M/I Homes: Over-Punished by the Markets

We saw here that the market values of home builders track reasonably well with their book values, and we saw here that currently most builders are trading at a discount to their book values. M/I Homes (MHO) is one such company on that list, trading at a healthy discount of 58% to its book value. MHO's debt to capital level sits at just 30%, while others on that list are flirting with much higher debt levels. On the surface, MHO appears as though it could be a value play, and warrants a closer look.

Upon further inspection, it turns out that not all shareholder equity is owned by the common shareholders. A good chunk of it is in preferred shares, which trade as separate securities (MHO-A). If we back out the value of the preferreds, the discount to book value changes from 58% to just under 49%, which still remains relatively attractive.

But the question of future writedowns remains a concern for this industry, as we discussed here. MHO is not as geographically diversified as many other home builders, and has a large percentage of its business in Florida, one of the hardest hit areas of the housing crash. In fact, the vast majority of MHO's $22 million in writedowns in Q1 took place in Florida.

But even if MHO requires writedowns of the same magnitude as what it had last quarter ($22 million) for the next four quarters, it would still be trading at a 35% discount to book value for common shareholders. At its slow sales pace of last quarter, it would get through its inventory in about one and a half years.

As an aside, I am a little bit concerned about management excesses. During the real-estate bubble, it seems the company went out and bought a rather large airplane. To lower costs, it traded down to a smaller plane last quarter, picking up $9.5 million in the trade. It's a move in the right direction, but nevertheless it seems rather strange that a $500 million home builder requires its own airplane, but perhaps I'm just too nitpicky.

Overall, however, this company appears to have been over-punished by the markets, and as such offers a margin of safety. I would recommend this stock be owned as part of a long-term, well diversified, value portfolio.

Disclosure: None.

Comments

[Jim Hawthorne]

Nonsense!
MHO might have been a good value back in June '05 or Jan '06, but ever since the stock has been fairly-valued or over-valued.

Today, it is at best fairly-valued as the sales and EPS numbers show NO sign of improvement.

This is VERY poor investment advice!
Pass!

[This Game is So Rigged]

My work shows razor thin margins and a loss of $5 per share this year. With almost no cash (after burning through the $100MM pref from last year); I expect another dilution shortly.

In my opinion, this is the worst of all the home builders. No upside because of limited footprint - and bk on the downside.


Disclosure - I'm short of MHO

[Saj]

You guys are right, the company is losing money. But consider for an instant a company that has $50 of real estate, and loses $1 a share. If you only look at the earnings, you may value the company under $10 / share. But if you consider that in the long term they will realize value from liquidating the real estate, there may be value to be had in such a company.

That's the vantage point from which I'm arguing MHO...you guys are absolutely right about the earnings being poor.

[This Game is So Rigged]

Saj, the problem is that $40 (not $50) of real estate on the books was primarily puchased between '04 and '06 - currently dirt trades at about .35 on the dollar (so let's be generous and say book is $16). However, the pref-A eats another $7 of that. And the next dilution (which also "increases" book value) - drops the common book to about $9.

I'll cover my short at $5.

[Saj]

Hi Game,

The company has substantial writedowns on its real estate to reflect the fact that they've overpaid (therefore book value is written down). If you're saying the book value is actually 35 cents on the dollar of what they're currently paying, does this mean you feel management is not following GAAP (and are therefore following fraudulent policies?) or am I not understanding you correctly?

[This Game is So Rigged]

Yes Saj,

My belief is that management is not marking real estate to market (as in the case of a bankruptcy sale). Just to where they believe it's "properly valued". Additionally, $100MM of that book value was "artificially&quo... created when they diluted your common shares with Pref-A. My opinion is that they will "create" another $50-100MM of "book value" with another dilution.

Many smart people have been arguing that this isn't a book value story; but a cash flow story. To which I respond, after they produce the cash flow to cover their $160MM of annual SG&A - and burn through all their dirt - what do you own as a shareholder?

They're borrowing your money at 10 cents a share dividend (which is why I don't mind paying your dividends for you) while the stock moves down from $40 to $14.

[Saj]

Hi Game,

I don't actually own the stock, but if you have shorted it down since 40 you have done well. How low do you expect it to go?

You're right they pumped up book value with pref shares, but I subtracted them in the article for the purpose of calculating common shares.

[This Game is So Rigged]

My belief is that there is zero value in the common. The bond holders and pref-A will most likely get all their money back. I, however, will cover between $3-5 per share; because this stock is so lightly traded - heavily shorted - and easily manipulated upward. If the stock hits $20 again - I'll short more.

Incidentally, I just paid the dividend yesterday (for ex-div 6/27). What a bargain for the shorts!