Forestar Group Inc (FOR) 2021 Q3 法說會逐字稿

Good afternoon, and welcome to Forestar's Third Quarter 2021 Earnings Conference Call.

(Operator Instructions)

As a reminder, this conference is being recorded. I will now turn the call over to Katie Smith, Director of Finance and Investor Relations for Forestar.

Thank you, Paul, and welcome to our call to discuss our results for the third quarter of fiscal 2021. 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. 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-K and its most recent quarterly report on Form 10-Q, both of which are filed with the SEC.

This afternoon's earnings release can be found 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.

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

Thank you, Katie, and good afternoon, everyone. In addition to Katie, I am pleased to be joined on the call today by Jim Allen, our Chief Financial Officer; and Jessica Hansen, D.R. Horton's Vice President of Investor Relations.

The Forestar team delivered an outstanding third quarter. We have built our team quickly and they have done an amazing job of executing on our development projects and identifying attractive investment opportunities.

We accelerated our development activities last year. And now that those lots are beginning to deliver, it has put us in a position to capitalize on the significant market demand for finished lots. This resulted in significant revenue growth and margin expansion, creating meaningful value for our shareholders.

Our development teams and contractors continue to execute solidly positioning us for long-term profitable growth. We have delivered over 11,000 lots to homebuilders fiscal year-to-date, enabling us to increase our expected deliveries for fiscal 2021 to between 15,500 and 16,000 lots.

Executing on our plan is delivering measurable results. Our third quarter gross profit margin increased 610 basis points year-over-year to 17.8%. Several factors contributed to this quarter's gross margin improvement. The demand for developed lots remains incredibly strong as homebuilders bolster their inventory positions to meet sales demand.

This, combined with our strategy of pricing lots closer to the time of delivery, enable Forestar to take advantage of favorable market conditions when setting finished lot prices in select markets. We also made further progress in delivering more lots from Forestar source projects, and we continue to reduce our exposure to lot banking.

We are committed to our returns-focused business model, our high-turnover, low-risk manufacturing strategy led us to achieve a 10% return on equity for the trailing 12 months ended June 30, 2021. This was a 390 basis point improvement year-over-year and our fifth consecutive quarter of ROE improvement.

We expect to continue to increase our returns on equity and inventory as our platform gains additional maturity and scale and our team captures increased share in their respective markets.

Jim will now discuss our third quarter results in more detail.

Thank you, Dan. In the third quarter, Forestar's net income increased 56% to $15.8 million or $0.32 per diluted share compared to $10.1 million or $0.21 per diluted share in the prior year quarter. For the quarter, revenues increased 76% from the prior year to $312.9 million.

We sold 3,858 residential lots during the quarter, an increase of 91% year-over-year. The average lot sales price for the quarter was $80,700. 86% of lots sold in the quarter were from development projects, up from 77% in the same quarter in 2020. Lots sold to D.R. Horton during the quarter represented 96% of Forestar's total lots sold, down from 98% in the third quarter of fiscal 2020. We sold lots to 8 builders other than D.R. Horton during the third quarter this year, up from 4 builders in the same quarter last year. Dan?

Our pretax income in the third quarter increased 105% to $21.1 million with a pretax profit margin of 6.7%. As previously announced, during the quarter, we refinanced our 8% senior notes due in 2024 with 3.85% senior notes that mature in 2026. As a result of the redemption, we recognized a loss on extinguishment of debt of $18.1 million. However, the refinancing transaction resulted in substantial interest savings. Excluding that $18.1 million charge, our pretax income increased 281% to $39.2 million and our pretax profit margin improved 670 basis points to 12.5%.

In the third quarter, our gross profit margin increased 610 basis points to 17.8% from 11.7% in the prior year quarter. The improvement was primarily due to increased margins on lot sales from development projects, which was largely driven by capitalizing on the strong demand for finished lots. We continue to expect fluctuations in our gross and pretax margins due to the quarterly mix of our lot deliveries and the timing of tract sales.

