Forestar Group Inc

NYSE:FOR

Earnings Call Transcript 2020-Q4

[Operator]

Good afternoon, and welcome to Forestar's Fourth Quarter 2020 Earnings Conference Call. [Operator Instructions] I will now turn the call over to Jessica Hansen, Vice President of Investor Relations for D.R. Horton, the majority shareholder of Forestar.

[Jessica Hansen]

Thank you, Paul, and good afternoon. We welcome each of you to the call to discuss Forestar's fourth quarter and fiscal 2020 financial results.

Before we get started, today's call may include comments that constitute 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 Forestar does not undertake any obligation to publicly update or revise any forward-looking statements. Additional information about issues that could lead to material changes in performance is contained in Forestar's 2019 annual report on Form 10-K and the subsequent quarterly reports on Form 10-Q, all of which are filed with the Securities and Exchange Commission.

This afternoon's earnings release is on Forestar's website at investor.forestar.com, and the 10-K is planned to be filed in about 2 weeks. After this call, we will post an updated investor presentation to Forestar's Investor Relations site under Events and Presentations, for your reference.

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

[Daniel Bartok, executive]

Thank you, Jessica. Good afternoon, everyone. In addition to Jessica, I am pleased to be joined on the call today by Jim Allen, our Chief Financial Officer; and by Collin Dawson, D.R. Horton's Vice President of Corporate Finance and Treasurer.

We're extremely proud of the Forestar team's accomplishments in fiscal 2020. We continue to deliver on key milestones, which we believe will create additional value for our shareholders. We are rapidly scaling our business and have capitalized on the strength of the residential finished lot market. We delivered more than 10,000 lots to homebuilders in fiscal 2020, more than double our deliveries in fiscal 2019.

We continue to implement drivers, which will translate to increased pretax profitability. We are efficiently scaling our business with SG&A leverage improving 180 basis points from fiscal 2019. And we expect improved gross margins in fiscal 2021. As a result of the overall market strength and our intentional shift towards more Forestar-sourced transactions and less lot banking. We are consolidating market share in the undercapitalized and fragmented lot development industry. As Forestar's lots sold to D.R. Horton doubled as a percentage of D.R. Horton's closings on a year-over-year basis.

In addition, we are pleased to report we recently closed our first project, which was sourced by a third-party builder. We continue to execute on our returns-focused business model and build upon the foundation, which has been set. Our high turnover, lower-risk manufacturing strategy led to a 260 basis point year-over-year improvement in Forestar's return on equity. We expect to generate further growth in profits and increases in returns in fiscal 2021 as our platform continues to gain scale and our team matures. We'll now discuss our fourth quarter and fiscal 2020 results in more detail. Jim?

[James Allen, executive]

Thank you, Dan. In the fourth quarter, net income attributable to Forestar increased 91% to $24.2 million, or $0.50 per diluted share, compared to $12.7 million, or $0.30 per diluted share, in the prior year quarter. Consolidated revenues for the fourth quarter totaled $347.6 million, which included $5.2 million of revenue from residential tracts sold. Forestar's fourth quarter lot sales revenues increased 90% from the prior year quarter to $342.4 million. Residential lots sold during the quarter totaled 3,977 lots, an increase of 108% from the prior year quarter. The average lot sales price for the quarter was $86,000. 77% of lots sold in the quarter were from development projects, with the remainder from lot banking.

For the fiscal year ended September 30, 2020, net income attributable to Forestar was $60.8 million, or $1.26 per diluted share, compared to $33 million, or $0.79 per diluted share, in fiscal 2019. Consolidated revenues for fiscal 2020 totaled $931.8 million, which included $51.1 million of revenue from residential and commercial tracts sold. Forestar's fiscal 2020 lot sales revenues increased 150% from the prior year to $880.3 million. Residential lots sold during fiscal 2020 totaled 10,373 lots, an increase of 151% from fiscal 2019. The average lot sales price for the year was $84,000 -- $84,600, and 71% of lots sold in fiscal 2020 were from development projects. During the fourth quarter, we sold 3,900 lots to D.R. Horton and 10,200 lots during the fiscal year. Dan?

