Meritage Homes Corp. (NYSE:MTH), Scottsdale, after market close Wednesday reported a net profit of $75.5 million, or $1.91 per share, for its fourth quarter ended December 31. Wall Street was looking for a gain of $1.52. The gain compares with a net of $35.6 million ($0.87 per diluted share) in 2017.
The 120% increase in diluted EPS reflects the benefit of an effective tax rate of 18% in 2018, compared to 58% in the fourth quarter of 2017, which included a $19.7 million charge resulting from a revaluation of the company’s deferred tax asset based on lower corporate tax rates enacted in 2017 and effective in 2018, as well as a 1.5 million reduction in diluted share count primarily due to the repurchase of shares in the fourth quarter of 2018.
Highlights for the quarter included:
- Pre-tax earnings increased 9% over the prior year to $91.8 million for the fourth quarter of 2018, from $84.1 million in the fourth quarter of 2017. Pre-tax earnings growth primarily reflects higher home closing revenue and gross margins.
- Home closing revenue increased 8% over the prior year on 11% higher closing volume. Average closing prices for homes were 3% lower in the fourth quarter of 2018, reflecting a mix shift toward more entry-level homes. Fourth quarter closings grew year-over-year in all states but California, where a 21% decline in closings resulted from lower absorptions and fewer communities on average in the fourth quarter of 2018 compared to 2017.
- Home closing gross margin increased to 19.0% for the fourth quarter of 2018, its highest level since 2015, and compared to 18.2% in the fourth quarter of 2017. The improved margins reflect efficiencies in operations and cost controls within an inflationary environment.
- Land closing gross profit of $2.9 million in the fourth quarter of 2017 benefited the prior year’s net earnings, while 2018 land closings included $2.2 million of impairments, resulting in a net loss of $825,000.
- Selling, general and administrative expenses totaled 10.6% of home closing revenue compared to 10.4% in the fourth quarter of 2017. Additional marketing costs and sales commissions were incurred in an effort to stimulate orders in the fourth quarter of 2018, which combined with lower than expected closings and resulted in a loss of leverage of overhead expenses.
- Total orders for the fourth quarter were 8% lower than 2017, which benefited from a rebound in Florida and Houston orders following the hurricanes during the third quarter of 2017. Those events contributed to an unusually strong fourth quarter of 2017 with 20% orders growth and an 18% increase in absorptions over 2016. Traffic levels and gross sales in the fourth quarter of 2018 were on par or better than the previous year, though cancellations increased to 21% of orders from 16% in the prior year, reflecting heightened caution among buyers due to uncertain market conditions. This was especially pronounced in California and Colorado, where absorptions came down to near the company average in 2018, compared to their highly elevated levels in 2017.
For the full year:
- Pre-tax earnings increased 14% for the year to $283.3 million in 2018, from $247.5 million in 2017, primarily reflecting higher home closing revenue and home closing gross margin, similar to fourth quarter comparisons.
- Net earnings of $227.3 million ($5.58 per diluted share) for the year 2018 compared to $143.3 million ($3.41 per diluted share) in 2017, also reflected the benefit of a 20% effective tax rate in 2018 compared to 42% in 2017, and a 1.5 million reduction in diluted shares for the year.
- A 9% increase in home closing revenue over 2017 was due to an 11% increase in home closing volume, partially offset by a 1% decrease in average closing price, due to an intentional shift toward more entry-level communities with higher absorptions.
- A 60 bps improvement in home closing gross margin – 18.2% in 2018 compared to 17.6% in 2017 — combined with the 9% increase in home closing revenue, drove a 12% increase in home closing gross profit and the 14% increase in pre-tax earnings.
- Total selling, general and administrative expenses were relatively flat at 10.9% and 10.8% of home closing revenue in 2018 and 2017, respectively.
- Total orders for the year increased 2% over 2017, with a 2% decline in total orders value, reflecting a 3% reduction in ASP (average sales price) for the year, as the overall mix shifted more towards lower-priced entry-level homes.
At quarter’s end:
- Cash and cash equivalents at December 31, 2018, totaled $311.5 million, compared to $170.7 million at December 31, 2017. The increase was primarily due to a $209 million reduction in total land and development spending in 2018, primarily due to lower average lot cost of new entry-level lots and constrained spending in the second half of the year, partially offset by $100 million of share repurchases.
- A total of $195 million was invested in land and development during the fourth quarter of 2018 to meet expected demand and maintain an adequate supply of lots. Total spending on land and development for the full year 2018 was $812 million, compared to $1.02 billion in 2017.
- Meritage ended 2018 with approximately 34,600 total lots owned or under control, in line with approximately 34,300 total lots at December 31, 2017, translating to 4.1 and 4.5 years supply, respectively, based on trailing twelve months closings. Management targets maintaining a 4-5 year supply of lots. Approximately 69% of total controlled lots were owned and 85% of newly controlled lots in 2018 are intended for entry-level communities.
- The company repurchased and retired approximately 2.58 million shares (approximately 6.4% of outstanding common stock at the beginning of the year) for $100 million during 2018, completing the full amount previously authorized by the Company’s Board of Directors.
- Debt-to-capital and net debt-to-capital ratios of 43.2% and 36.7%, respectively at December 31, 2018, were reduced from 44.9% and 41.4%, respectively at December 31, 2017.
The strong demand early in the year waned in the later months of 2018 as rising interest rates and home prices caused buyers to delay their home purchasing decisions,” said Steven J. Hilton, chairman and chief executive officer of Meritage Homes. “This was most evident in higher-priced communities, while the demand for affordable entry-level homes continued to outpace the move-up market.
“As a result of the pause in home buying activity during the latter part of 2018, our orders for the fourth quarter were down 8% from the strong fourth quarter of 2017. Despite the order declines in the second half of the year, our full year orders were up 2% over 2017. Orders for more affordable entry-level homes expanded approximately 25% to 41% of our full year orders for 2018, up from approximately one-third of orders a year ago,” he continued. “Markets like California, Denver and Dallas, which had experienced the strongest orders pace and home price appreciation over the last few years, were among those most impacted by reduced affordability and changing buyer preferences, as reflected in our fourth quarter year-over-year order trends, and we are in the process of ramping up our entry-level communities in those markets.
“As we continue the transition to more entry-level communities for the Millennial generation, as well as Baby Boomers looking to move down into a new home, we believe we’re well positioned to address what is expected to be the strongest part of the market for the next decade,” concluded Hilton. “While the near-term outlook is less clear, we’re confident in the longer-term opportunities, considering the underlying drivers for housing demand remain strong. Economic and job growth, household formations, higher incomes and strong consumer confidence, combined with relatively low inventories of homes for sale and the prospect of interest rates stabilizing, should continue to drive demand. We expect to share our projections for the full year 2019 next quarter after we assess market conditions with the benefit of the spring selling season.”
