If Meritage Homes CEO Steve Hilton gets his way, he'll have a good story to tell investors and company stakeholders a year from now. Barring any more major housing market convulsions, the Arizona-based public home builder appears poised to make a return to profitability a reality in 2010.
The company's most recent earnings marked a balance sheet swing from red to black for the first time since 2006. Meritage posted a net profit of $43 million, or $1.35 per diluted share, for 4Q2009. Driving most of the positive performance was a $93 million tax benefit resulting from the extended net operating loss (NOL) tax carryback law, which significantly offset the charges that the company booked during the quarter, including $39 million in land impairments and option walkaways plus roughly $12 million in charges related to drywall mediation, litigation, and lease abandonment accruals.
Despite the higher-than-expected charges, a number of housing analysts noted that on a purely operational basis, meaning excluding what one analyst called "extraordinary items such as impairments and one-time accruals," Meritage was technically profitable during the quarter, even if only marginally.
During a related earnings call Jan. 27, Hilton told investors, analysts, and company stakeholders that the stage was set for the company to capitalize in the year ahead on a number of strategic initiatives in land, operations, and sales and marketing management that ultimately will accelerate profitability. In fact, Hilton said Meritage could be looking at significant unit volume growth over the next three to four years, assuming the housing market doesn't take another leg down in the interim.
"I think we could grow at a 15% or 20% clip without a lot of appreciation in the market," he said. "[However,] if the market begins to improve, maybe we can do better than that."
Hilton's confidence in the company's performance going forward stemmed mainly from some of the work its management completed in 2009 that effectively would create a platform for future earnings growth.
First, management focused on restocking the company's lot pipeline with better-located, lower-priced land. In 2009, it spent roughly $182 million on lot purchases, growing its owned lot count by approximately 4,000 lots to around 10,000 total lots. Roughly 75% of those owned lots are finished lots.
"About the only place we aren't buying land today is Las Vegas," added CFO Larry Seay during the call.
Moreover, Hilton noted that Meritage had not only secured lots at the right price but also in the right locations thanks to what he called "strategic market research." Such research is churned out by a propriety market intelligence system developed by the company's director of market research, Phillippe Lord, formerly of both Acacia Capital and Centex. The system essentially earmarks land opportunities by identifying and analyzing geographic areas where a number of positive market metrics, such as decreased risk of house price decline and declining inventory, for example, converge.
With lower-cost lots in stock, Hilton said the company would be able to open new communities that would yield average gross margins of between 19% and 20%, roughly 500 to 600 basis points higher than the average margins on existing communities. Currently 20 of Meritage's 153 actively selling communities are built on low-cost lots, Hilton said. Although Hilton said he didn't expect community count to grow much, he noted that there were plans to open 21 new communities in 2010 to replace closeout communities, which he estimated would account for 40% to 50% of total sales by 4Q2010.
In addition, Hilton said he expected margins to continue to improve in existing communities as cycle times continue to come down. In Las Vegas, for example, the average build time is 40 days. "We're almost able to build the home without paying for it before we close it," Hilton said.
However, Hilton also said he believed a lot of growth could come from increasing absorptions by community. Hilton said Meritage would be ramping up its spec production to ensure that the company had adequate quick-close inventory available for buyers motivated by the extended federal home buyer tax credit, which requires home sales be under contract by April 30 and closed by June 30. On a per community basis, Hilton said that meant increasing specs from roughly 3.5 specs per community to roughly 5.5 specs per community.
Also expected to drive absorptions are a number of new sales and marketing initiatives, including the launch of the company's Simply Smart value-oriented product line, its commitment to building 100% of its homes to Energy Star standards through its Meritage Green program, and its 99-day guaranteed home delivery program.
Sarah Yaussi is executive editor for BIG BUILDER magazine.
Learn more about markets featured in this article: Las Vegas, NV.