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Morningstar | D.R. Horton Has Another Great Quarter; Gross Margin Trending Toward High End of Guidance; FVE to $46. See Updated Analyst Note from 27 Jul 2018

Shares of D.R. Horton surged 11% on July 26 after the no-moat homebuilder reported great third-quarter results. Although we were certainly pleased with D.R. Horton's strong fiscal third-quarter performance, not much surprised us with exception of the firm's home sales gross margin, which came in at 21.9% versus 19.8% in the year-ago quarter. We now think D.R. Horton will likely achieve the high end of its full-year gross margin guidance of 21%. Investor sentiment on homebuilding stocks has been quite bearish this year, so we think D.R. Horton's strong performance helped assuage fears of a slowing housing market, rising mortgage rates, and rising input costs. After reviewing D.R. Horton's third-quarter results, we increased our fair value estimate to $46 per share from $45, mainly due to the time value of money since our last update.

Homebuilding revenue increased over 17% year over year to $4.3 billion, mainly driven by a 13% increase in home deliveries and a 3% increase in price. New orders, a leading indicator of future demand, grew about 12%, and the average selling price of new orders during the quarter was $298,000, about flat with the year-ago quarter. At the end of the quarter, D.R. Horton's backlog of yet to be delivered homes was valued at almost $5 billion, up about 7% year over year. As mentioned above, home sales gross margin was particularly strong, up 210 basis points year over year, due in part to D.R. Horton's ability to offset rising construction costs with price. The firm also continues to realize strong operating leverage; selling, general, and administrative expenses as percentage of sales declined 30 basis points to 8.1%. Homebuilding pretax margin expanded 240 basis points to 13.6%. Management now expects consolidated pretax margin, which also includes D.R. Horton's financial services and Forestar businesses, of 12.7% to 12.9%, versus 12.1% to 12.3% previously.

D.R. Horton's land acquisition strategy continues to shift toward capital- friendly land options. At the end of the third quarter, D.R. Horton owned or controlled 277,700 lots, of which 56% were controlled through option contracts. At the end of fiscal 2017, D.R. Horton controlled 50% of its 249,000-lot land position through option contracts. D.R. Horton's increased use of options should help the homebuilder improve returns on inventory. Indeed, ROI reached about 19% during the third-quarter, and management's mid-term outlook assumes the homebuilder can maintain a 20% ROI.

During the quarter, D.R. Horton spent $18 million to acquire Lexington Homes in Spokane, Washington and Permian Homes in Midland-Odessa, Texas. Based on our math, these acquisitions added 159 homes to D.R. Horton's backlog.