Forestar Group Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
April 18, 2024

There are 8 speakers on the call.

Operator

Good afternoon

Speaker 1

and welcome to Forestar's Second Quarter 2024 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 2

Thank you, John. Good afternoon, and welcome to the call to discuss Forestar's 2nd 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 Forrester believes any such statements are based on reasonable assumptions, there is no assurance that actual outcomes will not be materially different.

Speaker 2

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 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 early next week. After this call, we will post an updated investor presentation to our Investor Relations site under Events and Presentations for your reference.

Speaker 2

Now, I will turn the call over to Andy Oxley, our President and CEO.

Speaker 3

Thanks, Katie. Good afternoon, everyone. I'm also joined on the call today by Jim Allen, our Chief Financial Officer and Mark Walker, our Chief Operating Officer. The Four Star team delivered a solid second quarter with net income increasing 67% to $45,000,000 or $0.89 per diluted share. Our pre tax income increased 64% to $58,900,000 and our pre tax profit margin improved 570 basis points to 17.6%.

Speaker 3

Consolidated revenues increased 11% to $333,800,000 while lots sold increased 10% to 3,289 lots. Forestar achieved a 14.9% return on equity for the trailing 12 months ending March 31, 2024. There is strong demand for developed lots and supply is still constrained in most markets. Forestar's unique blend of financial strength, operating expertise and geographic reach positions us as a leading supplier of finished lots. Over the last 90 days, I've been on the road visiting with our local teams, walking our active projects and assessing our pipeline to better understand our strengths and opportunities.

Speaker 3

We have talented market leaders with a proven track record of producing results. Our current land portfolio offers attractive finished lot positions for builders and our pipeline is full of opportunities supporting our future growth. We remain focused on investing in compelling land parcels, turning our inventory, maximizing returns and consolidating market share in the highly fragmented lot development industry. Jim will now discuss our Q2 financial results in more detail. Thank you, Andy.

Operator

In the Q2 net income increased 67 percent to $45,000,000 or 0 point $9 per diluted share compared to $26,900,000 or $0.54 per diluted share in the prior year quarter. Revenues for the quarter increased 11 percent to $333,800,000 compared to $301,500,000 in the prior year quarter. Lots sold in our 2nd fiscal quarter increased 10% to 3,289 lots with an average sales price of $98,400 Our average sales price was higher this quarter due to the mix of lot deliveries from communities and higher price point markets. We expect continued quarterly fluctuations in our average sales price based on the geographic and lot size mix of our deliveries. Our pre tax income increased 64 percent to $58,900,000 compared to $35,900,000 in the Q2 of last year And our pre tax profit margin this quarter was 17.6% compared to 11.9% in the prior year quarter.

Operator

Pre tax margin for the prior year quarter includes $19,400,000 of non cash real estate impairment charges partially offset by high margin track sales. Our gross profit margin for the quarter was 24.9% compared to 18.5% for the same quarter last year. Gross margin this quarter was positively impacted by non recurring revenue items with unusually high margins, including selling excess sewer capacity and a land contract assignment fee. Excluding the effects of these items in the prior year impairment charges and unusually high margin track sales, our 2nd quarter gross profit margin would have been approximately 22.5% compared to approximately 23% for the prior year quarter. In the 2nd quarter, SG and A expense increased 33% to $29,200,000 primarily due to a 25% increase in the number of employees.

Operator

SG and A expense as a percentage of revenues was 8.7% compared to 7.3% in the prior year quarter. We are pleased with the progress we have made building our team and we continue to attract high quality talent. We remain focused on efficiently managing our SG and A while investing in our teams to support our continued growth. 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 are favorable despite elevated mortgage interest rates and inflationary pressures. Builder incentives continue to bridge the affordability gap for many homebuyers and the lower resale supply continues to be a driver of buyers choosing new construction. Availability of contractors and necessary materials has improved over the past several months, but we have not seen overall reductions in the cost of developing land. We utilize best management practices and work with our trade partners to develop lots in the most efficient way possible. Our development cycle times are still impacted by governmental delays.

