Forestar Group Q3 2023 Earnings Call Transcript

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Provided by Quartr
July 20, 2023

There are 9 speakers on the call.

Operator

Afternoon, and welcome to Forestar's Third Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. Please note this conference is being recorded. I will now turn the call over to Katie Smith, Director of Finance and Investor Relations for Forestar.

Speaker 1

Thank you, Paul. Good afternoon, and welcome to the call to discuss Forestar's 3rd quarter results. Thank you for joining us. Before we get started, Today's call includes forward looking statements as defined by the Private Securities Litigation Reform Act of 1995. Although Forestar believes any such statements are based on reasonable assumptions, there is no assurance that actual outcomes will not be materially different.

Speaker 1

All forward looking statements are based upon information available to Forestar on the date of this conference call, and we do not undertake any obligation to update or revise any forward looking statements publicly. Additional information about factors that could lead to material changes in performance This is contained in Forestar's Annual Report on Form 10 ks and its most recent quarterly report on Form 10 Q, both of which are filed with the Securities and Exchange Commission. Our earnings release is on our website at investor. Forestar.com, and we plan to file our 10 Q tomorrow. After this call, we will post an updated investor presentation to our Investor Relations site under Events and Presentations for your reference.

Speaker 1

Now, I will turn the call over to Dan Bartok, our CEO.

Speaker 2

Thanks, Katie. Good afternoon, everyone. As always, we appreciate your interest in Forestar and taking the time to discuss our Q3 results. In addition to Katie, I am joined on the call today by Jim Allen, Our Chief Financial Officer and Mark Walker, our Chief Operating Officer. Our solid third quarter results were driven by stronger market conditions.

Speaker 2

Our strategy of continuing to develop lots during the market transition positions us well to capitalize on the increased demand for finished lots from builders. Our 3rd quarter net income increased 18% from the prior year quarter to $46,800,000 or $0.93 per diluted share. Pretax income increased 18% to $62,400,000 And our pre tax profit margin was 16.9%. Consolidated revenues increased 20% $368,900,000 while lot deliveries increased 10% to 3,812 lots. We evaluate each project at local market conditions to determine the appropriate pricing and sales pace to maximize returns.

Speaker 2

We have demonstrated that our unique and flexible business model can quickly pivot based on changing homebuilder demand and market conditions. None of that can happen without an incredible team. Their dedication, passion and expertise allow us to continue putting Our long term value creation goals are the center of every decision we make. Thank you to all of our value team members for your efforts. Jim will now discuss our Q3 financial results in more detail.

Speaker 3

Thank you, Dan. In the Q3, net income increased 18 percent to $46,800,000 or $0.93 per diluted share compared to $39,700,000 or $0.80 per diluted share in the prior year quarter. Consolidated revenues for the quarter increased 20% To $368,900,000 compared to $308,500,000 in the prior year quarter. The current quarter included $10,300,000 in revenue from deferred development projects and $23,800,000 in tracked sales and other revenue. Lots sold in our 3rd fiscal quarter increased 10% to 3,812 lots with an average sales price of $87,700 We expect continued quarterly fluctuations in our average sales price based on the geographic location and lot Our pre tax income increased 18% to $62,400,000 compared to $52,700,000 In the Q3 of last year and our pre tax profit margin this quarter was 16.9% compared to 17.1% in the prior year quarter.

Speaker 3

Our gross profit margin this quarter was 23%, up 4 50 basis points sequentially and down 100 basis points from a year ago. In the Q3, SG and A expense was $26,400,000 As a percentage of revenue, SG and A expense improved 60 basis points to 7.2% from 7.8% in the prior year quarter. We will continue to focus on controlling our SG and A costs while ensuring that our infrastructure supports our business. Mark?

Speaker 4

As for current market conditions, the supply of new and existing homes at affordable price points remains limited And demographics supporting housing demand remain favorable, despite higher mortgage rates and inflationary pressures. Builder incentives have helped raise the affordability gap for many homebuyers and low resale supply is a driver of buyers choosing new construction. Buyers are increasing housing starts and many are focused on buying finished lots. Forestar is a key supplier to many homebuilders And is uniquely positioned to take advantage of the shortage of finished lots for the homebuilding industry. During the Q3, we sold lots to 16 customers, which was a new quarterly high.