[Daniel Bartok, executive]

Our pretax income for the quarter was $32 million, with a pretax profit margin of 9.2%. Our pretax income for all of fiscal 2020 was $78.1 million with a pretax profit margin of 8.4%. Our gross profit margin was 12.7% in the fourth quarter and for the year. SG&A expense as a percentage of revenue was 3.7% in the quarter and 4.9% for the year. We currently expect our pretax profit margin to improve to approximately 10% in fiscal 2021, driven mostly from improvement in lot sales gross margin, as we expect a lower mix of lot banking and higher proportion of Forestar-sourced development lot sales in fiscal 2021 compared to fiscal 2020. However, we still expect quarterly fluctuations in our gross and pretax margins due to the mix of our lot deliveries and the timing of potential tract sales.

We remain focused on managing our SG&A efficiently, while building out our infrastructure to support our significant growth. We believe we will continue to manage our business at an SG&A percentage significantly lower than most public homebuilders. Jessica?

[Jessica Hansen]

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 fourth quarter, investments in lots, land and development totaled $320 million, of which $170 million was for land and $150 million was for land development. During fiscal 2020, investments in lots, land and development totaled approximately $1 billion. In fiscal 2021, Forestar expects to invest at least $1.25 billion in lots, land and development, subject to market conditions.

Forestar's lot position at September 30 was 60,500 lots, of which 42,400 lots are owned and 18,100 are controlled through purchase contracts. 14,000 or 33% of Forestar's owned lots are under contract to sell to D.R. Horton, representing approximately $1 billion of future revenue. Another 16,400 or 39% of Forestar's owned lots are subject to a right of first offer in D.R. Horton under the master supply agreement. Of Forestar's owned lot position at September 30, 39% was sourced by Forestar, up from 28% a year ago. Forestar continues to target a 3- to 4-year owned inventory of land and lots. Jim?

[James Allen, executive]

Forestar remains focused on maintaining a strong balance sheet with ample liquidity and modest leverage. At September 30, we had approximately $740 million of liquidity, including $400 million of unrestricted cash and $340 million of available capacity on our revolving credit facility. Total debt at September 30 was $641 million, with no senior note maturities until fiscal 2024, and our net debt-to-capital ratio at year-end was 22.1%.

During the quarter, we entered into an equity distribution agreement to issue and sell from time to time up to $100 million of our common stock through an aftermarket equity offering program. As of September 30, no shares have been issued under the program. At September 30, stockholders' equity was $871 million, and our book value per share increased to $18.12, up 8% from a year ago. Dan?

[Daniel Bartok, executive]

Forestar is uniquely positioned to consolidate market share in a highly fragmented lot development industry through housing market and economic cycles. Based on today's market conditions, we now expect to deliver between 13,000 and 13,500 lots, and to generate approximately $1.1 billion of revenue in fiscal 2021. And as I mentioned earlier, we currently expect our pretax profit margin for the full year of fiscal 2021 to be approximately 10%. At scale, we continue to expect our operating model to produce financial results and returns that are similar to or better than most mid-cap homebuilders.

Before we turn to questions, I'd like to remind everyone of Forestar's investment highlights. We have a unique lot manufacturing business model, very different than a typical land developer. We have no unentitled plan. We are focused on developing lots for affordably priced housing. We have an experienced management team that knows how to navigate through market cycles. We have a strong balance sheet and liquidity position with low net leverage. We are profitable and expect to continue to manage our business at an SG&A percentage significantly lower than most public homebuilders. And most importantly, we have a unique competitive advantage due to our relationship with D.R. Horton, which derisks the expansion of our operating platform and allows us to have a national geographic footprint. To put it simply, we are executing on our plans and are positioned for success.

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

[Operator]

[Operator Instructions] Our first question comes from Ryan Gilbert with BTIG.

[Ryan Gilbert, analyst]

First one, just on the 2021 guidance. Pretty significant step-up even from what we were thinking in November of 2019 and January of 2020. And I'm wondering if you can talk a little bit about the initiatives that you may have put into place to flex up, I guess, your production capacity or production cadence to get to that 13,000 to 13,500. And it seems like whatever you've done, you've also been able to put it in place for the fourth quarter as well given -- to meet expectations there. So yes, just any color would be very helpful.

[Daniel Bartok, executive]

Sure, Ryan. So during the year, we obviously continued our land acquisition program, even though it slowed up for a little while during the, I think, the COVID crisis' main period there. We haven't really lost any of those deals and continued that land acquisition. And as soon as we saw that the market came out strong, we really ramped up production and put more lots underdevelopment than we may have originally anticipated, making sure that we are prepared to hit the demand today and potentially increase demand for next year. So we feel pretty comfortable where we sit today and the guidance that we've provided.