Speaker 4

The supply of vacant developed lots, especially at affordable price points, remains constrained across our footprint. And Forestar is uniquely positioned to take advantage of the shortage of finished lots. Our ongoing focus is to develop lots for homes at affordable price points. Homebuilders are competing to secure land and lot positions and many are looking to replace current closed out communities to position for future growth. As a result, we are not seeing any softening in land prices.

Speaker 4

However, our team remains disciplined, flexible and opportunistic on pursuing new land acquisition opportunities. Jim? Doctor Horton is our largest and most important customer. 15% of the homes Doctor Horton started in the past 12 months were on a

Operator

4 star developed lot. With a mutually stated goal of 1 out of every 3 homes Doctor Horton sells to be on a lot developed by 4 star, we have significant opportunity to grow our market share within Doctor Horton. We also continue to work on expanding our relationships with other homebuilders. 6% of our 2nd quarter deliveries or 184 lots were sold to other homebuilders. Katie?

Speaker 2

Forestar's underwriting criteria for new development projects remains unchanged at a minimum 15% pre tax return on average inventory and a return of our initial cash investment within 36 months. We are positioning Forestar to return to strong growth by accelerating our investments in land acquisition and development. During the Q2, we invested approximately $350,000,000 in land and land development, almost double the investment from the prior year quarter. Roughly 2 thirds of our investment was for land development and 1 third was for land acquisition. We still expect our investments in land acquisition and development to total $1,500,000,000 to $1,600,000,000 in fiscal 2024 subject to market conditions.

Speaker 2

Our lot position at March 31 increased 26 percent to 96,100 lots from 76,400 lots a year ago. At quarter end, our total lot position was comprised of 57,400 owned lots and 38,700 lots that are controlled through purchase contracts. Lots owned at March 31 include 6,300 finished lots. We continue to target owning a 3 to 4 year supply of land and lots and remain focused on managing our development in phases to deliver finished lots at a pace that matches market demand consistent with our emphasis on capital efficiency. 31% of our owned swaps are under contract to sell, representing approximately $1,600,000,000 of future revenue.

Speaker 2

These contracts have $145,000,000 of hard earnest money deposits associated with them. Another 30% of our owned lots are subject to a right of first offer to D. R. Horton based on executed purchase and sale agreements. Jim?

Operator

We have significant liquidity and are using modest leverage to keep our balance sheet strong and support our growth objectives. We ended the quarter with approximately $800,000,000 of liquidity, including an unrestricted cash balance of $420,000,000 $380,000,000 of available capacity on our undrawn revolving credit facility. Total debt at March 31 was $706,000,000 with no senior note maturities until fiscal 2026 and our net debt to capital ratio was 16.4%. We ended the quarter with $1,500,000,000 of stockholders' equity and our book value per share increased to $29.09 up 16% from a year ago. During the quarter, we issued approximately 546,000 shares of common stock under our at the market equity offering program raising net proceeds of $19,700,000 Forestar's capital structure is one of our biggest competitive advantages and it sets us apart from other land developers.

Operator

Project level land acquisition and development loans are less available and have become more expensive in recent years impacting most of our competitors. Other developers generally use project level development loans which are typically more restrictive, have floating rates and create administrative complexity, especially in a volatile rate environment. Our capital structure provides us with operational flexibility while our strong liquidity positions us to take advantage of attractive opportunities when they arise. Andy, I'll hand it back to you for closing remarks.

Speaker 3

Thanks, Jim. In closing, I'm incredibly excited to be leading Forestar and I believe there's tremendous opportunity ahead of us. Forestar is uniquely positioned to gain market share in the highly fragmented lot development industry. Continued execution of our strategic and operational plans supported by favorable market tailwinds across our diverse national footprint positions Forestar for further success. We are expanding our team and accelerating our investments in land and development to position the company for consistent long term growth.