Speaker 4

The supply of vacant developed lots, particularly at affordable price points, Continues to be constrained across our footprint. Forestar is focused on developing lots for homes at affordable price points demonstrated by our average sales price of roughly $88,000 While contract availability And materials are still challenging to procure in certain markets, the availability continues to improve. The cost to develop a residential lot has not declined, And we currently do not expect development costs to decrease, given the strengthening demand from builders and the overall inflationary environment. We will continue to be proactive and work with our trade partners to control development cost. Homebuilders are returning to the land market to Secure lots for future growth and home prices have generally stabilized.

Speaker 4

As a result, land prices have not fallen As many expected at the beginning of this year. However, land sellers have been adjusting back to normal contract terms, resulting in more customary due diligence timelines and takedown structures. Jim?

Speaker 3

D. R. Horton is our largest and most important customer. However, we look to continue expanding our relationships with other homebuilders and still have an intermediate term goal of selling 30% of our lots 16% of our 3rd quarter deliveries or 625 lots were sold to other customers, which includes 105 lots that were sold to a lot banker who expects to sell those lots to D. R.

Speaker 3

Horton at a future date. 13% of our deliveries in the prior year quarter or 4 35 lots were sold to 3rd party customers. In addition to growing by expanding our customer base, we have significant runway to grow our market share within D. R. Horton.

Speaker 3

Our mutually stated goal is for 1 out of every 3 homes that D. R. Horton sells to be built on a lot developed by Forestar. Katie?

Speaker 1

Forrester's underwriting criteria for new development projects includes a minimum 15% pretax return on average inventory and a return of the initial cash investment within 36 months. During the Q3, we invested approximately $215,000,000 And in Land Development, of which $190,000,000 was for Land Development and $25,000,000 was for Land. While our investments this quarter were down compared to the prior year quarter, they were up 17% sequentially. We expect our investments in land acquisition and development to increase in the coming quarters. Our lot position at June 30th was 73,000 lots, Of which 53,700 lots are owned and 19,300 lots are controlled through purchase contracts.

Speaker 1

The majority of our own lots were placed under contract to purchase from land sellers before 2021, resulting in an attractive cost basis. At quarter end, we have 7,800 finished lots on hand. We generally expect to maintain a higher inventory of finished lots to meet builder demand. When we agree to lot takedown schedules, there is typically a price escalator built in to compensate us for carrying the assets. We remain intensely focused on managing our development and phases as we strive to deliver finished lots at a pace that matches market demand consistent with our emphasis on capital efficiency.

Speaker 1

We are continuing to target a 3 to 4 year owned inventory of land and lots. 28% of our owned lots are under contract to sell, representing approximately $1,400,000,000 of future revenue. These contracts have $124,000,000 of hard earnest money deposits associated with them. Another 31% of our own lots or subject to a right of first offer to Darryl Horton based on executed purchase and sale agreements. Jim?

Speaker 3

We are retaining significant liquidity and using modest leverage to keep our balance sheet strong, while maintaining our disciplined approach when investing capital. We ended the quarter with approximately $780,000,000 of liquidity, including an unrestricted cash balance of $400,000,000 And $380,000,000 of available capacity on our undrawn revolving credit facility. Total debt at June 30 was $707,000,000 With no senior note maturities until fiscal 2026 and our net debt to capital ratio was 19.1%, down from 32.8 percent in the prior year period. We ended the quarter with $1,300,000,000 of stockholders' equity And our book value per share increased to $25.96 up 13% from a year ago. According to the National Association of Home Builders, project level land acquisition and development loans continue to become more expensive, which directly impacts the majority of our competitors.

Speaker 3

Forestar's capital structure is one of our biggest competitive advantages and it sets us apart from other land developers. Other developers generally use project level development loans, which are typically more restrictive, have floating rates and create administrative complexity, particularly in a rising rate environment. Our bonds provide us with operational flexibility and fixed cost debt, while our strong liquidity allows us to take advantage of attractive opportunities when they arise. Dan, I will hand it back to you for closing remarks. Thanks, Jim.

Speaker 5

I am

Speaker 2

pleased with the Forestar team's execution during our 3rd fiscal Quarter. They delivered growth and strong profitability, allowing Forestar to maintain double digit returns. I'm even more pleased with how well we are positioned and the strength of our balance sheet. Our strong balance sheet and ample liquidity Give us the flexibility to invest in land opportunities that will drive our future growth and maintain an appropriate level of finished lots and inventory We are the market leader in a highly fragmented and undercapitalized industry And we are uniquely positioned to take advantage of the strong demand for finished lots by homebuilders. We will continue to aggregate Significant market share over the next few years, while maintaining our disciplined approach when investing capital to enhance the long term value of Forestar.

