M.D.C. Holdings: Pros And Cons Of Investing Now

Aug. 04, 2022 12:51 AM ETM.D.C. Holdings, Inc. (MDC)4 Comments
Bela Lakos profile picture
Bela Lakos
416 Followers

Summary

  • While MDC has posted a year-over-year revenue and net income growth in the second quarter, the declining demand for new units and the increasing number of cancellations are concerning.
  • The macroeconomic environment remains challenging, which may lead to further decline in demand.
  • On the other hand, the safe and sustainable dividend payment, combined with an attractive valuation may appeal to many investors.
  • Due to the near-term uncertainties, we currently rate MDC as hold.
Aerial View of a Construction Site

RichLegg

M.D.C's (NYSE:MDC) stock price has fallen by as much as 38% year to date, substantially underperforming the broader market, which has declined by about 13% in the same time period.

Chart
Data by YCharts

In our opinion, the sell-off is justified due to the current macroeconomic environment. In this article, we will analyse what macroeconomic factors could be primarily shaping MDC’s stock price in the near term, and highlight some of the pros and cons of investing in the firm now.

To start our discussion, we will first take a look at the recently released second quarter financial results.

Q2 Financial results

In the second quarter of 2022, home sale revenues increased 6% to $1.45 billion from $1.37 billion. While this figure alone may sound promising, we have to understand that this increase in home sale revenue was primarily driven by the increase in average selling price of deliveries, which were up 14%, reaching $572,000. On the other hand, unit deliveries were down by 7% totaling to only 2,536 units, indicating a significant decrease in demand compared to the prior year.

Bar chart revenue and income

Revenue and net income (M.D.C.)

Bar chart deliveries and price

Homes delivered and avg. selling price (M.D.C.)

Further, project abandonment expense has also skyrocketed, reaching $15.5 million in Q2 2022 vs. $1.1 million in Q2 2021. This increase in expenses is combined with a 40% decrease in dollar value of net new orders and an increase in the cancellations as a percentage of beginning backlog by 400 basis points to 9.7% from 5.7%.

Bar chart home orders

Net new home orders (M.D.C.)

While we are not particularly impressed by MDC’s financial performance, due to the current macroeconomic environment, the relatively poor performance driven by the decreasing demand was expected.

Macroeconomic environment

First of all, the rapidly increasing interest rate has begun to make mortgages more expensive and less accessible for many potential home buyers.

line chart interest rate

U.S. Interest rates (tradingeconomics.com)

Several economic indicators were in fact pointing to a potentially slowing housing market in 2022, including number of building permits issued, construction spending, existing and new home sales.

line chart permits

Building permits (tradingeconomics.com)

line chart spending

Construction spending (tradingeconomics.com)

line chart sales

Existing home sales (tradingeconomics.com)

line chart sales

New home sales (tradingeconomics.com)

Other macroeconomic factors, like rising inflation and the unfolding geopolitical tension in the Eastern European region, have also had a significant influence on consumer sentiment. In an environment where consumer confidence is low or steadily declining, potential home buyers may be reluctant to make a purchase that requires a large amount of capital and often a large mortgage. They would likely delay buying a new home until their financial outlook becomes more clear and the environment becomes more favorable for them.

While we expect the macroeconomic environment to remain challenging in the near future for both home builders and home buyers, we need to understand whether the current drop in the share price could be a good buying opportunity.

Pros and cons of investing now

By looking at a set of traditional price multiples, MDC appears to be significantly undervalued compared to both its peers and its own historic average.

The following table summarizes some of the key ratios used for valuation purposes.

table of metrics

Valuation (seekingalpha.com)

We can see that both in terms of price-to-earnings and EV-to-EBITDA the firm is trading at a more than 50% discount compared to the sector median and also to its 5-year average. Despite the challenging macroeconomic environment and a slowing demand, we believe that the current valuation appears to be attractive.

Naturally, however, one of the main questions now is: have we seen the bottom yet?

To answer this question, we will consider two elements:

1. Performance during the burst of the housing bubble

The following chart depicts how MDC performed between 2007 and 2010, the period when the housing bubble popped, leading to a financial crisis.

Chart
Data by YCharts

We can see that in this period, at the bottom, the stock price was down by as much as 60% from its peak, reached in 2009. Although, in our opinion, the current situation is not as severe as it was in 2008, we believe that further possible downside risk should not be ignored.

2. Rising interest rates

While interest rates have been already hiked several times, there are still some more ahead. The extent of these hikes are largely dependent on how the inflation rate develops in response to the Fed’s actions. As long as the uncertainty remains high regarding the rate hikes, the demand for mortgages are not likely to increase, which could lead to a further declining demand for new housing units.

For these reasons, despite the attractive valuation, we remain cautious about prematurely recommending to buy the stock.

This is not the end of the story, however. Many investors own MDC for its dividends. The firm is currently paying a quarterly dividend of $0.5 per share, which is equivalent to an annual dividend yield of 5.8%.

Barnhart dividend

Dividend history (seekingalpha.com)

In fact, the firm has been paying dividends each year in the last 27 years. While the payment was constant for a relatively long time, between 2005 and 2018, in the last few years the firm has started to increase the payments, which was driven by the improving financial performance. While the dividend payments were increasing, simultaneously the payout ratio was trending downwards. The current payout ratio of 22.7% appears to be safe and sustainable, even if demand decreases further.

line chart payout

Payout ratio (seekingalpha.com)

Due to these facts, we believe that the stock may be suitable for dividend and dividend growth investors; however, the above discussed potential downside risk should not be ignored.

Key Takeaways

MDC’s second quarter performance indicated a declining demand for new units, which was however to some extent expected due to the challenging macroeconomic environment.

While MDC’s stock price has declined significantly year to date, and substantially underperformed the broader market, the bottom for the stock price may not yet be in.

On the other hand, the stock appears to be attractive from a valuation point of view and it offers a safe and sustainable dividend of almost 6%.

Currently we rate the stock as “hold”.

This article was written by

Bela Lakos profile picture
416 Followers
Petroleum engineer with an enthusiasm for investing, accounting and personal finances.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.

Additional disclosure: Past performance is not an indicator of future performance. This post is illustrative and educational and is not a specific offer of products or services or financial advice. Information in this article is not an offer to buy or sell, or a solicitation of any offer to buy or sell the securities mentioned herein. Information presented is believed to be factual and up-to-date, but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. Expressions of opinion reflect the judgment of the authors as of the date of publication and are subject to change. This article has been co-authored by Mark Lakos.

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