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Meritage Homes (MTH) Banks on First-Time Buyers, ASP Drops

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Meritage Homes (MTH - Free Report) has been riding high on an improving housing market, backed by low mortgage rates and increased demand for family homes in low-density areas. The strategy to target entry-level buyers is gaining traction and will continue to boost performance over the long haul.

Recently, Meritage Homes reported first-quarter 2021 results, wherein earnings and revenues beat the Zacks Consensus Estimate. Moreover, the top and the bottom line grew 20.3% and 88% year over year, respectively. The upside can be primarily attributed to solid home closing volume, increase in pricing power, expanded gross margin and improved overhead leverage.

However, lower ASP, supply-related constraints, and higher land, labor and material costs may build pressure on margins in the forthcoming quarters.

Major Growth Drivers

Meritage Homes is focused on tapping the growing demand for entry-level homes with its LiVE.NOW product that addresses the need for lower-priced homes. The company is continuously building homes on a spec basis for LiVE.NOW. communities. Notably, since millennials are showing a tendency to set up homes, demand is likely to pick up, which will lead to higher volumes.

Meritage Homes, which shares industry space with KB Home (KBH - Free Report) , PulteGroup, Inc. (PHM - Free Report) and Lennar Corporation (LEN - Free Report) , believes that its strategy of targeting entry-level and first move-up buyers is gaining momentum and will continue to boost performance over a long period of time. As of Mar 31, 2021, 58,000 lots were controlled by the company. During first-quarter 2021, the company added 5,900 net new lots, representing 43 future communities, approximately 95% of which are targeted toward first-time buyers.

The company reported 11% year-over-year growth in total orders for first-quarter 2021, which was driven by sound market conditions as absorptions were 5.8 per month in March 2021, up from 4.3 per month a year ago. Also, higher demand for entry-level homes added to the positive. In fact, entry-level homes comprised 76% of first-quarter 2021 orders.

Meritage Homes’ performance continues to improve on strong order growth and higher gross margin. The company is majorly focused on widening its gross margin levels and increasing profit to the maximum level on every scale. The company has strategically shifted its focus to entry-level and first-time buyers, promising them faster delivery at a lower cost. This will improve the company’s community count manifold.

Furthermore, Meritage Homes has reduced the average selling price (ASP) for homes in order to address the needs of millennials and baby boomers who want affordable homes and highly desirable communities. For the first quarter of 2021, despite a 3% drop in ASP, home closing revenues grew 21.3% year over year backed by these initiatives.

During the first quarter of 2021, the company aggressively invested in land acquisition for expansion of community count. The investment in land acquisition and development amounted to $370 million. Also, the company expects to spend more than $1.5 billion annually during 2021 and beyond to sustain and replenish its 300 communities.

Concerns

Although the company has reported solid results in the past few quarters, earnings might remain under pressure in the forthcoming quarters due to lower ASP. Despite being able to push its ASPs of entry-level products a little higher in the first quarter of 2021, closing ASPs dropped a bit year over year, while orders and backlog ASPs increased just a small percentage year over year.

Lately, the company witnessed shortage of some home building materials due to pandemic-related supply chain disruptions, some weather events and 12-plus months of elevated demand. At present, shortage of buildable lots, skilled labor and capital for smaller builders is limiting home production, thereby lowering the inventory of homes, both new and existing.

Rising land and labor costs are threatening margins as they limit homebuilders’ pricing power. Labor shortages are leading to higher wages while land prices are rising due to limited availability. Also, the shortage of input materials is raising commodity costs, impacting the company’s results. Raw material inflation, especially lumber, is eating into homebuilders’ margins. The company anticipates additional overhead costs attributable to its expansion to 300 communities. This will bump up SG&A expenses over the next several quarters.

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PulteGroup, Inc. (PHM) - free report >>

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Lennar Corporation (LEN) - free report >>

Meritage Homes Corporation (MTH) - free report >>