SG&A expense as a percentage of revenues in the third quarter was 5.4%, an improvement of 90 basis points from 6.3% in the prior year quarter. We remain focused on efficiently managing our SG&A expenses as we build out our platform to support our significant growth. We believe we will continue to manage our business at a mid-single-digit SG&A percentage. Katie?

Forestar's underwriting criteria for new development projects includes a minimum 15% annual pretax return on inventory and a return of the initial cash investment within 36 months. During the third quarter, our investments in lots, land and development totaled $400 million, of which, roughly 40% was for land and 60% was for land development. For the fiscal year-to-date, our investments in lots, land and development totaled $1.25 billion. We now expect to invest at least $1.6 billion in lots, land and development for the full year of fiscal 2021.

Forestar's lot position at June 30 increased 91% from a year ago to 96,600 lots, of which, 64,200 lots are owned and 32,400 lots are controlled through purchase contracts. Of our 64,200 owned lots, 33% are under contract to sell to D.R. Horton, representing at least $1.6 billion of future revenue. Another 28% of our owned lots are subject to a right of first offer to D.R. Horton under the master supply agreement. Lot source by Forestar continue to grow as a percentage of the company's owned lot portfolio, supporting long-term improvement in our gross margins. Of the company's owned lot position at June 30, 51% were sourced by Forestar, up from 34% a year ago. We are continuing to target a 3- to 4-year owned inventory of land and lots. Jim?

Forestar remains focused on maintaining a strong balance sheet with ample liquidity and modest leverage. We ended the quarter with $470 million of liquidity, including $120 million of unrestricted cash and $350 million of available capacity on our revolving credit facility. Total debt at June 30 was $704 million, and our net debt-to-capital ratio at quarter end was 37.8%.

As previously announced, during the quarter, we amended our revolving credit facility to increase the facility size to $410 million and extended the maturity date from 2022 to 2025. At June 30, stockholders' equity was $970 million, and our book value per share increased to $19.58, up 11% from a year ago. Dan?

Looking ahead, we remain confident in the outlook for our business. Continued execution of our strategic and operational plan, supported by favorable market tailwinds across our diverse national footprint, positions Forestar for further success. Forestar is uniquely positioned to gain market share through housing market and economic cycles in the highly fragmented lot development industry.

Based on our results for the fiscal year-to-date and current market conditions, we now expect to deliver between 15,500 and 16,000 lots, generating approximately $1.3 billion of revenue in fiscal 2021. We are now expecting our pretax profit margin for the full year of fiscal 2021 to be in the range of 11.5% to 12%, excluding this year's $18.1 million loss on extinguishment of debt. Additionally, we expect our tax rate for the full fiscal year to be approximately 25%, which does imply a tax rate of approximately 26% for the fourth quarter.

Before we turn to questions, I'd like to remind everyone of Forestar's investment highlights. We have a unique lot manufacturing business model that is very different from a typical land developer. We have no unentitled land. We are focused on developing lots for the affordably priced housing market. We have a seasoned management team that is experienced in consolidating market share and in navigating through market cycles. We have a strong balance sheet and liquidity position with low net leverage. We have been increasingly profitable and are managing our business to a mid-single-digit SG&A percentage. And most importantly, we have a unique competitive advantage due to our relationship with D.R. Horton, the nation's largest builder. This highly strategic relationship allows us to expand our platform nationally while minimizing risk. To summarize, we are continuing to execute on our plan and are positioned for continued success.

Paul, at this time, we'll now open up the line for questions.

(Operator Instructions)

Our first question comes from Ryan Gilbert with BTIG.

First question is just on, I guess, the overall market. And Dan, I'd appreciate any color or detail you can add on the demand that you're seeing from homebuilders. I think that there's been some concern in the market that homebuyer demand is leveling off a bit and maybe there's a sense that, that might be bleeding back into the land market, although from your results, that certainly doesn't seem to be the case. So just any color that you could give us or details on demand from homebuilders would be helpful.