Speaker 2

Builder incentives have been impactful in bridging the affordability gap for buyers. Forecasts now expect 2023 U. S. Single family housing starts to decline approximately 10% to 20% compared to 2022, An improvement from a decline between 15% 30% forecasted just 3 months ago. While new home starts and sales have been stronger than expected in 2023, mortgage rates are back to peak levels reached in late 2022, which could impact demand as buyers adjust.

Speaker 2

We cannot control the macroeconomic backdrop or directly influence the demand for housing. However, we can and will stay focused on strengthening our platform and increasing operational efficiencies to drive future growth. We are closely monitoring each market, submarket and project as we strive to balance pace and price Our goals have not changed. We still intend to double our market share to 5% over the intermediate term. Looking forward, we believe that Doctor Horton and many other homebuilders We'll continue to shift their focus towards buying finished lots from 3rd party developers instead of self developing.

Speaker 2

We believe our market share gains will accelerate as financing remains expensive and less available for the majority of our competitors. We have a track record of solid execution and are focused on the long term opportunity before us. As appropriate, We will utilize our platform and strong balance sheet to capitalize on opportunities that build shareholder value. With our experienced team that has successfully managed through prior market cycles, we are well equipped to navigate this dynamic environment Paul, at this time, we will open up the line for questions.

Operator

Thank you. At this time, we will be conducting a question and answer session. And the first question today is coming from Truman Patterson from Wolfe Research. Truman, your line is live.

Speaker 6

Hey, good afternoon, everyone. Thanks for taking my questions. First, your largest customer just Suggested that they're positioning for growing potentially kind of 10% in 2024. Your whole net debt to total capital ratio really healthy at 19%. I'm just trying to understand where that metric might need to go, If you all are targeting to potentially support that type of growth as well.

Speaker 2

Well, I think our capital structure as it sits today, we are well positioned to meet that growth for them without additional capital. I think as we said before, we believe we can actually grow our volume at about a 20% annual rate without raising additional Capital, although it would require potentially leveraging some additional debt when appropriate.

Speaker 6

Got you. Fair enough. So kind of maybe that net debt to total cap to hit 20% growth rate might creep up to the 30%, maybe 40% range. On your lot ASP, It was up about 3.5% both year over year and quarter over quarter. And I realize that there's a lot that can impact that metric Geographically, lot size, etcetera, I'm just trying to understand how kind of core finished lot pricing Has been trending recently, given the strong rebound in demand, but Builders bumping up incentives to move some of the homes.

Speaker 3

Well, obviously, you can't I don't draw too many conclusions on prices from our ASP. There's so much Impact from mix, right, in there, so due to lot sizes and geography. So that's always going to be Changing. But I think as far as pricing goes, we on a per front foot basis, I mean, we really haven't seen reductions in pricing. So we've seen pricing hold consistent, probably reflected more in our margins than our ASP.

Speaker 6

Got you. Fair enough. Thank you for your

Speaker 2

time. Thanks, Truman.

Operator

Thank you. The next question is coming from Carl Eckhart from BTIG. Carl, your line is live.

Speaker 5

Thanks,

Speaker 7

everybody. I did want to follow-up, I think, on part of what Drew was asking, Really on margin variability and the $1,400,000,000 you've got in backlog. As you look out the next few quarters or maybe even just the Full year of 2024, are you expecting the gross margin to be somewhat less variable than it has been, either due to mix or just strength in conditions? And do you think you've reached in the past sort of a peak gross margin that you can achieve in the future or you expect it to go above your last Brian Peek?

Speaker 2

That's a tough one. We always talk about returns more than margins. Again, it's really about maintaining the appropriate pace and meeting the builders' demands. What's really been interesting over the last several quarters There's no really as we've dialed in on a project by project basis, the same as the builders do. And there's been some cases where we've had to make Price adjustments and reduced margins.

Speaker 2

There's also been occasions where we've been able to increase price and increase margins. So I think it's going to be lumpy. Hopefully, we haven't peaked. Hopefully, there's some better margins ahead. But development costs aren't Look to be coming down.

Speaker 2

Land costs don't look to be coming down. I think there's going to be pricing pressure. We're just going to have to see how that plays out on a project by project basis.

Speaker 7

Thanks, Dan. And then can you talk a little bit about any regional trends really over the last two quarters? I think Obviously, in 2022, we had relative strength in the Southeast, Florida, big for you, Carolina is big for you, Texas, with a lot of weakness in parts of the West.