[Ryan Gilbert, analyst]

Okay. That's great. And second question, just on the land bank. I mean, getting it up 10,000 lots sequentially. It doesn't seem like there's -- or I should say, it seems like you're able to adequately source lots in the market. But I'm wondering if you can talk about the competitive landscape in your regions, is that -- are you finding that competition for lots is heating up? Or does it feel about the same as it did last quarter?

[Daniel Bartok, executive]

It definitely feels like the builders are out, actively trying to refill their pipelines with lots. But they're more focused on what I would call the smaller lot positions, land positions or maybe that 150 to 200 lots. From a Forestar-sourced opportunity, we've been working on building this pipeline for a while now. And I think we have targeted that slightly larger transaction that maybe doesn't have the same competition as the smaller transaction. So although I think there's a lot more people out trying to buy land today, we still feel like our pipeline is very strong for what we're doing.

[Operator]

Our next question comes from John Lovallo with Bank of America.

[John Lovallo, analyst]

Maybe starting off with the revenue growth outlook. It seems like around 20% to 25% is what you're contemplating. What makes that sort of the right growth rate? And what's preventing you from growing faster? Is it a focus on just being more profitable growth? Or any help on that would be appreciated.

[Daniel Bartok, executive]

Well, it's obviously been a crazy year. We're taking our best guess today and what we feel very comfortable with as to looking forward into this year, we feel really comfortable with the guidance of 13,000 to 13,500 lots. There could potentially be some upside if from a year-end, we ended the year with about 5,000 finished lots and about 12,000 lots under development. So I think we're trying to be prepared to meet any additional demand that may come beyond our current comfort level.

[Jessica Hansen]

And then, John, for the delta between the lots sold and the revenue guidance, that's really being driven by an ASP decline that's expected really just as a result of mix shift. So the lot guidance is actually up for 25% to 30% versus the revenue guidance that's up slightly lower than that.

[John Lovallo, analyst]

Right. Okay. That's helpful. And then if we think about gross margin heading into next year, you expect it to improve. And one of the things that you called out was just less third-party-sourced deals. Can you just remind us what the margin differential is between a Forestar-sourced deal and a third-party-sourced deal?

[Daniel Bartok, executive]

Yes. It's really hard to pinpoint that exactly. I mean, the good thing about Forestar-sourced deal is we control the transaction. Whenever a builder, whether it be Horton or a third-party builder, when they're bringing that deal to us, they control the transaction. So they always have choices, right? So they could self-develop it, they can hand it off to a different developer or do the transaction with us. So it's more competitive in that margin. I mean, it really varies on the length of the deal, the size of the transaction as to what that market is going to be. We just feel really good about the kind of the mix of where we stand right now.

[John Lovallo, analyst]

Okay. Maybe if I could just dovetail off that for a second. The gross margin in the quarter of 12.7%, it looks like tract sales were relatively low in the quarter, I think, $5.2 million. Can you just help us understand some of the puts and takes on the margin in the quarter then?

[Daniel Bartok, executive]

I'm not quite sure 100% how to answer that. So within the quarter itself, again, it's always based on product mix. And what -- are we selling shorter-duration deals, lot banking deals or Forestar-sourced deals. The Forestar-sourced transactions are really just starting to kick in from the standpoint of sales. So I think from where we were this quarter, I continue to see expansion in that margin. And again, lot banking is starting to roll off. I think we did 29% total lot banking this year as compared to 39% last year, and there's probably going to be sub-20% the year coming up.

[Jessica Hansen]

And then, John, on the different lot sales, really not a whole lot of change other than if you recall, in Q3, we did call out the tract sale margin was pretty low. The tract sale margin this quarter was not abnormally low. So that is part -- a driving part of the benefit from Q3 to Q4, but we also saw a lot banking stay relatively flat and not a whole lot of movement in development margin.

[Operator]

Our next question comes from Anthony Pettinari with Citigroup.

[Unknown Analyst]

This is actually [indiscernible] on for Anthony. I guess just first off, can you just talk about maybe the cadence of lot sales in the quarter and then maybe the cadence contemplated in your 2021 guidance? Should we think be thinking about growth in '21 as more front-loaded with demand maybe normalizing in the back half? Or maybe even throughout the year or even accelerating as the year goes on? And then is that kind of reflective of maybe how you think about the overall sustainability of housing demand?

