Assessing The Value Of M/I Homes

Sep. 1.11 | About: M/I Homes, (MHO)

The other day, the idea that home builders should trade near their book values was discussed on this site. Seeing as how sentiment in the industry is such that many builders trade at discounts to their book values, an opportunity for profit may be present for value investors with a long-term outlook. M/I Homes (NYSE:MHO) is one company that fits this description.

M/I trades for $150 million, but has a book value of common equity of around $185 million. The biggest part of the company's book value is its inventory of homes and land in various states of construction, carried at $463 million. A determination of what this inventory is worth will go a long way towards determining if this company has downside protection.

The company pulls in a gross margin of about 13%, suggesting the inventory is worth what the companies carries it at. But at the company's current sales rate, it would take almost a year to get through all of its inventory. Because SG&A and interest costs are running higher than gross margins, this means the inventory is likely to turn into less than its $463 million carrying value when it is turned into cash.

Even as that inventory is turned into cash, however, it's pumped right back into inventory. Rather than shrink to a smaller company, M/I is actually growing! The company just made an acquisition, and current inventory is higher both sequentially and year-over-year, which may rightfully make some investors nervous.

The company notes that orders and backlog are up from last year, and gross margins on its newer communities (likely purchased by M/I at much better prices) have gross margins which are 600 basis points higher than those of its older communities. As such, perhaps re-investing cash proceeds from sales is a good idea. But this action does create an element of risk for value investors buying at a discount to assets. Rather than shrink and pay down its obligations, by implementing this strategy the company is increasing the likelihood that it will have to raise additional capital, which may not be on terms favourable to shareholders.

Complicating matters is the fact that M/I also finances mortgages, and thus holds some mortgage receivables on its balance sheet. Since it sells most of its mortgages, however, M/I's holdings of these mortgages are relatively small compared to assets related to its building operation.

Buying assets that turnover frequently at a discount to their market values can generate strong returns for investors. M/I Homes may offer value investors such an opportunity.

Disclosure: No position