Speaker 2

I would say that Phoenix and Denver, 2 of our markets Where we were seeing kind of late to come back to the market have both rebounded nicely and we're definitely seeing demand for lots in those markets return As we had hoped for, we didn't sell a lot during the last several quarters in those markets because of Really lack of demand and lack of hard starts. I think it really goes back to the builders' inventories, where were they long, where do they need to kind of right size their inventories. And It seems like their starts paces have leveled off and that's kind of on a level and increasing basis again. So hopefully that gives us the opportunity to Continue to be strategic in each of the markets.

Speaker 7

Okay. Thanks very much, Dan. I appreciate it. Thanks, Carl.

Operator

Thank you. The next question is coming from Anthony Pettinari from Citigroup. Anthony, your line is live.

Speaker 8

Hi. This is Ashra Sonan on for Anthony. Thanks for taking my question. Just thinking back to 2022, you saw builder demand kind of pull back on the surge in interest And obviously, housing demand fell. But I was wondering just sort of over the course of this quarter and maybe quarter to date, how responsive has like builder interest in lots been Kind of relative to mortgage rates, as mortgage rates have risen over the past couple of months, have you seen a corresponding cooling of inbound builder demand?

Speaker 8

And then Even more finally, when mortgage rates start to level off for a couple of weeks, do you see builder interest kind of pick up?

Speaker 4

Yes, we're seeing the builders appetite increase, especially for finished lots. I mean, they're all looking for the option lots, they're all looking for finished lots. So today, we're seeing the appetite increase across the board for builders. We're not just our number one customer with D. R.

Speaker 4

Horton, but also with the other builder clients that we have. So we're Receiving more calls, so we have not seen a fall off. Actually, we've seen the opposite, we've seen an increase in demand.

Speaker 8

All right. No, that's helpful. And then I guess in your I think in your prepared remarks, you mentioned that your lots are kind of an attractive cost basis. So I was wondering if you're able to kind of size that Roughly at all, I think maybe in terms of timing like how long before you move through that land? And if so, once that happens, is it kind of a meaningful step down in margin kind of baked in?

Speaker 4

Typically, we underwrite a 12 month development timeframe. Again, it goes to market to market, project by project. It's been interesting in terms of if we elongate that timeline, we've been able to hold some pricing power just because the demand for finished lots has been there. We're We're kind of riding those tailwinds at the moment. But again, we look at the market every time we price lots.

Speaker 4

We don't price our lots upfront. So that's been helpful for us. If we see something in the first, let's say, 4 months or so of development that There's a concern we can consider that when we're pricing our lots. We can't always get back to pricing power to offset the cost increases, but as Dan said, we're not focused Primarily on margin, but protecting our return maximizing our returns.

Speaker 8

Fair enough. Thank you. That's super helpful. I'll turn it over.

Operator

Thank you. The Next question is coming from Mike Rehaut from JPMorgan. Mike, your line is live.

Speaker 5

Hi, guys. Doug Wardlaw on for Mike. I'm taking a step back to the end of last quarter and with your comments on the banking volatility. I just want to know if you had any further color and if there's been any change since That last conversation on the banking volatility's impact on other land developers. If so, Towards the beginning of the previous quarter, did you see any type of material benefit?

Speaker 1

Were you asking about banking volatility? Sorry, you were kind of breaking up.

Speaker 5

Sorry, yes, yes. Just if there is any update on banking volatility's effect on your competitors? And if there was, did you guys see any type of damage there?

Speaker 2

It's more anecdotes that we hear than anything that we have experienced because we don't use Project level financing, but we have definitely heard that other developers, the terms at which they're being quoted to do deals have gotten It's more stringent. Interest rates have clearly risen to do acquisitions development loans for developers. And So again, the anecdotes are they are having a more difficult time, in some cases, not being able to get the loans That they would have needing more equity to balance out and paying higher interest rates.

Speaker 5

Got it. So nothing material enough outside of any

Speaker 2

Yes. I would say nothing in addition to that.

Speaker 5

Got it. Thank you.

Operator

Thank you. There were no other questions at this time. I would now like to hand the call back to Dan Bartok for closing remarks.

Speaker 2

Thank you, Paul. And thank you to everyone on the Forestar team for your focus and hard work. I'm proud of the results the team achieved this quarter. We will stay disciplined, flexible and opportunistic as we continue to consolidate market share. We appreciate everyone's time on the call today and look forward to speaking with you again in November to share our Q4 fiscal 2023 results.

Speaker 2

Thank you.

Operator

Thank you. This does conclude today's conference. You may disconnect your lines at this time. Have a wonderful

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