Yes. As it relates to what the home builders are seeing, I don't really have that strong visibility as to whether they really -- they're really seeing a falloff in demand. What I know is that they have a hunger for lots that seems to be, at this point, at least insatiable.

Our number of finished lots that we have on our inventory actually went down this quarter, even though we delivered really strong lot deliveries. As fast as we can deliver them, they're buying them. And obviously, based on our guidance for the rest of the year, we expect fourth quarter to be a record breaker for us.

So at this point, we're not seeing any lack of demand from homebuilders that want to buy a lot. I think one of their constraints is the ability to get lots to build houses on.

Okay. Great. Second question is just on 2022. I think you've discussed like a 20% sustainable growth rate with no additional capital needed on the balance sheet going forward, and that's kind of how I've been thinking about 2022. But your land bank is up 91% year-over-year, so it seems like you have the lots in place to do better than 20% growth. So do you think you can produce ahead of that growth rate in 2022? Or just any color on 2022 would be helpful.

Yes, at this point, it's probably too early to give any real guidance for next year, although we thought about it a lot preparing for this call. And I'm not backing off that 20%. I feel very good that we will be able to hit that 20% growth rate based on the lots that we have under development today. Obviously, market conditions are strong right now, and we hope that those continue.

But at this point, I feel really good about that 20% guidance, Ryan. And I said, I think next quarter we're going to try to tighten that up and give you some better color going forward.

Okay. Great. And then last one for me is just on pricing. It looks like your average selling price was pretty flat sequentially from the second quarter. I'm assuming that's mostly mix, but maybe you can just talk about what you're seeing in the market in terms of finished lot price appreciation and how that compares to pricing of undeveloped lots.

Yes, it is mix. We are definitely seeing some pricing power. I think that showed up in the margins. As you remember, last quarter, we were probably guiding it down the rest of the year, and we were able to overachieve on that. We are definitely seeing strength, but we really can look at every project on a project-by-project basis and think about the returns that we're trying to achieve and really looking at velocities and making sure that, as we believe there's pricing power there, we're being very careful not to hamper that affordability of the house and lot package.

But again, I felt really good about the quarter. Again, obviously, better than we probably had anticipated for the quarter in pricing power. Really, I am looking forward to seeing what the future brings. As we say, we have a lot of lots under development right now.

Our next question comes from Anthony Pettinari with Citi.

Can you talk a little bit about what drove the change in lot delivery guidance, I guess, 1,000 units at the midpoint? How much of the raised guidance was 3Q deliveries above maybe your internal expectations versus sort of the outlook for the balance of the year?

Yes. I don't know that I have a specific number of what was delivered in third quarter versus fourth quarter. I think it's probably more driven by fourth quarter expectations. There's been a lot of talk in the market, at least from our perspective, of delays in being able to get certain materials. There's been potentially delays in getting projects completed. We are very careful in making sure what guidance we give we're comfortable with. As this quarter has unfolded and we see where we're at in deliveries for next quarter, it made us comfortable in raising that guidance. So I feel really good about what we're seeing for the next quarter.

Okay. That's very helpful. And then in terms of just sort of hitting the higher or lower end of guidance. Do you think it's mostly a function of demand materializing on the part of the builders or maybe just timing? Or is it sort of those maybe labor-permitting, material-related bottlenecks that in terms of kind of driving the greatest risk to the upside and the downside?

Yes. I think the risk of upside versus downside is really on the delivery side. We have not seen any falloff in demand for lots. If anything, I think the demand has increased, which again has given us a little bit of pricing power. So I think it's predominantly based on the ability to complete those projects that we see hitting substantial completion this quarter and being able to deliver those lots.

Okay. That's very helpful. Maybe just 1 quick follow-up. In terms of cycle times, it seemed like you were able to sort of accelerate cycle times in the wake of the pandemic because of some looseness in the labor markets. Obviously, that's probably tightened quite a bit. In terms of cycle times, where they stand now, are they stable, improving, maybe deteriorating? Just any color you can give there.