[Daniel Bartok, executive]

Yes. Again, from a cadence, we're really not giving any monthly guidance. We did that a little bit earlier this year during the -- I think during the height of the crisis, when everybody was wondering what was going to happen in the market, just to kind of show the variability. I think we don't really see a lot of seasonality in our numbers. So I think that when I look forward to the guidance that we've given, there's probably going to be some volatility quarter-to-quarter, but it's really hard to pinpoint that. Again, we really look at it more with the comfort of the guidance that we've given on an annual basis.

[Jessica Hansen]

So a significant growth ramp annually in '21. And of course, going forward, even further into '22 and beyond. But as Dan mentioned, some quarter-to-quarter variability to that.

[Unknown Analyst]

All right. That's helpful. And then just sort of maybe on -- switching gears to pricing. We've seen a lot of rising home prices. And I'm just wondering, has that kind of driven in terms of your negotiation with builders, that driven your pricing strength on your end? And then as we think about the builders facing some rising costs, particularly in lumber, is that -- is there a possibility that builders might come back to you and look for maybe concessions to help them preserve margins if maybe the ASP growth starts to slow? Or does that really only happen when ASPs actually kind of decline?

[Daniel Bartok, executive]

I think you really see that when ASPs decline, more than slowing. They usually turn to incentives first to try to regain that sales pace. From our standpoint, most of what we're selling has been under contract for a few months or up to a year. So we don't see a lot of price movements immediately when we see strength in the market. But as we set prices for the next phases, we're definitely taking advantage of pricing where we can.

[Operator]

Our next question comes from Michael Rehaut of JPMorgan.

[Elad Hillman, analyst]

This is Elad Hillman on for Mike. Congrats on the quarter. First, I think you mentioned that you're expecting less lot banking next year. And in the past, you talked about the mix between lot development and lot banking is roughly 2/3 and 1/3. I'm just curious if -- what you're kind of thinking for 2021 at this point?

[Daniel Bartok, executive]

Yes. For 2021, I see it being sub-20%. Again a lot of this -- because we use the lot banking to put our cash to work while we build our pipeline. So at this point, we're using it less to put that money to work. So I see it being sub-20% this year.

[Elad Hillman, analyst]

Okay. Great. So that -- just following up on that. I think pre-COVID-19, you had guided to pretax margins of roughly 10%. And if now you're having a higher mix of lot development, which generally is at a much higher margin. I'm just wondering kind of what could be impacting the pretax margin there? Any color you could give on how to think about those puts and takes.

[Daniel Bartok, executive]

I think we're guiding back to that approximate 10% number. I think that what we saw before COVID, we feel strong about being able to regain that kind of performance level. I think that's -- on a go-forward basis, that's the model that we expect to be able to see, which is between margins. And our SG&A percentage, we have delivered that 10% pretax margin.

[Jessica Hansen]

And compared to this year, that will be approximately 160 basis point improvement. So a pretty substantial driver on a year-over-year basis.

[Operator]

Our next question comes from Truman Patterson with Wells Fargo.

[Truman Patterson, analyst]

Congrats on a really nice quarter. First, a few questions around horizontal development. I mean, you all were essentially able to deliver, I think, 60% more lots than you originally expected. Could you just discuss your strategy the past 6 to 7 months on the horizontal development side of the business? I know you all secured some crews while everyone was pausing. Are you still finding plenty of availability? Are you starting to see development times lengthen now that demand has returned? And are you seeing any sort of inflationary pressure after some of the price concessions earlier in the year?

[Daniel Bartok, executive]

Yes. I think from an availability, I think our strategy earlier this year of putting -- keeping guys at work and putting some new guys to work has really paid off for us. We're making sure that we're keeping those crews busy, whether it's on the next job in town or putting more lots on the ground in that phase. I think part of our strategy is making sure that we're paying quickly and that we're keeping people at work. And so far, we have not seen any fall off in the availability of work.

From a pricing standpoint, we're seeing a little bit of increase, primarily in PVC pipe that's going in the ground. We've taken some actions to try to save that off. Hopefully, it won't last long, because generally, it's kind of tied to petroleum prices, which have stayed pretty consistent. I think it's a little bit of over demand and maybe some of the plants are producing the pipe shutdown for a while, which created a shortage. So I don't see it being a long-term problem at this point. So right now, we feel really good about the ability to continue to put lots on the ground.

[Truman Patterson, analyst]

Okay. So your third-party developer costs aren't necessarily increasing. And are you actually seeing the development time line lengthen?

