LGI Homes Is Now Fairly Valued
Summary
- LGIH was our favorite homebuilder stock in early March
- Since then, the stock has rallied 35%, making it the best performing homebuilder stock in that time frame
- The valuation is now nearing a cyclical peak, while macro headwinds continue to mount
- We believe now is a good time to start reducing exposure
In early March, we singled out LGI Homes (NASDAQ:LGIH) as a value pick in the roaring homebuilder space. At that time, the stock was materially undervalued relative to its peers due to its dependence on certain oil-based housing markets. Since then, though, things have turned around for LGIH.
After disappointing home closing numbers in March, LGIH roared higher in May after topping Q1 estimates thanks to strength in rising home prices. That was followed by a record number of home closings in June and all of Q2. All in all, the stock is up some 35% since our article in early March.
Although the LGIH growth story has only strengthened since March, we believe now is a good time to start fading the rally due to a capped out valuation.
One of the features we liked about LGIH stock in March was that it was a huge under-performer on a trailing basis. But that is no longer the case. In fact, LGIH's 35% gain since early March makes it the best performing homebuilder stock in the group we follow in that time frame.
The big run-up also eliminates another feature we liked about LGIH stock: its depressed valuation relative to peers. In early March, LGIH stock was trading around 9.5x trailing earnings, while the group traded around 13x to 20x. That is a huge valuation disconnect of more than 35% from the low-end of the group.
Today, though, that is no longer the case. LGIH trades around 12.5x trailing earnings, while the group trades around 14x to 23x. That 35% valuation gap has narrowed to just 12%.
LGIH is also approaching what looks like a valuation peak. We noted in early March that it looked like LGIH was at the beginning of a multi-quarter expansion in the P/E multiple. In early 2016, the stock's P/E multiple crashed to around 9x before rallying to roughly 13x by mid 2016. The same thing has happened this year. In early 2017, the stock's P/E multiple crashed to around 9x and has now rallied to just shy of 13x.
By this same logic, it now looks like the stock is due for some sort of valuation pullback. In mid-2016, the stock couldn't hold a 13x P/E multiple for long, and we think that will be the case here as well.
Overall, we think there is limited upside at these levels and believe the risk-reward profile now skews towards the downside. We realistically believe the company can reach management's target of $4.25 EPS this year. The stock normally trades around 10.5x to 11x trailing earnings. A 10.75x multiple on $4.25 in EPS implies a year-end price target of about $46, roughly 10% higher.
That isn't great return, especially considering the warning signals that the housing market is starting to slowdown. Home-builder confidence is being dragged down by labor and lot shortages. In May, housing starts hit an eight-month low and building permits fell to their lowest level since April 2016. All the while, mortgage rates are rising.
These are all risks to the LGIH growth story. The stock, though, is near a valuation peak, and that implies that any hiccups in the growth story could cause a significant pullback in the stock. For all of these reasons, we feel now is a good time to start unwinding long positions in LGIH.
This article was written by
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
Recommended For You
Comments (5)
623 closings in one month! --- Up 75% from 355 a year ago!1511 closings in one quarter! --- Up 34% from a year ago! --- Up 33% from the previous all-time record!Up just 99% sequentially!And assuming that the price per home continued up 10% or so, revenue will have been up 47% from a year ago, and probably earnings too. And 623 closings, divided by 71 active developments, gives me an absorption rate of 8.8 per development, by far the highest ever! You say "Home-builder confidence is being dragged down by labor and lot shortages. In May, housing starts hit an eight-month low and building permits fell to their lowest level since April 2016." Do you think LGIH confidence has been dragged down. And seeing that they hit those enormous numbers the month after housing starts hit an eight month low, what do you think?How about $5.00 earnings and a PE of 12 = $60 (up 43%). A PE of 12 is really conservative for earnings up 47% year over year, don't you think?Saul