I think as compared to where they were 6 months ago, we are definitely seeing cycle times extend. Again, you're right, we were able to kind of accelerate cycle times when we really stepped on the gas earlier last year when a lot of people were not. But it's really into lots of things. It's delivery of certain materials. It's the ability to get inspections. It's the ability -- a little bit on weather. I always hate to use weather, but it's been a pretty rainy season in certain parts of the country. So we're definitely seeing an extension, but probably back to more what was normal for us 1 year ago or 1.5 years ago, but extended definitely from earlier this year.

Our next question comes from Deepa Raghavan with Wells Fargo Securities.

Just following up, getting -- trying to get a little bit more clarity on the kind of growth you're experiencing but also trying to manage your operations for that level of growth. Are there any new challenges that kind of cropped up this quarter? You mentioned a little bit of the cycle time, but labor seems like it should be more of a challenge just given the way you're growing. Just curious, anything new that actually cropped up this quarter, any new challenges? And if you can generally talk about how you're managing for this kind of growth, especially with regards to operations, that would be pretty helpful.

Yes. I guess I'll start with the second question or second part of your question first. We have been planning for our growth for quite a while, and we've been staffing up pretty considerably. We've almost doubled our head count from a year ago on really preparing for the volumes that we have today. So from a labor standpoint for Forestar itself, I think we're very well positioned for -- to continue to execute on our business plan. And obviously, we'll need to continue to add staff as we continue down the growth path.

As it relates to our operators and getting projects completed, again, to some extent, I feel very fortunate. We're not really seeing delays, any delays really related to the contractors not being able to get people on the jobs to complete the jobs. We are hearing that they're having more turnover, where people are -- operators are moving to another operator for a couple of extra dollars an hour, but they've been able to replace those people. So we feel good about that. Probably the one thing that I would say, last quarter, I was talking about we're hearing about shortages in material. We are starting to experience some delays in getting things like fittings to put PVC pipe together. We have seen some delays related to concrete allocations, not being able to get full-day pours in on certain projects where you're kind of limited the amount of concrete you can pour.

So I think some of the things that last quarter we were hearing about, we are starting to see some impact of, but nothing that at this point has been dramatic. I think we're trying to stay ahead of the curve. We're making sure materials are ordered earlier in the process than would have normally been appropriate. And part of it is relying on really good contractors. Our customer base is strong, and our contractor base is strong. And we've aligned ourselves with, I think, some of the best people in the various markets. So that has, I think, been very beneficial for us.

Okay. That's helpful. My second question is on the lot price increases. I mean it's kind of flattish, but still, the trajectory is not down. And in fact, it's already at $80,000. Is this where you're starting to see it stabilize a bit at this point in time? Or you think there's enough -- the backdrop is still pretty strong demand-wise and there's still a supply imbalance. So I think, in all fairness, expectation is lot prices have still more to run. They're not stabilizing here. But from your side, are you taking any steps? Are you undertaking any measures to keep that lot pricing, average lot pricing under a certain affordability threshold? How are you thinking about that?

Well, we think about it on a project-by-project basis. We really look at sales velocity that the builders are experiencing in those projects. Or in the case of a new project, what we think is a comparable project. And we try to make sure that we're balancing price versus velocity. At this point, even with an average sale price of a little over $80,000, we still think it keeps us in that affordable price point. An interesting fact is our -- even though our average is $80,000, our median price is closer to $70,000. So over half of our lots that we sell are under $70,000, which, again, I think really sets us up well for that affordable-price house today.

But yes, as far as just trying to manage it, it's probably where we spend a significant amount of time on a project-by-project basis as we're setting prices and trying to negotiate appropriate pricing is making sure that we're keeping velocity to keep our returns high.

All right. My final one. Any updates on how July is trending so far? Just curious, and I'll leave it there.