[Daniel Bartok, executive]

No. Again, we're seeing costs stay relatively the same. Often, we're asking people to move to the next phase and they're holding pricing from the prior phase. And again, if they're not putting lots on the ground quick enough, we start looking for alternates because we try to keep it right on pace.

[Truman Patterson, analyst]

Okay. Okay. That's really helpful. And then a couple of follow-ups. One on, the builders have just had very robust pricing recently. How well are you all positioned to participate in the upside? I'm really thinking, could you walk us through what portion of your portfolio has phased price escalators? And are those escalators tied to market pricing?

[Daniel Bartok, executive]

There's no automatic escalators tied to market pricing. What we do is, we price phase by phase, so we're not locked in too long, and then we evaluate on a project-by-project basis, where we stand with our inventory. We look at what the builders' inventory is, their need and their velocity for sales. And when we -- we just look for those opportunities to push pricing where we can. But again, always cognizant that we're more returns-focused than we are margin-focused. We want to make sure that the velocity that they're selling at, continue to improve our returns as well as theirs.

[Jessica Hansen]

And there is about 1/3 -- there's 1/3 of Forestar's pipeline, though, that is not under contract or ROFO today. So that entire 1/3, it hasn't even been negotiated yet. So that's where they can definitely take advantage of the robust housing market conditions. And then on some portion of the ROFO as well, but definitely the full 1/3 that's not contracted.

[Truman Patterson, analyst]

Okay, okay. And then finally, just with the land markets becoming a bit more competitive. I realize you guys focus on a bit larger deals. But are there any areas that you would say are getting overheated or frothy? And then I know every land deal's different, but what sort of inflation are you seeing?

[Daniel Bartok, executive]

Again, it goes market by market. I was out in California a few weeks ago, and it feels like -- I think the landowners out there are trying to push pricing a little more than anywhere else. At least from some of the things I've seen, word on the street is we're looking at about 10% land inflation in the markets that we're looking at. But I haven't seen it hit those kind of numbers anywhere else yet. And again, as you know, we're not very deep in California to begin with.

[Operator]

Our next question comes from Ryan Gilbert with BTIG.

[Ryan Gilbert, analyst]

It was a little surprising to see your cash balance increase in the fourth quarter from the third, and it looked like there was a nice pickup in inventory turnover. Is that just a function of doing more lot options as a percentage of your lots controlled? Or is there anything else that you can point to that, that's gotten the turns up?

[Daniel Bartok, executive]

I think it was the fact that we sold almost 4,000 lots last quarter. We almost attribute it entirely to that. It was a very strong quarter for us. Sales were strong. We are continuing to use lot option contracts for our purchases as a higher percentage of our controlled lots. But really, it was just a function of sales, which is really strong last quarter.

[Jessica Hansen]

And Ryan, thanks for pointing out the increase in turns, as that really is the main driver to the 260 basis point year-over-year improvement and return on equity that Dan called out in his prepared remarks.

[Ryan Gilbert, analyst]

Okay. Great. And then last one for me. I was interested to hear that you've signed your first project with a third-party builder or your first sourced lot deal with a third-party builder. Just wondering if there's any color that you can add there? And then maybe how you're thinking about market sizing for -- or market potential for third-party builders versus D.R. Horton?

[Daniel Bartok, executive]

Yes. It's always been part of our goal to build third-party business as well as the Horton business. I think as you've heard me say many times, we had to have the teams in place first to be able to deliver. We now have -- I think we have 16 division offices now that are, if not fully staffed, they're staffed well enough to kind of be able to deal with third parties. The demand is out there. The builders continue to call us looking for transactions. It's nice to have the first one under our belts. And I think on a long-term basis, I think we've always kind of steered towards maybe at least 30% of our business being with builders other than Horton.

At this point, I would stick with that. I think we doubled last year. We went from 1% of our sales to 2%. So I think -- we have a ways to get there, but it's clearly nice to have that first one under our belt.

[Operator]

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

[Daniel Bartok, executive]

Thank you, Paul. And thank you to everyone on the Forestar team for your focus and hard work. I'm very proud of the results the team achieved this year and we look forward to working together to continue growing and improving our operations during fiscal 2021. We appreciate everyone's time on the call today and look forward to speaking with you again in January to share our first quarter results. Thank you.

[Operator]

This concludes today's program. You may disconnect your lines at this time. Thank you for your participation, and have a great day.