Meritage Homes Down to Strong Sell - Analyst Blog

On Jun 20, Zacks Investment Research downgraded Meritage Homes Corporation MTH to a Zacks Rank #5 (Strong Sell), given the unfavorable demand trends witnessed by the company in the last few months and a weak outlook for the upcoming quarters.

Why the Downgrade?

Shortage of lots and skilled labor and rising cost of materials have been making things difficult for builders for quite some time now. Meritage too expects higher land costs in 2014. However, despite the strong pricing power in the housing industry, Meritage expects softer pricing in 2014. As a result, the company expects home closing gross margin to remain flat year over year in 2014.

The company has been witnessing slower sales pace in the Western region, one of its strong markets, over the last few quarters. Particularly, home sales in Arizona were sluggish in the last few months. Even housing demand in California and Colorado slowed down in the first quarter 2014 compared to the year-ago quarter. The weak demand trend in the Western region, which accounts for more than 47% of the company's total revenue, resulted in declining order trends in the first quarter of 2014.

Further, the housing data provided by the U.S. Department of Housing and Urban Development and the U.S. Census Bureau for the month of May corroborates the trend. Per the data, housing production declined 16.3% in the West. Even the housing permit data, which is an indicator of future home building activity, declined in the West. As such, Meritage is likely to witness continued weakness in this operating region in the near term.

The company missed both earnings and revenue estimates in the first quarter of 2014 due to slowdown in order trends..

Estimates have been declining ever since the company released its first quarter 2014 results in Apr 2014. During the last 60 days, the Zacks Consensus Estimate for fiscal 2014 declined 11.8% to $3.36 per share while that for 2015 declined 7.6% to $4.16 per share.  

Investors interested in the homebuilding sector can consider stocks like Gafisa S.A. GFA, Toll Brothers, Inc. TOL and TRI Pointe Homes, Inc. TPH. All the three companies hold a Zacks Rank #2 (Buy).