As far as July, again, we're issuing our guidance today for the full year, which, again, implies a record-breaking quarter for us in lot deliveries. So at this point, as I sit here on July 20, I feel really good about July, and I feel really good about the next 2-plus months ahead of us.

Our next question comes from Truman Patterson with Wolfe Research.

First, I just wanted to touch on your balance sheet and kind of spend going forward. You're approaching that 40% net debt to total capital threshold. Your owned lots, over 64,000, 4 years owned, if you look at kind of '21 closings. I guess going forward, assuming that development work takes up a decent amount of net working capital, right, are you all comfortable going above that 40% threshold? Or should we just expect that your lot acquisition to start to moderate a little bit over the next, we'll call it, 6 to 12 months?

Well, our sales velocity should continue to accelerate. So the need to replace the existing lots will be there. As far as am I comfortable going over 40%, we're really managing to that 40% number. It may trend over a little 40% for a while, but our goal will be to bring it back down. It's still about finding those projects that we believe fit our operating model and our underwriting requirements.

And frankly, it's also a little bit harder to find those with as much other people that are out there trying to bid up the price of land, especially in those smaller shovel-ready projects. There may be just less that fit our underwriting requirements today anyway.

So I feel good about our pipeline. I think that we're going to be very careful in making sure that we're only buying projects that we think are really good solid projects. But again, we're going to guide to that 40%. We're not -- we don't look to exceed 40% for very long or by very much if that happens at all.

Okay, okay. And then you all are finding lots that are hitting your underwriting. There's clearly some lot pricing power in the market right now, very strong builder demand in your markets. When I look back at the past couple of quarters, gross margin in that 18% range, same thing. Just looking at your guidance, it seems like it will be at least in that range. Is it safe to assume just given kind of the tailwinds in the market that this is kind of a new normal that we should see at least maintain out into 2022? Or are there any big items that we need to think about?

We're still maturing our portfolio. I think you're still going to see some fluctuations from quarter-to-quarter. I wouldn't take that 18% as a run rate. I think that what I've now done, at least to myself and I think maybe to you folks as well, is show that we can actually hit 18% more than just once, which is really good. But I wouldn't -- if it was me, I wouldn't be betting that I'm going to do that every quarter for the next umpteen quarters. Hopefully, that will happen. I can't say that it's impossible. But the market is still the market. I got to make those pricings fit the market.

And we were really fortunate when you really think back a year ago and we had those quarters -- was it for our first quarter of the year or maybe last quarter, when we bought a lot of land. It was really outsized for us and before all these prices ran up. So whether it was luck or just we were really smart people, but we bought a lot of land at a really good point in the market and feel really good about the inventory that we have.

And Truman, as you've heard Dan and team say over and over, I mean, the focus is more on returns than it is gross margins. They've reported a fifth consecutive quarter of improvement in ROE. And the gross margin will be what it will be based on market conditions, but they're going to maximize their portfolio to drive the best possible return.

Okay, okay. Fair enough. And then just final one for me. There's been a lot of talk already on the call about very strong demand and builders are basically short lots right now. Just hoping you could give a little bit more color. Are there any markets that you're scaling back investment, just any metros where you perceive as a bit of a frothy land environment? Or are there any markets where you're starting to see or hear builders push back a little bit or their appetite for lots soften a little bit?

I don't think there's really anywhere we're seeing a slow up in demand. When our investor presentation deck gets published and you compare our map against the map last quarter, you'll probably see we have less exposure up in the Pacific Northwest than we did before. And again, further increased exposure in Florida and in Texas. Again -- so our focus has been in the markets that we know we can get velocity and are hopefully not as governmental regulated -- governmentally regulated as other markets where we can have a more plannable and deliverable lot time frame.

So again, it's not for lack of demand. It's more from looking at opportunities and making sure that the projects that we're underwriting we can deliver on. So I say, you will see a less allocation of our dollars on lots into the Pacific Northwest right now.

Our next question comes from Michael Rehaut with JPMorgan.

