Sell LGI Homes Now And Book Your Profits

Shares of LGI Homes Inc. (Nasdaq:LGIH) enjoyed a rally in the second half of 2015, but the price has dropped since and may be poised to decline even further. As the bust in petroleum prices drags on, LGI Homes may face hits to its bottom line as housing prices decline in areas of Texas, where LGIH has over 50 percent of its inventory.

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(Nasdaq.com)

Stark Home Price Declines

Home sellers are reducing prices and increasing incentives to attract buyers as the oil slump takes a toll on areas such as Houston. Meanwhile, home construction permits declined 26 percent in the third quarter of 2015 compared to the same period in 2014 in the Houston area, while sales of existing single-family homes in December dropped almost 10 percent versus December of 2014.

As a result, home builders are actively working to reverse rising cancellation rates and slowing sales revenues. For example, KB Homes (NYSE:KBH) offered price cuts in several Houston area developments and additional commissions to buyers' agents to thwart the downward trends.

The average single-family home price in the Houston area declined approximately 7.5 percent to the $280,200 range from its record highs in June, according to the Houston Association of Realtors. Local experts and economists point to the slump in petroleum prices as the causative factor, as oil prices have decline from $100 a barrel in August 2014 to $30 and below.

LGI Homes Feels Pressure, Prices Significant Below Average

LGI Homes targets current renters in apartments near its new home developments often comparing low mortgage payments of $700 to $1,000 per month versus rental payments that may be higher.

While the average price of an LGI home rose 15.8 percent in the second quarter versus the same period the previous year, that average price is $186,197, significantly below the average price of a single family home. The company's strategy involves keeping constructions costs low by building simple homes and using standard floor plans repeatedly throughout their developments.

Results Mask Enormous Pressure, Risk

The company performed well last year, with a record 3,404 home closings surpassing its previous record of 2,356 home closings for 2014, representing an increase of 44.5 percent. Even December 2015 had good results with 433 homes closed for an all-time record during one month. In addition, LGIH closed 946 homes in the fourth quarter of 2015, another record. LGI Homes currently has 52 actively selling communities.

Despite this performance, LGI Homes may face strong pressures as the local economies bear the brunt of the plunge in oil prices. While the Houston area has diversified its industrial makeup, it is still primarily based on oil production. LGI Homes also builds in Arizona, New Mexico, Florida, Georgia, North Carolina, South Carolina, Washington and Colorado; however, these additional markets may not be profitable enough to balance out the potential declines in Texas. Moreover, several other housing markets have been identified as overprices, such as Colorado in addition to Texas, according to the Housing and Market Review published by Arch Mortgage Insurance Company.

Petroleum prices tripled between 2009 and 2014, which helped the Texas housing market, especially the Houston market where existing home prices increased 37 percent since 2011. Hopes for a recovery in oil prices were dashed recently when Saudi Arabia announced that the country will not cut production in an effort to impact global demand thus reducing the oil glut.

As the slump in oil prices is expected to continue, not only does LGI Homes face a troubled local economy in Texas, the company holds a significant inventory of approximately 22,000 owned and controlled lots, which represents three to five years of supply based upon previous sales and trends. Should those trends reverse and interest rates rise, the value of the lots may decline while the cost to carry them will increase.

Volatile Stock Performance

The stock price of LGI Homes has seen significant volatility recently. On March 10, 2015, the price reached a low of $13. Then beginning in August, shares rallied to reach a high of $35.54 on December 1. The price declined to $19.49 on February 11, 2016, and shares currently trade at $23.70. (See chart above.)

Conclusion: LGIH Has Further To Fall, Sell Now

As oil continues to fall with no clear reverse in sight, investors might do well to get out of LGIH. Further downside clearly remains.