Dream Finders Homes: Tough Road Ahead (NYSE:DFH)

After a blowout quarter, it’s hard to not be very positive about the performance of Dream Finders Homes, Inc. (NYSE:DFH), but in light of economic headwinds, including inflation and rising interest and mortgage rates, it’s getting difficult to believe that the company isn’t going to take some big hits going forward.

Its cancellation rate in the third quarter was 25.5 percent, far above the 13.9 percent in cancellation rates year-over-year, suggesting it could get much worse with the current visibility we have.

So even though the company has been breaking its performance records and logging a huge backlog, it appears to me, it’s going to enter into some tough times, even if it’s able to squeeze one more solid quarter out of the housing market; something that’s not guaranteed, but possible.

The market appears to be in agreement with me, as even after the extraordinary numbers put forth by the company, its share price has done nothing to suggest investors believe its growth trajectory will continue on.

In this article, we’ll look at some of the numbers from its latest earnings report while considering the growing headwinds that will probably interrupt its recently growth cycle.

Latest numbers

Revenue in the third quarter soared to $784 million, up 117 percent from the $361 million in revenue generated in the third quarter of 2021.

Gross margin percentage in the reporting period increased to 18.6 percent, up 260 basis points from 16.0 percent year-over-year.

Net income in the quarter was $70 million, or $0.71 per share, significantly above the $19 million in net income, or $0.20 per share in the same reporting period last year.

EBITDA was $98 million, almost $70 million over the $30 million in EBITDA from 2021’s third quarter.

As of the end of the third quarter DFH had cash and cash equivalents of $124 million, with $38 million of that being restricted cash, down from the $54 million in restricted cash it had last year in the third quarter. That was down from cash and cash equivalents of $227 million it had last year in the third quarter. But including its revolving credit facility, available capita was at $274 million.

The company held $976 million in long-term debt at the end of the reporting period, more than double the $444 million it held at the end of the third quarter of 2021.

The challenge heading into DFH is how is it going to compete with those types of number, especially as the housing market is expected to continue to come under pressure in the months ahead. Barring an extraordinary performance in the months ahead, the comps are going to be extremely difficult to compete against.

In the fourth quarter, if the number of cancellations don’t escalate, the company may have one more solid quarter under the best-case scenario. I don’t think it’ll be able to continue the momentum, but there may be just enough juice left in demand to scratch one more big quarter out before economic forces stand in its way.

Housing downturn and its effect on DFH

The combination of rising inflation and increasing interest and mortgage rates are starting to have a significant effect on the housing market.

With mortgage rates quickly rising, it has brought about accelerating cancellations, which in light of the fact the Federal Reserve is going to continue to increase interest rates, means mortgage rates are going to rise with them. That will definitely happen for the next several months, and could continue on depending on where inflation stands and how the Fed responds to it further out.

DFH said new orders have already been cancelled, to the point they are already down 15 percent year-over-year. I don’t see how that isn’t going to get worse before it gets better over the next few months at least.

Management noted that even under the deteriorating economic conditions, there is still a national shortage of homes. The company believes it is strongly positioned to be a competitive factor for consumers looking for an entry-level or first-time move-up.

While I don’t disagree with the housing shortage, but when it comes to affordable mortgage rates, buyers are only able to make an offer if they can pay the mortgage without sacrificing the rest of their lifestyle. I just don’t see that as an option as economic headwinds remain strong and mortgage rates continue to rise.

When considering new net orders dropped to 1,110 in the third quarter of 2022, against the 1,301 in new orders of the third quarter of 2021, you can see how things are already slowing down, and it’s going to continue to do so.

Combined with the aforementioned increase in cancellation from 13.9 percent in the third quarter last year to 25.5 percent in the third quarter of 2022, and it’s readily apparent the current performance of DFH, as good as it has been, is no longer feasible in a sustainable way.

Conclusion

Nothing can take away from the fact Dream Finders Homes had an amazing third quarter, but it’s my belief that there isn’t going to be an encore, even if there is some momentum heading into the fourth quarter.

The Federal Reserve isn’t going to stop raising interest rates for the next two to three months at least, and that means mortgage rates are going to continue to climb, resulting in the cost to own a home out of reach for a growing number of consumers.

That means even with a housing shortage in the U.S. it’s not going to generate ongoing sales if people can’t afford them.

With cancellations already rapidly climbing and new orders declining, I don’t see anywhere for the share price of DFH to go but down. It will likely be choppy and volatile, but I don’t see what catalyst there is out there that will allow the company to maintain growth momentum.

Like I said, there may be one last hurrah in the fourth quarter based upon momentum, and even for some people looking to lock in a lower mortgage rate before the rise in response to increasing interest rates. But even there I don’t see how DFH will come close to repeating its third quarter performance, even with its backlog, because that backlog is going to shrink as cancellations accelerate.

While the company got a little boost in its share price after the earnings report, it wasn’t a lot when considering what the company did in the third quarter. That suggests to me the market is already starting to price in a weaker performance in the quarters ahead.

Even under stronger economic conditions that would probably happen because of the difficulty in repeating that type of performance. But under these weak housing condition, I see the share price dropping further as the market looks to rising mortgage rates and the negative catalyst that is going to derail housing growth for a period of time.

DFH’s share price will participate in the drop in demand.