This is Maggie on for Mike. First, I was hoping to zero in a little bit on the gross margins this quarter. I mean, you listed several factors driving the upside demand, pricing a lot closer to delivery, delivering more Forestar sourced lots. But I was wondering if you could maybe rank order the different drivers of that upside. Maybe give a little bit more color there.

Oh boy, rank order. That's a tough one. But I can say it's probably -- if I had to pick the top 2, it is Forestar sourced transactions where we had -- where we did price earlier in the transaction, and it's just strong market demand. So we happen to be in a position last quarter where we were delivering lots that had been recently priced into the market strength. But again, that -- a lot of that is driven by Forestar sourced transactions versus builder sourced transactions. And again, we're growing our portfolio in that area. Now over 51% of the lots that we own are in Forestar sourced transaction.

Got it. And second, just on SG&A. I know you spoke to kind of a mid-single-digit range. I know in the past, you had talked about maybe being comfortable in kind of 5% to 6% range, so mid-single digits. But as we look forward into '22 and kind of the next few years, can you talk about the ability to continue to see some leverage on that line and how we should be thinking about SG&A over kind of the more medium to longer term?

Yes. I think 5% is a pretty darn good rate in at least the way I was brought up, and I think that we can manage to that. That -- is it going to be 6%? Is it going to be 4%? I think you'll see some variability quarter-to-quarter based on volumes. As far as can it be leveraged further, I think as our platform continues to mature and scale up, I think that you will probably see some leverage, but I don't know that I could quantify that for you today.

Our next question comes from Alex Barrón with Housing Research Center.

I was hoping you could help me understand how sensitive are your prices on the lots relative to the home prices. In other words, if home prices start to move up as they have in the last couple of quarters, how quickly could you reprice your lots? And b, are the lots priced as a function of the home price? Or is there some other metric you guys are using?

Well, I think our -- as far as our ability to continue to move up lot prices, it's probably more based on the builders' margins than it is on the house price itself. Obviously, they're trying to manage with certain margins themselves. And if I can squeeze some of that increased margin out of it, I will.

As far as metrics, we do not -- we don't have any kind of true-up based on a percentage of the house price. That's not the way we're pricing our lots. We do our best to try to get a sense of what the market pricing is in an area. But really, it's focused on project by project, trying to understand that balance between velocity and pricing and hitting that number where we're really maximizing our returns on our invested dollars.

Got it. If I could ask another one, on materials, as you mentioned, builders have been facing various material supply chain issues. And I think I heard you mention concrete. So I was curious if you could give us a sense whether you guys are experiencing shortages of concrete. And if so, is it just in one market? Or is it pretty widespread across the country?

It is really in only certain isolated markets. And where basically a couple of things that we're seeing delays on, and that is, in some places, we are seeing concrete allocations, where you're only allowed so much concrete per day as they're allocating out to their various jobs. But again, it's not widespread. It's only in certain locations.

The other thing that we're seeing, again, more delays on is pipe fitting. We're able to pretty much get pipe. But with the fitting that put the sections of PVC pipe together, there seems to be a shortage of that. My understanding is a lot of that is being manufactured in India. And because of some of the COVID issues in India that those factories have been either closed down or operating only marginally, which has created somewhat of a shortage for those fittings, at least from the suppliers that we're getting things through. But we've been still able to get them. It's -- we're trying -- we learned to order them earlier in the process. But in some cases, we have had some delays in getting them on job sites.

But again, pretty isolated. Some of our contractors inventory more things than others. Some of them only buy to kind of outfit your job. So it isn't that widespread, but they are things that we're seeing.

There are no further questions at this time. I would like to turn the floor back over to Dan Bartok for any closing comments.

Thank you, Paul. And thanks to everyone on the Forestar team for your focus and hard work. It was a great quarter. We look forward to working together to continue growing and improving our operations over the coming years. We appreciate everyone's time on the call today. We look forward to speaking with you again in November to share our fourth quarter results and our full year results. Thank you.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation. Have a wonderful evening.