Forestar Group Inc

NYSE:FOR

Earnings Call Transcript 2023-Q3

[Operator]

Good 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. [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, Director of Finance & IR]

Thank you, Paul. Good afternoon, and welcome to the call to discuss Forestar's third 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 and 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 tomorrow. After this call, we will post an updated investor presentation to our Investor Relations site under Events and Presentations for your reference.

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

[Dan Bartok, CEO]

Thanks, Katie. Good afternoon, everyone. As always, we appreciate your interest in Forestar and taking the time to discuss our third quarter results. In addition to Katie, I'm 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. 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 third quarter net income increased 18% and the prior year quarter to $46.8 million or $0.93 per diluted share. Pretax income increased 18% to $62.4 million and our pretax profit on was 16.9%. Consolidated revenues increased 20% to $368.9 million, while lot deliveries increased 10% to 3,812 lots.

We evaluate each project in local market conditions to determine the appropriate pricing and sales pace to maximize returns. 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 at the center of every decision we make. Thank you to all of our value team members for your efforts.

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

[Jim Allen, CFO]

Thank you, Dan. In the third quarter, net income increased 18% to $46.8 million or $0.93 per diluted share compared to $39.7 million or $0.80 per diluted share in the prior year quarter. Consolidated revenues for the quarter increased 20% and to $368.9 million compared to $308.5 million in the prior year quarter. The current quarter included $10.2 million in revenue from deferred development projects and $23.8 million in track sales and other revenue.

Lots sold in our third fiscal quarter increased 10% to 3,812 lots with an average sales price of $87,000 and $70. We expect continued quarterly fluctuations in our average sales price based on the geographic location and lot seismic of our deliveries. Our pretax income increased 18% to $62.4 million compared to $52.7 million in the third quarter of last year, and our pretax profit margin this quarter was 16.9% and compared to 17.1% in the prior year quarter. Our gross profit margin this quarter was 23%, up 450 basis points sequentially and down 100 basis points from a year ago.

In the third quarter, SG&A expense was $26.4 million. As a percentage of revenue, SG&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&A costs while ensuring that our infrastructure supports our business. Mark?

[Mark Walker, COO]

As for current market conditions, the supply of new and existing homes at affordable price points remains limited. Demographic supporting housing demand remained favorable despite higher mortgage rates and inflationary pressures. Builder incentives have helped race 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 third quarter, we sold lots of 16 customers, which was a new quarterly high. 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 in the overall inflationary environment. We will continue to be proactive and work with our trade partners to control development costs.

Homebuilders are returning to the land market to secure lots for future growth and home prices have generally stabilized. 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 time lines and take down structures. Jim?

[Jim Allen, CFO]

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 to customers other than D.R. Horton. 16% of our third 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 lots to D.R. Horton at a future date.

13% of our deliveries in the prior quarter were 435 lots were sold to third-party customers. In addition to growing by expanding our customer base, we have significant runway to grow our market share within D.R. Horton. Our mutually stated goal is for 1 out of every three homes that D.R. Horton sells to be built on a lot developed by Forestar. Katie?

[Katie Smith, Director of Finance & IR]

Forestar'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 third quarter, we invested $215 million in land and land development, of which $190 million for land development and $25 million 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 30 was 73,000 lots, of which 53,700 lots are owned and 19,300 lots are controlled through purchase contracts. The majority of our own loss 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 agreed to lot take-down schedule, there's typically a price escalator built in to compensate us for carrying the asset.

We remain intensely focused on managing our development in phases as we strive to deliver finished lots at a pace that matches market demand consistent with our emphasis on capital efficiency. We are continuing to target a three to four-year owned inventory of land and load. 28% of our owned lots are under contracted sales, representing approximately $1.4 billion of future revenue. These contracts have $124 million of hard earnest money deposits affiliated with. Another 31% of our owned lots are subject to a right of first offer to D.R. Horton based on executed purchase and sale agreements. Jim?

[Jim Allen, CFO]

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 million of liquidity and including an understated cash balance of $400 million and $380 million of available capacity on our undrawn revolving credit facility.

Total debt at June 30 was $707 million, with no senior note maturities until fiscal 2026, and our net debt-to-capital ratio was 19.1%, down from 32.8% in the prior year period. We ended the quarter with $1.3 billion 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 Homebuilders, project level land acquisition and development loans continue to become more expensive, which directly impacts the majority of our competitors. 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 head back to you for closing remarks.

[Dan Bartok, CEO]

Thanks, Jim. I'm pleased with the Forestar team's execution during our third 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 to meet builder demand.

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 on investing capital to enhance the long-term value of Forestar.

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. We an improvement from a decline between 15% and 30% forecasted just three months ago.

While new home starts and sales have been stronger than expected in 2023, a mortgage rates are back to peak levels reached in late 2022, which could impact demand as buyers adjust. 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 to vacate returns.

Our goals have not changed. We still intend to double our market share to 5% over the intermediate term. Looking forward, we believe that D.R. Horton and many other homebuilders will continue to shift their focus towards buying finished lots from third-party developers, instead of self-developing. We believe our market share gains will accelerate as financing remains expensive and thus available for the majority of our competitors.

