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Why D.R. Horton may look at acquisitions after its 3Q14 report



D.R. Horton reports third quarter 2014 earnings per share

D.R. Horton (DHI) reported net income of $113 million, or 32 cents per share, for the third quarter of 2014. Net income decreased 22.5% from $146 million, or 42 cents per share, in the third quarter of 2013. Wall Street estimates were under 49 cents a share, so the number was a sizable miss. The quarter also included an impairment charge of $54.7 million to inventories. This number increased cost of goods sold, which decreased gross margins.

Gross margins and selling, general, and administrative expenses improve

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Gross margins may have peaked, as they decreased 150 basis points on a sequential basis and 280 basis points on a year-over-year basis.  Selling, general, and administrative expenses decreased to 10.6%. Most builders are reporting extremely high gross margins, including Lennar (LEN), PulteGroup (PHM), Standard Pacific (SPF), and Toll Brothers (TOL).

Size and scale matter

The big builders such as PulteGroup, Standard Pacific, Lennar, and Toll Brothers have an advantage over the smaller builders—they’re able to access the capital markets and raise funds very cheaply. The smaller builders are finding themselves almost shut out of the capital markets. This gives the bigger builders a tremendous advantage. The big institutional investors are almost throwing money at these bigger builders, while the smaller guys can’t take advantage of opportunities due to tight credit conditions.

This climate is obviously a recipe for mergers and acquisitions activity. The smaller builders will be driven into the arms of the bigger builders. Also, some of the larger builders may believe merging makes sense.

In fact, we’ve already seen some deals. We saw a wave of mergers in the late 1990s in this sector as it recovered from the mini bust of the late 1980s and early 1990s. D.R. Horton has unrestricted cash of over $930 million and will look at acquisitions as a way to grow. The company also has a convertible bond issue, which is deep in the money and will be converted into stock.


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