Forestar Group Inc

NYSE:FOR

Earnings Call Transcript 2024-Q2

[Operator]

Good afternoon, and welcome to Forestar's Second Quarter 2024 Earnings Conference Call. [Operator Instructions] 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.

[Katie Smith, executive]

Thank you, John. Good afternoon, and welcome to the call to discuss Forestar's second 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. 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 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 & Presentations for your reference.

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

[Anthony Oxley, executive]

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 Forestar team delivered a solid second quarter, with net income increasing 67% to $45 million or $0.89 per diluted share. Our pretax income increased 64% to $58.9 million, and our pretax profit margin improved 570 basis points to 17.6%. Consolidated revenues increased 11% to $333.8 million, while lots sold increased 10% to 3,289 lots. Forestar achieved a 14.9% return on equity through 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. 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 second quarter financial results in more detail.

[James Allen, executive]

Thank you, Andy. In the second quarter, net income increased 67% to $45 million or $0.89 per diluted share compared to $26.9 million or $0.54 per diluted share in the prior year quarter. Revenues for the quarter increased 11% to $333.8 million compared to $301.5 million in the prior year quarter. Lots sold in our second 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 pretax income increased 64% to $58.9 million compared to $35.9 million in the second quarter of last year. And our pretax profit margin this quarter was 17.6% compared to 11.9% in the prior year quarter. Pretax margin for the prior year quarter includes $19.4 million of noncash real estate impairment charges, partially offset by high-margin tract 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 nonrecurring 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 tract sales, our second quarter gross profit margin would have been approximately 22.5% compared to approximately 23% for the prior year quarter.

In the second quarter, SG&A expense increased 33% to $29.2 million, primarily due to a 25% increase in the number of employees. SG&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&A while investing in our teams to support our continued growth.

Mark?

[Mark Walker, executive]

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. 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 tract closeout communities to position for future growth. As a result, we are not seeing any softening in land prices. However, our team remains disciplined, flexible and opportunistic when pursuing new land acquisition opportunities.

Jim?

[James Allen, executive]

D.R. Horton is our largest and most important customer. 15% of the homes D.R. Horton started in the past 12 months were on a Forestar-developed lot. With a mutually stated goal of 1 out of every 3 homes D.R. Horton sells to be on a lot developed by Forestar, we have significant opportunity to grow our market share within D.R. Horton. We also continue to work on expanding our relationships with other homebuilders. 6% of our second quarter deliveries or 184 lots were sold to other homebuilders.

Katie?

[Katie Smith, executive]

Forestar's underwriting criteria for new development projects remains unchanged at a minimum 15% pretax 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 second quarter, we invested approximately $350 million in land and land development, almost double the investment from the prior year quarter. Roughly 2/3 of our investment was for land development and 1/3 was for land acquisition. We still expect our investments in land acquisition and development to total $1.5 billion to $1.6 billion in fiscal 2024, subject to market conditions.

Our lot position at March 31 increased 26% 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 includes 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 lots are under contract to sell, representing approximately $1.6 billion of future revenue. These contracts have $145 million 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?

[James Allen, executive]

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 million of liquidity, including an unrestricted cash balance of $420 million and $380 million of available capacity on our undrawn revolving credit facility. Total debt at March 31 was $706 million, with no senior note maturities until fiscal 2026, and our net debt-to-capital ratio was 16.4%.

We ended the quarter with $1.5 billion 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 $19.7 million.

Forestar's capital structure is one of our biggest competitive advantages, and it sets us apart from other land developers. 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.

[Anthony Oxley, executive]

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.

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 D.R. 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 14,500 and 15,500 lots and generate between $1.4 billion and $1.5 billion 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.

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.

[Katie Smith, executive]

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

[Operator]

[Operator Instructions] The first question comes from Carl Reichardt from BTIG.

[Carl Reichardt, analyst]

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?

[Katie Smith, executive]

No. Some of those will come off in fiscal 2025 if they have a land takedown structure. So if the builder is buying 25 lots a quarter, that could roll into fiscal '25.

[Carl Reichardt, analyst]

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

[Katie Smith, executive]

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 it is structured on a take-down schedule.

[Carl Reichardt, analyst]

And then on the margin side, you talked about, Jim, the normalized margin, excluding some onetime items this quarter, it's about 22.5%. As you look at what you've got in backlog now, and recognize there will 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 a big move down there, do you think?

[James Allen, executive]

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

[Carl Reichardt, analyst]

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?