We have a track record of solid execution and are focused on a 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 while investing wisely for our future growth and further strengthening our industry-leading position.

Paul, at this time, I will open up the line for questions.

[Operator]

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

[Truman Patterson, Wolfe Research]

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 net debt to total capital ratio is 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.

[Dan Bartok, CEO]

Well, I think our capital structure as it sits today, we are well positioned to meet that growth 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.

[Truman Patterson, Wolfe Research]

Fair enough. So kind of maybe the net debt to total cap to hit a 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, et cetera. 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?

[Jim Allen, CFO]

Well, obviously, you can'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 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.

[Truman Patterson, Wolfe Research]

Got you. Fair enough. Thank you for your time.

[Dan Bartok, CEO]

Thanks, Truman.

[Operator]

Thank you. And the next question is coming from Carl Reichardt from BTIG. Carl, your line is live.

[Carl Reichardt, BTIG]

Thanks, everybody. I did want to follow up, I think, on part of what Truman was asking really on margin variability in the $1.4 billion you've got in backlog as you look out the next few quarters or maybe even just the full year of '24, are you expecting the gross margin to be somewhat less variable than it has been either due to mix or just strengthen 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 do you expect it to go above your last prior peak?

[Dan Bartok, CEO]

That's a tough one. We always talk about returns more than margins, I guess really about maintaining the appropriate pace and meeting the builders' demand. What's really been interesting over the last several quarters is really -- as we dialed in on a project-by-project basis, the same as the builders do. And then there's been some cases where we've had to make price adjustments and reduce margins.

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 -- doesn't look to be coming down. 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.

[Carl Reichardt, BTIG]

Thanks, Dan. And then can you talk a little bit about any regional trends really over the last two quarters, I think. Obviously, in '22, 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, does that begin to reverse at all in terms of builder demand for lots in '23? Thanks.

[Dan Bartok, CEO]

I would say that Phoenix and Denver, two 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 how it starts. And it really goes back to the builders' inventories, where were they long, where do they need to kind of rightsize their inventories. And it seems like their start paces have leveled off, and that's kind of at a level, an increasing basis again. So hopefully, that gives us the opportunity to continue to be strategic in each of the markets.

[Carl Reichardt, BTIG]

Thanks very much, Dan. I appreciate it.

[Dan Bartok, CEO]

Thanks, Dan.

[Operator]

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

[Unidentified Analyst]

Hi. This is [indiscernible] for Anthony. Thanks for taking my question. Just thinking back to 2022, you saw a builder demand kind of pull back on the surge in interest rates 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 built our interest in what's 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? And then even more finally chopping it more filing, when mortgage rates start to level off for a couple of weeks, do you see builder interest kind of pick up?

[Jim Allen, CFO]

Yeah. 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. And so today, we're seeing the appetite increase across the board for the builders. We're not just our number one customer with D.R. Horton, but also with the other biller clients that we have. So we're receiving more calls. So we have not seen a falloff actually, we've seen the opposite. We've seen an increase in demand.

[Unidentified Analyst]

All right. No, that's helpful. And then I guess, I think in your prepared remarks, you mentioned that your lots are a 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 there kind of a meaningful step down in margin kind of baked in?

[Jim Allen, CFO]

Yeah. Typically, we underwrite to a 12-month development time frame. Again, it goes to market-to-market, project-by-project. It's been interesting in terms of if we elongate that time line, we've able to hold some pricing power just because the demand for finished lots has been there. We're kind of writing those tailwinds at the moment. But again, we look at the market every time we price lots, we don't price our lots up front.

So that's been helpful for us. If we see something in the first, let say, four months or so of development that a concern, we can consider that 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 or return, maximizing our returns.

[Unidentified Analyst]

Okay, super helpful. I'll turn it over.

[Operator]

Thank you. [Operator Instructions] The next question is coming from Mike Rehaut from JPMorgan. Mike, your line is live.

[Unidentified Analyst]

Hi, guys. Doug [indiscernible] on for Mike. On a step back at the end of last quarter with your comments on the bank volatility. I just want to know if you had any further color in this been any change since that last conversation on the banking volatility impact on other land developers, if so, towards the beginning of the previous quarter, did you see any type of material benefit.

[Katie Smith, Director of Finance & IR]

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

[Unidentified Analyst]

Sorry. Yeah. Just if there is any update on banking volatilities in fact on your competitors and if it was did you guys see any type of benefit?

[Dan Bartok, CEO]

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 more stringent. Interest rates have clearly risen to do acquisitions, development loans for developers. And -- so again, the anecdote, 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.

[Unidentified Analyst]

Got it. So nothing material or not outside of [indiscernible].

[Dan Bartok, CEO]

Yeah, I would say nothing in addition to that.

[Unidentified Analyst]

Got it. Thank you.

[Operator]

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

[Dan Bartok, CEO]

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 fourth quarter and fiscal 2023 results. Thank you.

[Operator]

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