Development. New and existing home sales also recorded the highest level since December 2006 in the said month. Notably, July pending home sales marked the biggest monthly gain since April 2012.

Notably, these metrics are expected to rise backed by strong builder confidence and heavy buyer traffic. U.S. homebuilders’ sentiment has risen to the highest level in the index’s 35-year history in August, per National Association of Home Builders, matching the December 1998 level. September reading is scheduled for the third day of next week.

Shares of the company and the Zacks Building Products - Home Builders industry have jumped 27.2% and 26%, respectively, since the beginning of second-half 2020. This compares favorably with the Zacks Construction sector and S&P 500 index’s respective rally of 16.8% and 10.2% in the time frame.

Let’s discuss the factors that are substantiating growth of this Zacks Rank #1 (Strong Buy) company. You can see the complete list of today’s Zacks #1 Rank stocks here.

Solid Housing Fundamentals to Offset Headwinds: The overall homebuilding industry looks promising for the second half of 2020 on ongoing traffic trends that indicate higher inclination of buyers despite a bit pricier market. Notably, less than 3% mortgage rates, declining unemployment rate and lower supply of existing homes for sales are somewhat offsetting headwinds like increasing mortgage delinquencies and rising lumber costs. Also, buyers are now seeking homes in lower-density areas, boosting new home construction in such regions.

Along with Meritage Homes, industry bigwigs like PulteGroup, Inc (PHM - Free Report) , Toll Brothers, Inc. (TOL - Free Report) and D.R. Horton, Inc (DHI - Free Report) gained 31%, 30.8% and 26.7%, respectively, since July 1.

Performance & Growth: Meritage Homes continues to gain from its strong order growth, EPS improvement and solid gross margin. To this end, it is making homes out of speculations that promise faster delivery at lower costs. It reported 27% year-over-year growth in total orders in first-half 2020, primarily backed by 40% improvement in absorptions, which was driven by higher demand for entry-level homes.

The company’s earnings surged 113% year over year in first-half 2020. The uptrend can be attributed to solid home closing revenues and 320 basis points gross margin expansion in first six months of 2020. It expects home closing gross margins to be 21% for the third quarter and 2020 each, suggesting a significant increase from 18.9% in 2019. Also, it projects earnings within $8.75-9.25 per share for 2020 ($6.42 in 2019) and $2.15-2.35 for the third quarter ($1.79 in the prior-year period).

Per the Zacks Consensus Estimates, the company’s earnings are expected to surge 42.8% in 2020 compared with the industry’s average of just 3%. On a further encouraging note, Meritage Homes is expected to register 18.5% earnings growth in three-five years compared with the industry’s 9.3%, on an average. Notably, the company’s impressive earnings surprise trend, having surpassed the Zacks Consensus Estimate in 19 of the trailing 21 quarters, bodes well.

Strategies to Boost Top-Line Growth: Focus on building homes for entry-level, first-time and move-up buyers has been yielding positive results. Notably, its LiVE.NOW product addresses the need for lower-priced homes to solve the affordability problems for first-time/entry-level buyers. Also, strong brand presence, and innovation and strategies relating to entry-level/first-move-up communities along with strong housing industry prospects will likely drive the stock’s performance in the upcoming quarters.

Notably, entry-level orders contributed 61% to total order growth in the first quarter and 70% in the second quarter. Also, the same represented 57% of total active communities at June-end compared with 41% a year ago. First move-up accounted for one-third of communities as of Jun 30 and 26% of second-quarter orders.

The company is confident about the second half of the year and expects total home closings within 10,850-11,350 units in 2020. This indicates an increase from 9,267 homes in 2019. For the third quarter, it projects closings between 2,700 and 2,950 units, up from 2,419 homes reported in the comparable year-ago period.

It reduced the average selling price or ASP for the homes to addresses the needs of millennials and baby boomers. In first half, home closing revenues grew 23% year over year, despite 3% lower ASP, backed by these initiatives.

Superior ROE: Meritage Homes’ return on equity (ROE) is indicative of growth potential. The company’s ROE of 16.9% compares favorably with the industry average of 13%, implying that it is efficient in using shareholders’ funds.

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