Speaker 3

Elevated mortgage interest rates continue to impact affordability, but the underlying fundamentals of a housing shortage remain in place. We believe the low supply of existing homes will continue to drive buyers to new construction and our strong relationship with Doctor Horton provides a clear path for growth. Our guidance for fiscal 2024 remains unchanged. Based on current market conditions, we still expect to deliver between 14,515,500 lots and generate between $1,400,000,000 $1,500,000,000 worth of revenue. We are closely monitoring each of our markets as we strive to balance sales price and pace to maximize returns for each project.

Speaker 3

We are a market leader in a highly fragmented and undercapitalized industry and are uniquely positioned to take advantage of builder demand for finished lots. There is a significant opportunity to expand our presence in the markets we operate in and our goal remains the same, to double our market share to 5% over the intermediate term. We expect 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. With a clear strategic direction, a dedicated team and a strong operational and financial foundation, I'm excited about the future at Forestar.

Speaker 2

Okay, John. This time, we'll open the line for questions.

Speaker 1

Absolutely. Thank you. At this time, we will be conducting a question and answer session. And the first question comes from Carl Reichardt from BTIG. Please proceed.

Speaker 5

Thanks, everybody. First of all, just on the top line guide, if I've got this right, you've got 6,300 lots finished. You need about 8,500 more deliveries this year to get to the midpoint of your guide. So that's a relatively small number of lots you need to finish and move for the rest of the year. Am I assuming correctly that the 6,300 that you've got finished now will all come off this year?

Speaker 5

No.

Speaker 2

Some of those will come off in fiscal 2025 if they have a land takedown structure. So if a builder is buying 25 lots a quarter, that could roll into fiscal 2025.

Speaker 5

So Katie, you finish those up ahead of time, but then they'll do monthly takes to get to that then?

Speaker 2

Right. So let's say we finish 100 lots or 125 lots in a phase, the builder doesn't need that many at the time. So we can structure it on a take down schedule.

Speaker 5

Okay. All right. Thank you. Okay. And then on the margin side, you talked about Jim that normalized margin excluding some one time items this quarter is about 22.5%.

Speaker 5

As you look at what you've got in backlog now and recognize there'll be a lot of timing differential as things bounce around. Does that 22.5% feel like a fairly sustainable margin in terms of your backlog right now? Or is there going to be a big move up or big move down there, do

Speaker 6

you think?

Operator

No, that looks sustainable and it's really in line with what we've been tracking as kind of our normalized margin over the last 10 quarters or so.

Speaker 5

Okay, great. And then if you'll indulge me, Andy, can you tell me sort of in your travels now that you've been there in the seat for a bit, if you look at the markets where you think there's increased demand but very low supply of lots. Where are the markets that you feel that's most true? And then counter to that, where do you think there are markets where perhaps land is much more easily available and the market is somewhat more competitive?

Speaker 3

So I would say that the more constrained land markets would be Florida, Texas, sort of the southern smile markets, and going up into the Carolinas. I don't know that I can really say there's any place where there's an abundance of land. There are probably some secondary markets where that is, but mostly where our markets lining up with Wharton, it's a pretty competitive land marketplace.

Speaker 5

Great. Thank you, Andy. I'll get back in queue. Thanks

Speaker 6

Hey, good afternoon.

Speaker 7

You saw strong lot pricing in the quarter and you talked about some geographic and lot size dynamics that help to drive that. I'm just wondering where you think underlying year over year price appreciation might look like on kind of an apples to apples basis, if you can kind of generalize?

Operator

Yes. We did have one relatively large lot sale of expensive lots during the quarter in California from a project in California that really helped to impact the ASP for the quarter and for the year to date period. So if you exclude that, if you exclude those lot sales, our average selling price for the quarter was really closer to $90,300 which is about 6.5% or so above the same ASP or above the ASP last year. For the 6 month period, I think it brings the average lot price to 93,300. So again about 7% above last year.

Speaker 5

Got it, Got it. And from a

Speaker 7

big picture perspective, it seems like the quarterly performance is like a little bit better than we expected. I don't know if your results were if you'd agree with that or if you performed better or in line with expectations. But in terms of raising or adjusting full year guidance, how do you think about that? And from a big picture perspective, what are the factors that could get you maybe to the high end or the low end of the guide?

