M.D.C. Holdings may have one of the most liquid balance sheets of the public home builder set, but Wall Street analysts were less than impressed with the company's fourth quarter results, released Feb. 11. An abnormally high cancellation rate, a bloated overhead cost structure, and ambiguous volume projections for the year ahead left a number of analysts feeling shaky about the stock despite its financial management strengths. For full earnings results, click here.
Stephen East, an analyst with Ticonderoga Securities, for example, wrote in a research note, "One must look very hard to find anything good in this [earnings] release. We see good execution on only one Front--community acquisition and growth. Otherwise, there is disappointment on virtually every metric. There are so many issues to address that we believe investors would be well served avoiding this builder for the foreseeable future."
During a related earnings conference call, CEO Larry Mizel acknowledged that despite elements of its balance sheet strength, "we will be judged on our ability to turn profits." He pointed to the elimination of 113 positions during the quarter and reassured call participants that the management team continued to be focused on maximizing gross margins and would increase focus on inventory management.
However, one of the biggest surprises in the quarter was the company's 46% cancellation rate. Management attributed the high level of cancellations to buyers having difficulty either qualifying for financing or selling an existing home. In addition, management pointed to a late third quarter sales promotion, which included a mortgage rate buy down, as a key driver of cancellations in the quarter. The promotion drove roughly 520 new contracts in the third quarter, of which roughly 136 cancelled in the fourth quarter. However, excluding those promotion-related cancelled contracts, Mizel said the company's cancellation rate would have been roughly 32%, which he said was "consistent with last year."
The third quarter rate buy down and other sales incentives contributed to a 180 basis point year-over-year slide in gross margins to 17% as management moved to clear inventory and close out legacy communities.Management also pointed to higher land costs-22.8% of home revenues in 4Q2010 versus 18.3% the prior year-for the margin compression.
However, for most analysts on the call, the margin issue was most related to company's overhead structure. During the fourth quarter, the company's SG&A came in at roughly 24% of revenues compared to a 15% average for the company's peers. Analysts hammered management on this point, asking about additional costs cuts.
Mizel responded by saying, "The work we've done in preparing for the future hasn't been transparent, and some of it hasn't been implemented because of market conditions. We are very aware of our high level of G&A in relationship to others. And as I go back over the decades, we've been a little out of synch with them--sometimes too conservative, sometimes too aggressive."
Moreover, management said some of the higher overhead costs were related to a new enterprise resource system, a technology platform that would drive consistencies, reduce operating cost, and provide more real-time access to operating data. To date, the system has been implemented at corporate headquarters and two divisions.
But with large-scale cost cuts seemingly not on the agenda to help tame SG&A and improve margins, analysts pressured management to detail the kind of volume assumptions they were making. New order volume for the quarter was down 19% year over year.
"We expect 2011 to be a substantial growth period. In the short term, our No. 1 business goal is to return to profitability. It'll take a little bit longer than we hoped ... but we will achieve it," Mizel said.
It's clear that both top-line and bottom-line improvements are expected as the company both increases its overall community count and transitions out of its legacy communities. During the quarter, roughly 45% of closings came from the company's new communities and had margins that, on average, ran about 400 basis points higher than legacy communities. The company ended the year with lots in 130 new communities, which marked an 11% increase in community count; 26 of which were acquired in the fourth quarter alone.