Meritage Homes - Fair Deal With Legendary, Little Appeal Going Forwards

Jul.11.14 | About: Meritage Homes (MTH)


Meritage Homes announces the acquisition of Legendary Communities.

The deal multiple is fair and boosts the growth profile of the company.

Poor long-term track record concerns and debt outweigh appealing valuation on earnings metrics.

Meritage Homes Corporation (NYSE:MTH) announced the acquisition of privately-held competitor Legendary Communities in a deal, which will add nearly 10% in annual deliveries and 8% in sales.

Investors hardly reacted to the deal, which seems fair as bulls and bears have been weighing their arguments with shares trading in a relatively tight trading range in recent years.

The Deal Highlights

Meritage announced that it has entered into a definitive agreement to acquire Atlanta-based Legendary Communities.

Under terms of the deal, Meritage will pay some $130 million for the privately-held builder, which has a significant presence in Atlanta, Greenville-Spartanburg and Charlotte.

The company did not specify when it expects to close the deal.

Strategic Rationale

The acquisition is driven by anticipated growth, allowing Meritage to benefit from the growing housing market. Based on single-family permits being issued in 2013, Atlanta is the second largest and fastest growing housing market in the nation, according to the press release.

The company anticipates building permits being issued to grow by some 20% as well between 2013 and 2015 in the Greenville-Spartanburg market. While Atlanta and Greenville-Spartanburg are new markets for the company, Meritage is of course already active in Charlotte.

It should be noted that Legendary is a relatively new company having started operations only back as recent as 2009.

Financial Takeaway

The $130 million price tag values Legendary Communities at just 0.8 times sales, which came in at $156 million for 2013. The company delivered some 500 homes last year at an average price of little over $300k, as construction focuses on a wide range of price classes, which range from $120 to $550k.

The company owns or controls about 4,000 home sites, which allows the firm to produce at the current rate for 8 years before it runs out of sites to build on without adding to the sites backlog.

Unfortunately, no details regarding profitability of the business, or any potential accretion to earnings has been discussed by management.

Recent Investor Update

Back in May, Meritage updated its investors with a presentation at the Wells Fargo Securities Industrial & Construction conference.

The company notes that demand remains high amidst improved job creation, solid affordability as interest rates are low, and low supply levels. The company stresses that markets are still far from their long-term averages, while Texas and other Southeastern markets are driving growth in particular at the moment. It is these markets in which the acquired Legendary is active.

Besides improved volumes, higher prices are very important as well, being the major driver behind the recovery in gross margins. Even so, the market is not firing on all cylinders yet with order growth in April coming in at 8% to 580 units.

Valuing Meritage Homes

Back in April, Meritage released its first quarter results for this year. The company ended the quarter with nearly $339 million in cash and equivalents as well as short-term investments. Total debt of $905 million results in a net debt position of about $566 million. Factoring in the deal with Legendary, the company's net debt position will increase towards $700 million.

On a trailing basis, Meritage has now posted sales of $1.91 billion on which it net earned $138 million. Trading around $42 per share, Meritage's equity is valued at $1.6 billion. This values equity in the business at 0.8 times sales and 11-12 times trailing earnings.

Meritage does not pay a dividend currently.

Still Recovering From Long-Term Pains

Like most of the homebuilders, Meritage has seen very difficult times during the recession when many competitors were forced to close their doors.

At its peak in 2006, the company posted sales of nearly $3.5 billion, with sales falling to as little as $861 million in 2011. After being solidly profitable, the company was forced to post losses of close to $300 million in 2007 and 2008. Ever since the company has returned to profitability, it has been posting earnings north of a hundred million over the past two years.

Shares peaked around $90 in 2005 and fell to lows of $10 during the recession. Ever since shares have recovered to levels around $40-$50 per share, a range in which shares have been trading for the past two years. Note that the company has experienced cumulative dilution of about 50% over this time period.

Final Takeaway

The latest deal will push sales again above the $2 billion mark on a trailing basis while the deal multiple in terms of revenues is in line with the company's own valuation. Yet the company will have access to faster growing segments of the housing market, while the move creates additional geographical diversification as well.

The 500 annual deliveries add significantly to sales as well after the company delivered 5,259 units for the year of 2013. Momentum will push sales higher as order intake is very strong. Total orders of 1,525 units during the first quarter of this year results in a book-to-bill ratio of 1.38 based on deliveries of 1,109 units. This only added to the backlog, which now stands at nearly 2,300 units, which excludes the contribution from Legendary.

I must say the price-earnings multiple is attractive given the strong growth, the fair deal and the further prospects for a housing recovery. Potential risks to the valuation are the debt position, rising interest rates and a slowdown in the economy. Furthermore, the long-term track record, lack of dividends and dilution throughout the years are big drawbacks as well.

As such, it all depends on your view on the housing market and wider economy. For me, a potential investment does not pass my investment standards. I remain on the sidelines in what appears to be a fair deal.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.