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2Q21 Earnings: 3 Long Ideas Poised for Post-Pandemic Growth

Posted August 20, 2021 at 10:30 am
Matt Shuler
New Constructs

After 2Q21 earnings, long-term tailwinds give these three Long Ideas excellent opportunities to grow profits. This week’s Long Ideas are Meritage Homes Corp (MTH: $111/share), The Hershey Company (HSY: $180/share), and Packaging Corporation of America (PKG: $140/share).

We leverage more reliable fundamental data, proven in The Journal of Financial Economics[1], with qualitative research to highlight these firms whose stocks present excellent risk/reward.

Figure 1: Long Idea Performance: From Date of Publication Through 8/3/2021

Long Idea Performance: From Date of Publication Through 8/3/2021

Source: New Constructs, LLC
Performance measured from the date of publication of first Long Idea report for each stock. Dates can be seen in each company section below. Performance represents price performance and is not adjusted for dividends.

Meritage Homes Has 73%+ Upside

We made Meritage Homes a Long Idea in June 2020 as part of our “See Through the Dip” thesis. Since then, the stock has outperformed the S&P 500 by 6% and still has more upside.

What’s Working: The firm’s 2Q21 gross margin of 27% was the highest in company history. Even as the availability of lots ready for home construction continues to fall, Meritage Homes expanded its community count from 203 at the end of 1Q21 to 226 at the end of 2Q21. In 2Q21, the firm increased its total lots controlled from 43 thousand to 63 thousand, or 48% year-over-year (YoY).

The firm continues to focus on entry-level housing. 81% of the firm’s total orders in 2Q21 were company-defined entry-level homes, which is up from 70% in 2Q20. Meritage Homes typically aims to keep the average sales price (ASP) of entry-level homes within Federal Housing Administration (FHA) mortgage limits which vary by county and can range from $356 thousand to $822 thousand across the U.S. The focus on the lower end of the market has been prudent for the firm. According to the Census Bureau, ~73% of homes sold in 1H21 were priced between $200-$500 thousand. The firm’s ASP on homes closed in 1H21 was $380 thousand.

The COVID-19 pandemic accelerated the migration of people from urban centers to the suburbs, which contributes to long-term demand for entry-level housing. As the firm continues to shift its business to serve this segment of the market, demand for its homes is likely to remain strong over the medium term.

We also expect the influx of institutional investors buying single-family homes to continue driving growth in the housing market.

What’s Not Working: Meritage Homes is struggling to meet elevated comps from 2020 as the number of home orders fell by 2% YoY in 2Q21. However, the firm’s ASP on orders is up 18% YoY in 2Q21, which drove a 16% YoY increase in home order value.

The monthly supply of houses, a ratio of houses for sale to houses sold rose from 3.8 months of supply in December 2020 to 6.3 in June 2021. While the current monthly supply ratio is in line with the historic average since 1963, should the supply of houses continue to rise, Meritage could have a more difficult time selling its inventory without a drop in prices.

Despite Recent Gains, MTH Is Still Priced for Permanent Profit Decline: Meritage Homes’ price-to-economic book value (PEBV) ratio is 0.4. This ratio implies that the market expects Meritage Homes’ profits will permanently decline by 60%.

Below, we use our reverse discounted cash flow (DCF) model to analyze the expectations for future growth in cash flows baked into a couple of stock price scenarios for Meritage Homes.

In the first scenario, we assume Meritage Homes’:

  • net operating profit after-tax (NOPAT) margin falls to 7.4% (ten-year average vs. 13% TTM) from 2021 through 2030, and
  • revenue grows at a <1% CAGR from 2021 to 2030 (vs. consensus CAGR of 17% for 2021-2022)

In this scenario, Meritage Homes’ NOPAT falls by 6% compounded annually over the next decade and the stock is worth $111/share today – equal to the current price. See the math behind this reverse DCF scenario. For reference, Meritage Homes grew NOPAT by 25% compounded annually over the past five years. 

Shares Could Reach $192 or Higher: If we assume Meritage Homes’:

  • NOPAT margin falls to 7.5%, (average from 2015-2019 vs 13% TTM) from 2021 through 2030, and
  • revenue grows at a 12% CAGR through 2022 (below consensus CAGR of 17% for 2021-2022), and
  • revenue grows 2% a year from 2023 – 2030, which is below the average annual global GDP growth rate of 3.5% since 1961, then

the stock is worth $192/share today – 73% above the current price. See the math behind this reverse DCF scenario. In this scenario, Meritage Homes NOPAT falls <1% compounded annually over the next decade. For reference, Meritage Homes grew NOPAT by 15% compounded annually since 2000.

Should Meritage Homes grow profits closer to historical levels, the upside in the stock is even greater.

Figure 2: Meritage Homes’ Historical and Implied NOPAT: DCF Valuation Scenarios

Sources: New Constructs, LLC and company filings

Click Here to Read the Full Article

This article originally published on August 4, 2021.

Disclosure: David Trainer owns SPG. David Trainer, Kyle Guske II, and Matt Shuler receive no compensation to write about any specific stock, sector, style, or theme.

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[1] Our research utilizes our Core Earnings, a more reliable measure of profits, proven by professors at Harvard Business School & MIT Sloan.

Click here to download a PDF of this report.

Disclosure: New Constructs

David Trainer, Kyle Guske II, Sam McBride, Matt Shuler, Alex Sword, and Andrew Gallagher receive no compensation to write about any specific stock, style, or theme.

The information and opinions presented in this report are provided to you for information purposes only and are not to be used or considered as an offer or solicitation of an offer to buy or sell securities or other financial instruments. New Constructs has not taken any steps to ensure that the securities referred to in this report are suitable for any particular investor and nothing in this report constitutes investment, legal, accounting or tax advice. This report includes general information that does not take into account your individual circumstance, financial situation or needs, nor does it represent a personal recommendation to you. The investments or services contained or referred to in this report may not be suitable for you and it is recommended that you consult an independent investment advisor if you are in doubt about any such investments or investment services.

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