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Strategic Buyouts Bode Well for D.R. Horton (DHI), Costs High

Zacks Equity Research

D.R. Horton, Inc. DHI is well poised for growth on the back of accretive acquisitions, robust backlog, and a well-stocked supply of land, lots and homes.

Shares of this TX-based homebuilding company have outperformed its industry in a year’s time. The outperformance was backed by the company’s focus on strategically consolidating market share while growing revenues and profits, generating strong cash flows and returns, along with maintaining a flexible financial position.

However, gross margin compression owing to rising land, labor and material costs, reduced pricing power, along with higher incentives on sales activity raise concerns.

Let’s delve deeper into the factors that substantiate its Zacks Rank #3 (Hold).

Key Growth Drivers

D.R. Horton has been consolidating its market share by fast acquiring homebuilding companies in desirable markets. During first-quarter fiscal 2019, the company purchased homebuilding operations of three private builders for approximately $321 million. In December 2018, D.R. Horton entered Iowa by acquiring Classic Builders, the largest builder in Des Moines. It enhanced its market position in Raleigh, NC by acquiring Terramor Homes. In November 2018, the company acquired Westport Homes, which is among the top five builders in terms of volume in Indianapolis and Columbus, both belonging to the top 50 U.S. housing markets.

Notably, during the first six months of fiscal 2019, the value of net sales orders grew 3% to $8.2 billion (27,847 homes) from $8 billion (26,581 homes) in the corresponding prior-year period. Higher sales volumes in East and Midwest regions reflect its recent acquisitions of homebuilding operations of Terramor Homes, Westport Homes and Classic Builders, which added 119 and 497 net sales orders to the East and Midwest region's results, respectively, in the six-month period ended Mar 31, 2019.

Quarter-end sales order backlog (under contract) increased 6.6% from the comparable prior-year period to 16,890 homes. Backlog value also increased 3.4% from the comparable year-ago quarter to $5 billion. Solid backlog position will help the company to generate higher revenues in the future.

Strong cash position and low debt/capital ratio allowed D.R. Horton to make strategic land purchases even during the downturn, thereby giving it a significant competitive advantage. The company invested $3.8 billion in lots, land and development in fiscal 2018. It has plans to boost investments to replenish land and lot supply in 2019 for supporting revenue growth. The company made investments of $1.1 billion and $740 million in the fiscal first and second quarters of 2019, respectively, in lots, land and development.

Meanwhile, in order to address affordability issues arising from rising home prices amid higher building material costs, as well as land and labor shortages, D.R. Horton is strategically shifting more toward entry-level affordable home buyers. This move seems to be paying off, with the segment experiencing strong demand and limited supply. Notably, first-time homebuyers represented 53% of its closings in second-quarter fiscal 2019, up from 45% in the corresponding quarter of last year.

Key Impediments

Home sales gross margin decreased 30 basis points (bps) sequentially to 21.6% in the fourth quarter of fiscal 2018. In the first and second quarters of fiscal 2019 as well, the metric declined 80 bps and 150 bps year over year, respectively.

For the fiscal third quarter, the company expects gross margin in the range of 19.3-19.8% (down from 21.9% in the year-ago period) due to increased costs, reduced pricing power, higher incentives on sales activity and the impact of purchase accounting. This guidance indicates the lingering impact of competitive incentives that are slowing D.R. Horton’s margin recovery.

Stocks to Consider

Some better-ranked stocks in the same space are NVR, Inc. NVR, PulteGroup, Inc. PHM and Taylor Morrison Home Corporation TMHC, each sporting a Zacks Rank #1 (Strong Buy). You can also see the complete list of today’s Zacks #1 Rank stocks here.

NVR, PulteGroup and Taylor Morrison have solid earnings surprise history, having surpassed the Zacks Consensus Estimate in all the trailing four quarters, with the average being 17.6%, 13.5% and 38.7%, respectively.

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