Uncovering the Hidden Potential of Beazer Homes: A Look at Their Q1 Results, Future Growth, and Undervalued Stock (NYSE:BZH)

Summary

Beazer Homes USA (NYSE:BZH) reported weak results for Q1 2024, including lower revenues, lower earnings per share, negative free cash flow, and lower EBITDA. Q1 is typically a weak period for Beazer Homes and they guided these results at their last conference call. Here is a quick recap of Q1 results:

• Net income from continuing operations of $21.7 million, or $0.70 per diluted share, compared to net income from continuing operations of $24.4 million, or $0.80 per diluted share, in the fiscal first quarter of 2023
• Adjusted EBITDA of $38.0 million, down 19.4%
• Homebuilding revenue of $380.9 million, down 14.2% on a 10.8% decrease in home closings to 743 and a 3.8% decrease in average selling price (ASP) to $512.7 thousand

Also noted in the recent conference call, 40 closings were pushed into January due to a cyber-attack on one of its settlement service providers. Looking at Beazer Homes average selling price this would be about 5% of sales for the quarter.

The weak results should not be overly surprising as mortgage rates increased to 8% last quarter and demand fell. But even with demand falling, the supply of existing homes for sale probably fell even more keeping a nice balance to the new home markets. Very few homeowners are willing to trade their 3-4% mortgage for an 8% new mortgage.

The Good news

First and foremost are the rapidly falling mortgage rates. As of Feb. 1st, we are now down to 6.63%. This is a great start for the spring home-buying season. As for Beazer Homes, management has very good news for investors – 2024 and 2025 guidance:

• Net new orders of 823, up 70.7% on a 50.4% increase in orders per community per month to 2.0 and a 13.5% increase in average community count to 137
• As it relates to our goal to have more than 200 active communities by the end of fiscal ’26, we closed the quarter with 136 active communities, up 14% versus the prior year. By the end of the year, we expect that number to be above 155, or about 15% annual growth, and to be positioned for similar growth in both FY ’25 and ’26.
• In support of these efforts, our land spend in the quarter was almost $200 million, up 73% year-over-year

As we can see from these numbers, Beazer Homes negative free cash flow was due to the large increase in land and land development spending to achieve their robust growth targets. Community count is a key metric for new home builders and a good proxy for sales growth. In 3 years, the community count will grow from around 130 to 200 active selling communities, over 50% growth.

New orders are growing, the community count is increasing, mortgage rates are decreasing and the housing market has a very limited supply:

“Low existing housing supply is limiting options for prospective buyers and is keeping home-price growth elevated, resulting in a one-two punch that continues to constrain home purchase activity,” said Joel Kan, an MBA economist.

Jan 31st 2024 CNBC.

The market reaction

Well, not good, an 8% drop in Beazer Homes stock price. We think the reason may be the move for growth instead of returning money to shareholders in the form of share buybacks or dividends. While I have argued that since Beazer Homes trades well below its book and liquidation values, buying back shares makes a lot of sense. But with the current setup of falling interest rates, and continued lack of housing supply, growth may be the better option. A more visual depiction:

As we can see from above, with available housing units at record low levels, now is the proper time to focus on growth. Beazer Homes three-year growth strategy fits in nicely with the current supply/demand in the housing markets.

Beazer Homes is also funding this growth from its cash flows. Even this past quarter, with a large increase in investment in land, their long-term debt dropped again, now down to $975m – the lowest level of debt in the past 10 years.

2024 expectation and valuation

As we can see above, Beazer Homes is guiding for $4.5 of EPS in 2024. We feel this is too low. Our estimate is $5 of EPS. For fiscal year 2023, Beazer Homes average selling price was $518K, a 7% increase from the prior year.

From the conference call on Feb 1st, CFO David Goldberg:

Turning to our full year, we expect more than 4,700 closings, reflecting at least 10% annual growth and an ASP of about $510,000. Given our margin expectations for the second quarter, our first half gross margin should be between 21.5% and 22%. We think that’s also representative of where we’ll be for the full fiscal year.

So we can see that Beazer Home is forecasting a slight fall in average selling prices, but a nice jump in unit sales. We are modeling an increase in average selling prices of about 3-4%. This is due to the above-mentioned dynamics of lower mortgage rates and the continued lack of housing supply. Also, recent estimates from other experts are signaling higher selling prices:

Zillow just raised its home price forecast, seeing a 3.7% jump in 2024

From Zillow on Jan 25th

US home prices are projected to increase 5% this year, up from the previous forecast of 1.9%, Goldman Sachs Research’s Roger Ashworth, senior strategist on the structured credit team, and analyst Vinay Viswanathan write in the team’s report. In 2025, prices are expected to rise 3.7%, compared with the earlier forecast of 2.8%. Those forecasts are underpinned in part by signs of momentum in housing prices.

From Goldman Sachs Intelligence Jan 24th, 2024:

So while Beazer Homes is forecasting a drop in prices, Zillow and Goldman are seeing prices rise from 3.7-5%. So to be conservative, we are modeling in a 3% rise in selling prices for 2024 for Beazer Homes, or about $530K. This increase in boost 2nd half 2024 margins and gets us to a $5 per share of earnings.

Beazer Homes Valuation

For Homebuilders, we can use net asset value, or book value as a valuation metric since almost all the book value is land, homes for sale, and tangible assets that could be liquidated within a year. Let’s look at two other smaller public home builders Tri Pointe Homes (TPH), and M/I Homes (MHO):

So their Price to Book is 1.15, and 1.38, respectively. Also Price to earnings of 8-10. Let’s look at Beazer Homes current valuation:

We see the price to book of .8 and the price to earnings of 6 – both significantly lower than its peers, even with Beazer Homes growing their communities at a faster pace. We see this as another deep-value play as we did for Olympic Steel (ZEUS) in 2021, our top pick for that year and up over 350% since then.

Book value at the end of 2024 will be over $42 a share in our modeling. Currently, the share price is 17% below Beazer’s home book value. With their growth projects and market trends, we feel Beazer Homes should be selling at a 15% premium to book value as is Tri Pointe Homes. This gets us a $48 price target for 2024.

Investor Risks

Our continued risk would be the Federal Reserve keeping rates too restrictive in 2024, sending the US economy into a recession. This could lead to large-scale layoffs and a lower demand for home purchases. But judging from the recent jobs data and reports, we feel this is unlikely. The Fed may not cut rates very much in 2024, but the job market is so tight, and wages rising faster than inflation, that consumers have plenty of firepower to purchase a new home.

Another risk is Beazer Homes market cap of still less than $1B. This would now be considered a small-cap, or even micro-cap stock. With large-scale index investing, only a small handful of the largest-cap stocks are seeing price increases. This trend of underinvesting in small publicly traded forms could keep the stock price low.

Investor Takeaways

Beazer Homes is the only publicly traded home builder trading below its book value and liquidation value. With its much-improved balance sheet and growth, this below-market valuation is no longer valid.

Also, the home-building sector continues to have strong secular tailwinds, as the supply of new homes has lagged behind new household formation for many years.

For these reasons, we have continued our strong buy rating on Beazer Homes. Our 2024 price target is now $48 a share, about a 60% increase from the current stock price.