Monday, June 30, 2008

M / I Homes: A Diamond in the Rough

We saw here that the market values of home builders track reasonably well with their book values, and we saw here that currently most builders are trading at a discount to their book values. M/I Homes (MHO) is one such company on that list, trading at a healthy discount of 58% to its book value. MHO's debt to capital level sits at just 30%, while others on that list are flirting with much higher debt levels. On the surface, MHO appears as though it could be a value play, and warrants a closer look.

Upon further inspection, it turns out that not all shareholder equity is owned by the common shareholders. A good chunk of it is in preferred shares, which trade as separate securities (MHO-A). If we back out the value of the preferreds, the discount to book value changes from 58% to just under 49%, which still remains relatively attractive.

But the question of future writedowns remains a concern for this industry, as we discussed here. MHO is not as geographically diversified as many other home builders, and has a large percentage of its business in Florida, one of the hardest hit areas of the housing crash. In fact, the vast majority of MHO's $22 million in writedowns in Q1 took place in Florida.

But even if MHO requires writedowns of the same magnitude as what they had last quarter ($22 million) for the next four quarters, they would still be trading at a 35% discount to book value for common shareholders. At their slow sales pace of last quarter, they would get through their inventory in about one and a half years.

As an aside, I am a little bit concerned about management excesses. During the real-estate bubble, it seems they went out and bought a rather large airplane. To lower costs, they traded down to a smaller plane last quarter, picking up $9.5 million in the trade. It's a move in the right direction, but nevertheless it seems rather strange that a $500 million home builder requires its own airplane, but perhaps I'm just too nitpicky.

Overall, however, this company appears to have been over-punished by the markets, and as such offers a margin of safety. I would recommend this stock be owned as part of a long-term, well diversified, value portfolio.

Disclosure: None

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