Speaker 3

Yes. We're confident we

Speaker 4

can deliver between 14,500 to 15,500 lots based on current market conditions and our lot delivery timing. It sets us up well for a solid year anywhere from 3% to 10% growth. So since really 4Q 'twenty three, we've ramped up our development acquisition activity to be in line with market demand and sets us well sets us up well for future growth in 2025. So right now we're sticking with our guidance and confident we can hit those numbers.

Speaker 3

And we feel good about the quarter. It's a strong quarter. Demand is there. The degree of engagement between our teams and the builders' teams is very high and there's a lot of enthusiasm out in the field.

Speaker 7

Great, great. Maybe one last one if I could. In terms of increasing exposure to 3rd party builders, understanding that will be pretty choppy quarter to quarter. Is there anything you can say about that effort? And are maybe some of those smaller, midsized builders, are you seeing more appetite, less appetite in terms of lot acquisition versus your large customer?

Speaker 3

I think that there's a large appetite across the board. We want to have complementary builders when we have a multiple builder scenario. And particularly in our larger projects where another builder or several builders building different product in different price points help us monetize the asset and produce a return, that's a positive. We'll always focus on Horton, but I think last year we did business with 25 other builders and on a quarter by quarter, you're exactly right. It'll be a little choppy, but we expect to continue to grow that business as well.

Speaker 4

The interest is still strong from all builders across the board.

Speaker 2

Yes. So it's going to be lumpy just depending on which lots deliver in any given quarter, but we sold it to 6 other builders this past quarter.

Speaker 4

Okay. That's very helpful. I'll turn it over.

Speaker 1

The next question comes from Michael Imhof with JPMorgan. Please proceed.

Speaker 6

Hi, good afternoon. It's Mike Rehaut. Thanks for taking my question. So I wanted to discuss and maybe it's a little kind of more difficult question to answer. But with the stock pullback today, I was just curious what type of feedback you've gotten for investors, if there's been any kind of elements of surprise.

Speaker 6

I mean, relative to our estimates, your closings came in below what we were looking for, for the quarter deliveries, which would kind of make the back half shift some of the delivery timing a little bit more to the back half. But similar to your own comments around confidence on the full year, it doesn't seem like there's making those numbers is any too much of a stretch per se. So just kind of curious on the market reaction and if there is any kind of elements of disappointment that you've been able to detect from the investor base?

Speaker 2

We were disappointed too by the reaction to the stock today. We thought it was a really good quarter. Net income was up 67%, pre tax income was up 64% and revenues were up 11%. So we were surprised to see the reaction. Our deliveries might have been a little light from what you had estimated, but we beat on EPS across the board.

Speaker 2

So we don't have any specific feedback that we've received from the investor community today, but we'd be very interested to hear what they're thinking and why the stock traded the way that it did today.

Speaker 4

And based off of lot deliveries in the first half of the year, if you look back at fiscal year 2022 and 2023 and now for fiscal year 2024, they're all approximately a line up about 40% where we end the year. So we've been stacked up against 60% of lot closing at the back half of the year. The positive is we closed 1200 more units, approximately 1200 more units this first half of the year versus the last half. So we feel good.

Speaker 6

Right. No, no, no. Understood. And I'm happy to share any feedback I get over the next couple of days as well. But just wanted a couple of smaller questions if I could.

Speaker 6

I think in answer to one of the prior questions, you had kind of broken out that excluding some items, this current quarter, the average sales price per lot was closer to $90,000 for the Q2. Is that kind of a good number to use going forward for the back half?

Speaker 2

It's kind of I mean, it really just depends on which projects deliver in any given quarter, but our guidance implies ASP for the year of about 96,000.

Speaker 6

Right, right. Okay. And I guess just lastly, maybe more of a bigger picture question around the ability to sell lots to other builders outside of B. O. Horton.

