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Meritage Homes (MTH) Makes a Strategic Shift, Expenses High

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Meritage Homes Corporation’s (MTH - Free Report) strong order growth, robust earnings trend, improving gross margin, strong brand presence along with strategies relating to entry-level and first-move-up bode well. As a result of these, the stock has gained 8.6% in a year’s time, compared with the industry’s rally of 5.9%. However, rising costs of labor and land along with federal regulations remain concerns.

Growth Drivers

Meritage Homes is focused on growing demand for entry-level homes with its LiVE.NOW product that addresses the need for lower-priced homes, given the rising interest rates and home prices. The company is continuously building homes on a speculation basis for LiVE.NOW. communities in order to ensure faster delivery at a lower cost.

The communities drove 44% of its total orders in second-quarter 2018, higher than 35% a year ago on increased absorptions. The company intends to achieve 35-40% of community space in the entry-level market by 2018-end.

Meritage Homes’ growth potential lies in its strong brand presence as well as earnings and gross margin improvement. Its earnings surpassed the Zacks Consensus Estimate for 11 straight quarters, with the trailing four quarters’ average beat being 20.14%. In the second quarter of 2018, the company reported earnings per share of $1.31, surpassing the consensus estimate of $1.10 by 19.1%. Moreover, earnings estimates for 2018 have been revised 3.3% upward over the past 30 days, reflecting analysts’ optimism surrounding the company’s earnings potential.

Further, the company has been successful in improving its gross margin through proficient management of direct costs amid an inflationary environment. Meanwhile, home closing gross margin expanded 70 basis points (bps) in the first half of 2018.

Improving labor markets, steady wage growth, a recovering economy, falling unemployment rates, home price gains, historically low interest/mortgage rates, rising rentals, rapidly increasing household formation and a limited supply of inventory — all point to continued strong demand in 2018, thereby boosting homebuilders’ top line.


 

Headwinds

Rising land and labor costs are the biggest concern for the company as they limit homebuilders’ pricing power. Labor shortages and limited availability of land hampers margins in all key regions. Also, inflation is anticipated to rise.

Not only this, rising interest rates raise concern as it makes mortgage loans more expensive. This lowers the purchasing power of buyers, and in turn, hurts volumes, revenues and profits of homebuilders. In June, the Federal Reserve hiked funds rate for the second time this year by a quarter percentage point to the range of 1.75-2%. Also, the chances of two more rate hikes this year are high.

Moreover, Meritage Homes’ trailing 12-month return on equity (ROE) undercuts its growth potential. Its ROE of 12.2% compares unfavorably with the industry’s average of 12.8%, reflecting the fact that it is less efficient in using shareholders’ funds.

Zacks Rank & Stocks to Consider

Meritage Homes carries a Zacks Rank #3 (Hold).

Some better-ranked stocks in the industry are PulteGroup, Inc. (PHM - Free Report) , sporting a Zacks Rank #1 (Strong Buy), and Century Communities, Inc. (CCS - Free Report) and D.R. Horton, Inc. (DHI - Free Report) with a Zacks Rank #2 (Buy).
You can see the complete list of today’s Zacks #1 Rank stocks here..

PulteGroup has an expected current-year earnings growth rate of 61.2%.

Century Communities has average positive earnings surprise of 51.3% for the last four quarters.

D.R. Horton reported better-than-expected earnings in the last three quarters with an average beat of 8.9%

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