Smith Douglas Homes Corp. benefits greatly from the current macro situation in the US—high interest rates and a shortage of homes. As a home builder, SDHC has a clear demand tailwind for the foreseeable future, and given its differentiated operating model, it is well-positioned to continue capturing demand effectively.
Business Description
Smith Douglas Homes Corp. (SDHC) operates in the homebuilding industry, focusing on the construction and sale of single-family detached and attached homes. The company operates in eight key states: Atlanta, Birmingham, Charlotte, Chattanooga, Huntsville, Nashville, Raleigh, and Houston, which it entered via the acquisition of Devon Street Homes. SDHC went public earlier this year in January.
Current Macro Environment
The current high interest rate environment is favorable for SDHC. The surge in mortgage rates has caused many existing homeowners to delay selling their homes, as they do not want to refinance their mortgages at much higher rates.
According to a study, nearly 60% of homeowners have interest rates below 4%, significantly lower than the current rate of over 7%. This has led to a significant drop in existing home sales inventory, which is now at a near-all-time low.
The Federal Reserve’s stance on potentially supporting more rate hikes if inflation remains high suggests that high mortgage rates are likely to persist. This scenario limits the supply of existing homes, creating a massive tailwind for SDHC, as homebuyers are left with the option to purchase new homes.
As a result, SDHC is expected to see increased demand, driving both revenue and earnings growth.
Differentiated Business Operating Model
SDHC’s unique operating model positions it advantageously compared to other home builders. The company offers a customized build-to-order (BTO) approach to first-time home buyers with shorter build cycle times.
While the industry standard for build time is over 200 days, SDHC achieves a much shorter build time of about 60 days. Additionally, most first-time builders offer only pre-built homes with limited customization options, whereas SDHC provides significant customization, leading to minimal cancellation rates (~10%) and above-average gross margins.
SDHC’s success is largely attributed to its two proprietary systems: Rteam and SMART Builder. Rteam is a production process that allows for collaboration and coordination between SDHC and its trade partners, improving production efficiency by streamlining communication.
This system ensures that every trade partner is accountable for their part of the project, reducing the occurrence of major mistakes later in the project.
SMART Builder is an ERP database that provides data on project starts and closings, trade scheduling, job site prices, and lot-by-lot workstream status. This system allows SDHC to schedule workflow efficiently, improving utilization and translating to higher margins given the fixed cost nature of the labor involved.
Valuation
Based on research and analysis, the expected target price for SDHC is $31. Revenue growth should continue to benefit from the current macro tailwinds, supported by SDHC’s differentiated business model.
Growth projections for FY24 are based on management’s guidance for units sold and pricing. For FY25, similar growth strength is anticipated as the macro situation is unlikely to resolve soon.
Earnings margins are expected to remain flat for the next two years. While pre-COVID margins were in the high single digits, the current macro situation, where demand outpaces supply, should allow SDHC to sustain elevated margins.
SDHC is currently trading at 12x forward PE, near its all-time low. This valuation, combined with the growth outlook, makes the upside attractive even without multiple expansions.
Risk
A strong economy with persistent inflation could trigger wages to grow faster than SDHC can raise prices, hurting margins and dampening earnings. Additionally, management’s plans to expand into adjacent markets carry the risk of slower growth if local knowledge and expertise are lacking, potentially slowing consolidated growth.
Conclusion
Smith Douglas Homes Corp. (SDHC) is well-positioned to benefit from the current high interest rate and low home supply environment. The company’s differentiated business model, enabling short build times and high customization, should allow it to capture demand effectively.
Given the attractive valuation near its all-time low, SDHC presents a compelling investment opportunity.
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Kevin is an experienced business development strategist and content writer specializing in finance and stock market topics. He has a proven track record of driving sales and enhancing communications for small businesses by blending academic knowledge with practical experience to create engaging and accurate content.
