M.D.C. Holdings (MDC) has two primary operations: Homebuilding and Financial Services. The company’s Homebuilding business purchases ready-to-build lots, or develops lots to the necessary extent, for the construction and sale of single-family detached homes.
The company aims to sell its homes to first-time move-up homebuyers under the name “Richmond American Homes.” Additionally, its Financial Services segment originates mortgage loans principally for the company’s homebuyers. It also provides insurance coverage. I am bullish on the stock.
Industry Landscape
The COVID-19 pandemic had a major impact on the U.S. economy between 2020 and 2021, shaking consumer demand, the financial markets, and employment levels. While the homebuilding industry usually requires a stable trading environment and macroeconomic outlook to yield favorable results, surprisingly enough, demand for homes skyrocketed amid the pandemic.
This was due to the working-from-home economy igniting demand for new homes and home renovations. With home buyers still taking advantage of low mortgage rates at the time, home builders like M.D.C. experienced a fantastic trading environment over the past couple of years.
However, concerns over the industry’s outlook have spooked investors, which has resulted in all related stocks, including shares of M.D.C., plummeting.
With unease over an uncontrolled inflationary environment likely to adversely impact consumers’ purchasing power and an uneasy macro environment over food and energy costs that could cause the economy to contract, investors have become increasingly nervous over the future prospects of companies in the space such as M.D.C.
Additionally, after years of historically low mortgage rates, buyers are now being met with elevated financing costs for home purchases, as the average rate on the 30-year fixed-rate mortgage has advanced roughly 200 basis points year-to-date.
On the one hand, the current mortgage rates remain appealing from a long-term historical perspective. On the other hand, it is realistic to anticipate that this move higher will have a near-term impact on M.D.C.’s business as buyers adapt to this new reality.
In any case, M.D.C. has managed to retain strong momentum from the pandemic’s boost, with its results not only continuing to flourish, but its future home sale projections also remain quite optimistic.
Strong Momentum Retention
M.D.C.’s Q1-2022 results illustrated the company’s strong momentum coming off of the pandemic, with home sale revenues growing 19% year-over-year to $1.24 billion. The increase in revenues was mainly powered by a 3% rise in unit closings and a 16% rise in average selling prices.
With economies of scale kicking in amid a robust top-line growth, net income ended up at $148.4 million, or $2.02 per diluted share, an increase of 34% from $110.6 million, or $2.51 per diluted share, in the comparable period last year. Specifically, net income was stimulated by a 380 basis point gross-margin expansion to 25.7% as a result of the growth in home prices surpassing the increase in the costs associated with building materials and labor.
Despite the underlying concerns attached to the homebuilding industry, as mentioned earlier, M.D.C. continues to experience elevated demand for its homes. This is exhibited by the 2% year-over-year growth in unit orders, which amounted to $1.84 billion during Q1. Impressively, this was the case in spite of last year’s unprecedented demand levels.
The company believes that, despite the underlying concerns, strong demand and pricing power will be powered by strong local economies in several of its markets, historically low inventory levels, and encouraging demographics. Equally meaningful has been the lasting lack of existing home supply, which keeps the home construction market ignited.
Accordingly, the company anticipates achieving between 10,500 and 11,000 home deliveries during the year, including 2,400 to 2,600 deliveries in the upcoming quarter. The projected average selling price for Q2-2022’s unit deliveries is expected to be between $560,000 and $570,000. Again, this implies a further improvement from Q1-2022’s average selling price of $556,000, despite the underlying macro concerns.
The Valuation
Based on M.D.C.’s latest results and existing management outlook, I anticipate the stock to deliver EPS close to $10.00. This is notably lower than consensus estimates of $10.77, just to be prudent. Thus, M.D.C’s (forward) P/E stands close to 3.7 at the stock’s current price levels.
If the market’s worries end up being untimely, and the company was to keep producing these levels of profitability moving forward, investors could be looking at extraordinary returns from a valuation expansion push alone. However, even if earnings were to decline substantially in the coming years, M.D.C. appears to be very inexpensively priced.
Wall Street’s Take
Turning to Wall Street, M.D.C. Holdings has a Moderate Buy consensus rating based on one Buy and one Hold rating assigned in the past three months. At $55.25, the average M.D.C. Holdings price target implies 51% upside potential.
Takeaway
What I fancy about M.D.C.’s investment case is that investors don’t have to bet their future return prospects on the stock returning towards a “fair” price. The stock’s current dividend yield of 5.2% should meaningfully reward investors regardless of the stock’s movement in the short-to-medium term.
Following six years of consecutive annual dividend hikes, investors are likely to celebrate another dividend increase this autumn. The latest dividend hike was by 25% to a quarterly payout of $0.50.
With the payout ratio remaining quite low, an equally strong increase could be proven a decisive catalyst for the stock to rally higher, especially with a dividend yield at quite substantial levels already.
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