Speaker 6

I mean, noticing that the percent of total owned lots connected to Wharton remain around 60%, a little bit higher than perhaps a couple of quarters in 2023. You still have a fairly high percentage of lots sold to Wharton. Appreciate any type of update around how you're thinking about the next 2 or 3 years in terms of building out other builder relationships and how that might unfold? So

Speaker 3

we look at it, number 1, to grow our footprint within Horton, and then number 2, to grow our overall footprint. So with the stated goal of trying to achieve 1 out of every 3 lots, that is a Horton start requires phenomenal growth by 4 Star. But then as I mentioned earlier, where we look particularly in larger communities where we can position a complementary builder in there to help absorb and monetize the asset. We have a lot of those conversations, but those bigger projects take a long time to bring to market. It takes a long time taking them through entitlement and then delivery of them.

Speaker 3

So that leads to some of the lumpiness on a quarter by quarter basis. But we do expect to grow our 3rd party builder business.

Speaker 2

Yes. Mike, as we get closer to that 30% fulfillment of Horton's needs that we've all talked about multiple times, Once we get closer to that, I think that the 3rd party business will start to grow faster. We just want to make sure that our largest and best customer is well taken care of. But we do believe that ultimately up to 30% of our lots can be sold to other customers.

Speaker 6

Great. One last one if I could sneak 1 in or I can get back in queue. I don't know if there's others behind me.

Speaker 2

That's okay. Go ahead.

Speaker 6

Just on the 26% growth in total controlled lots in the quarter. It was a nice step up this quarter and predominantly through the option lot bucket. Just trying to think about how the timing of how that might flow through. And in particular, I kind of have an eye on this question around lot delivery growth for fiscal 2025, If that would help support, I think a continued goal, correct me if I'm wrong, of at least double digit volume growth going forward?

Speaker 4

Yes. We're continuing to manage our business market by market, project by project. So trying to deliver finished lots at price and pace that meets demand. I mean back to land acquisition that can vary just based off the project in terms of entitlement and timing. And so across our landscape, the specific it gets down to the division in that project and what their goals are to expand their business model.

Speaker 4

As Andy said earlier, just penetrating the markets that we're currently within. I don't know that we can actually put a timeframe on that, but a lot of it's got to do after we acquire the lots or cycle times and getting those deliveries to market. So we do put some cushion in there, But at the end of the day, there's no specific way based off market to market, project by project of how we can put those in the queue to map those out.

Speaker 2

Yes. And so of the $1,500,000,000 to $1,600,000,000 that we're going to spend this year, about a third of that will be on land acquisition. And those projects can take anywhere from 12 to 15 months to deliver that first phase. And so we're really growth at that 20% range or maybe even a little bit higher. And we are putting stuff under contract and doing the due diligence process before we bring it on to our balance sheet.

Speaker 2

We've also added to our team to help us to be able to do that faster.

Speaker 6

Great. Appreciate it. Thank you. Sure. We have

Speaker 1

a follow-up question coming from Carl Reichardt with BTIG. Please proceed, Carl.

Speaker 5

Thanks. And Katy, on that point, I wanted to ask about SG and A and recognizing the leverage bounces around with the top line. But is a good run rate to you still sort of $30,000,000 a quarter? When do we get to a point where the staff up is going to have some revenue leverage on it? Or should we expect you to continue to add staff over into through 2025 to support the growth you're talking about?

Speaker 2

So the leverage is going to change quarter to quarter just based on volume. We always see really good SG and A leverage in that Q4. It's not going to stay at stagnant $30,000,000 a quarter. We're continually adding to our team. And so I would expect a step up quarter to quarter.

Speaker 2

But we do think that the business can be managed at that mid single digit SG and A percent on an annual basis. And so we're adding team members in line with that, but we do need to add members that are focused on land acquisition and development so that that way we can double in size.

Speaker 5

Okay, great. Thank you very much.

Speaker 1

Okay. We've reached the end of the question and answer session. I will now turn the call over to Andy Oxley for closing remarks.

Speaker 3

Thank you, John, and thank you to everyone on the Forestar team for your focus and hard work. 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 July to share our Q3 results.

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