[Anthony Oxley, executive]

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 we're -- our markets lining up with Horton, it's a pretty competitive way in the marketplace.

[Operator]

[Operator Instructions] It appears we have a question coming from Anthony Pettinari with Citi.

[Anthony Pettinari, analyst]

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.

[James Allen, executive]

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, 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.

[Anthony Pettinari, analyst]

Got it. Got it. And from a big picture perspective, it seems like the quarterly performance was 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?

[Anthony Oxley, executive]

Yes. We're confident we can deliver between 14,500 to 15,500 lots based on current market conditions and our lot delivery timing. And it sets us up well for a solid year, anywhere from 3% to 10% growth. So since really 4Q '23, we've ramped up our development and acquisition activity to be in line with market demand and it 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.

[James Allen, executive]

And we feel good about the quarter. It was -- 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.

[Anthony Pettinari, analyst]

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

[Anthony Oxley, executive]

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 products and 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 will be a little choppy, but we expect to continue to grow that business as well.

[James Allen, executive]

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

[Katie Smith, executive]

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

[Operator]

The next question comes from Michael Imhoff (sic) [ Michael Rehaut ] with JPMorgan.

[Michael Rehaut, analyst]

It's Mike Rehaut. 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'm just curious what type of feedback you've gotten for investors, if there's been any kind of elements of surprise. I mean, relative to our estimates, your closings came in below what we were looking for, for the quarter or 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 as any too much of a stretch per se. So just kind of curious on the market reaction and if there's any kind of elements of disappointment that you've been able to detect from the investor base.

[Katie Smith, executive]

We were disappointed, too, by the reaction to the stock today. We thought it was a really good quarter. Net income was up 67%, pretax income was at 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. 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.

[James Allen, executive]

And based off of lot deliveries in the first half of the year, if you look back at fiscal year '22 and '23 and now for fiscal year '24, they're all approximately lined up about 40% from where we end the year. So we've been stacked up against 60% of lot closings in the back half of the year. The positive is we closed 1,200 more units, approximately 1,200 more units in this first half of the year versus the last half. So we feel good.

[Michael Rehaut, analyst]

Right. No, no, understood. And I'm happy to share any feedback I get over the next couple of days as well. But just want a couple of smaller questions, if I could. I think in answer to one of the prior questions, you've kind of broken out that excluding some items, this current quarter, the average sales price per lot was closer to $90,000 for the second quarter. Is that kind of a good number to use going forward for the back half?

[Katie Smith, executive]

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.

[Michael Rehaut, analyst]

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 D.R. Horton. I mean noticing that the percent of total owned lots connected to Horton 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 Horton. I 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.

[Anthony Oxley, executive]

So we look at it, number one, to grow our footprint within Horton, and then number two, 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 Forestar. 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. So that leads to some of the lumpiness on a quarter-by-quarter basis. But we do expect to grow our third-party builder business.

[Katie Smith, executive]

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 third-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.

[Michael Rehaut, analyst]

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

[Katie Smith, executive]

That's okay. Go ahead.

[Michael Rehaut, analyst]

Just on the 26% growth in 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 growth, lot delivery growth for fiscal '25, 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.

[James Allen, executive]

Yes. We're continuing to manage our business market by market, project by project. So we're 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 projects in terms of entitlement and timing. And so across our landscape, the specific, it gets down to the division in that project and what our goals are to expand their business model. As Andy said earlier, just penetrating the markets that we're currently within. I don't know that we can actually put a time frame 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.

[Katie Smith, executive]

Yes. And so of the $1.5 billion to $1.6 billion that we're going to spend this year, about 1/3 of that will be on land acquisitions. And those projects can take anywhere from 12 to 15 months to deliver that first phase. And so we're really investing to grow in 2025 and beyond. We do want to get back to high 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. We've also added to our team to help us to be able to do that faster.

[Operator]

We have a follow-up question coming from Carl Reichardt with BTIG.

[Carl Reichardt, analyst]

And Katie, on that point, I wanted to ask about SG&A, recognizing the leverage bounces around with the top line. But is a good run rate to you still sort of $30 million 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 '25 to support the growth you're talking about?

[Katie Smith, executive]

So the leverage is going to change quarter-to-quarter just based on volume. We always see really good SG&A leverage in that fourth quarter. It's not going to stay at stagnant $30 million a quarter. We're continually adding to our team. And so I would expect a step up quarter-to-quarter. But we do think that the business can be managed at that mid-single-digit SG&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.

[Operator]

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

[Anthony Oxley, executive]

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 third quarter results.

[Operator]

This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.