The COVID-19 crisis is not over. Elevated unemployment and virus hot spots present a challenge to the economy and home builders. While we remain optimistic that low mortgage rates, years of underbuilding and a shortage of affordable homes will support the housing market, we don’t know how quickly the economy will rebound or how much the pandemic will affect the sentiment of potential buyers if it drags on.
The company should benefit from the experience of Chairman and CEO Larry Mizel who founded the company in 1972. He had probably seen just about everything – until this. We believe he has a good track record of making adjustments to preserve financial strength.
Pretax income came to $126 million. Our 3Q estimate was $102.3 million. Homebuilding pretax income increased 109% to $101.7 million.
Home sales revenue for the third quarter ended September 30, increased 33% from the prior-year quarter, to $1 billion. Our estimate was $920 million. Total revenue, which also includes $36.8 million of Financial Services revenue, was $1.04 billion. Our estimate was $939 million.
The company delivered 2,147 homes, which was a 25% increase from 3Q19. The StreetAccout consensus was 2,086 homes. Consensus was approximately $458 million. The 3Q conversion rate was 43%. That was up from 40% a year earlier.
New unit orders were up 73% to 3,515 homes, with the average number of active communities up by 1% to 193. Absorption, or monthly sales per community, rose 70% to 6.1 homes. The average order price was up 10% to $469,800. Net orders jumped 77% in July, 72% in August and 68% in September.
The cancellation rate was 12% of beginning backlog, down slightly from 15% a year earlier. MDC’s unit backlog rose 41% to 6,511 homes, with a value of $3.08 billion, at the end of 3Q. The increase in the dollar value was 47%. The average backlog home price was up 4% to $472,400. Consensus was for a backlog of 6,496 units.
The gross margin in the home business rose 170 basis points, to 20.5%, helped by price increases across the majority of communities. Our 3Q gross margin estimate was 19%.
The Homebuilding expense rate decreased by 200 basis points to 10.4%, in part because general and administrative expenses were well controlled among strong sales. Our estimate was 9%.
The 3Q tax rate rose to 21.5% from 19.5% a year earlier, because of slightly lower energy tax credits.
The total number of lots controlled was up 8% to 26,830, with 71% owned and 29% optioned. The company significantly slowed approval of building lots in 1Q. MDC said, in the 2Q call, that approvals were beginning to increase.
EARNINGS & GROWTH ANALYSIS
The company’s preliminary plan is to deliver at least 10,000 homes in 2021. We are raising our 1Q21 estimate to $1.20 from $1.15.
Our five-year growth rate is 10%. The company delivered growth of more than 30% per year in 2016, 2017, and 2018. Elevated unemployment may weigh on growth, but we still expect to see a lot of demand for affordable housing after the crisis. There have been years of under production.
FINANCIAL STRENGTH & DIVIDEND
Net debt was 21.5% of capital.
In 2018, MDC had a cash outflow of $7.9 million. In 2017, MDC generated $65 million in cash from operations, down from $116 million in 2016, but better than just $215,000 in 2015 and a cash use of $164 million in 2014. We note that land and land under development are in the operating portion of the homebuilder’s statement of cash flows. The 2018 outflow is attributable to the extra spending on land. Net income in 2018 was $211 million versus $142 million in 2017. Land and land under development was a $150 million use of cash in 2019.
On December 20, 2016, the company paid a 5% stock dividend in which holders received one additional share for every 20 shares they owned. MDC paid an 8% stock dividend on December 19, 2017 and another 8% stock dividend on February 28, 2019. Our database reflects all of the dividend payments as they were actually made rather than on a split-adjusted basis. We are raising our 2021 estimate to $1.60 from $1.32. Our dividend estimate for 2021 represents about 25% of our net income estimate for 2020.
The company has an existing authorization to repurchase 4 million shares of stock. However, it made no repurchases under this authorization in 2014-2018 or in 2019.
MANAGEMENT & RISKS
MDC’s original business. Robert Martin, formerly MDC’s controller, became CFO in May 2015. He replaced John Stephens, who had held the CFO post since 2012.
We are also seeing that some of the hottest housing markets have been rising faster than wages and that affordability is getting stretched.
In the near term, homebuilders may also face shortages of skilled craftsmen, including carpenters, plumbers and electricians, or be required to pay higher wages to attract workers.
MDC shares are up approximately 26% this year. The shares are trading at 9.4-times our 2020 estimate and 7.4-times our 2021 estimate.
The company stock is trading at 1.6-times 3Q20 book value, of approximately $30 per share and above the company’s own three-year historical average of 1.2. The company’s peers are trading in a range of 1.3-1.7-times.