Forestar Group Inc

NYSE:FOR

Earnings Call Transcript 2022-Q4

[Operator]

Good afternoon, ladies and gentlemen and welcome to Forestar’s Fourth Quarter 2022 Earnings Conference Call. At this time, all participants have been placed on a listen-only mode, and we will open the floor for your questions and comments after the presentation.

I will now turn the call over to Katie Smith, Director of Finance and Investor Relations for Forestar.

[Katie Smith, Director, Finance and Investor Relations]

Thank you, Matt. Good afternoon, everyone and welcome to the call to discuss Forestar’s fourth quarter and fiscal 2022 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 and 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. Our earnings release is on our website at investor.forestar.com and we plan to file our 10-K late 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 Dan Bartok, our CEO.

[Dan Bartok, 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 Mark Walker, our recently promoted Chief Operating Officer. Mark joined Forestar in 2019, as our East Region President and overtime also became responsible for our operations in the Mid Atlantic, North and Texas regions. I’d like to take a brief moment to have Mark introduce himself before we get started. Mark?

[Mark Walker, Chief Operating Officer]

Thanks, Dan and hello, everyone. I’m excited to further my career at Forestar and eager to help the company continue to build out our platform even further. We have a high performing team with great regional and divisional leadership. I’m also looking forward to getting to know our analysts and investors in my new role.

[Dan Bartok, CEO]

Thanks, Mark. Given that Mark is new to his role, he will not be an active participant today, but we are happy that he will help lead the Forestar team as we continue to scale our business and consolidate market share.

I want to thank our team for another quarter of strong execution and a great fiscal year. Our operational and financial results exceeded expectations and our strong performance is a testament to our differentiated business model and our team’s ability to react quickly and appropriately to market conditions.

Our pre-tax income for the fourth quarter increased 13% to $66.4 million, a $381.4 million of revenue. And our pre-tax profit margin improved 340 basis points to 17.4% when compared to our fourth quarter last year. For the full fiscal year, pre-tax income increased 61% to $235.8 million and our pre-tax profit margin improved 440 basis points to 15.5%. Consolidated revenues for the year increased 15% to $1.5 billion and 17,691 lots sold, which was an 11% increase in lot deliveries over last year.

Since fiscal 2019, Forestar’s consolidated revenues have more than tripled as we have continued to gain market share in the fragmented residential lot development industry. Over the same period, our pre-tax margin expanded 480 basis points, earnings per share increased 354%, book value per share increased 43% and return on equity expanded over 1,000 basis points to 16.2%. I am extremely proud of our team and the platform that we have built together.

Before turning the call over to Jim to review our financial results, I want to reiterate our optimism for the future Forestar. We are starting fiscal 2023 from a position of strength. Forestar has over $620 million of liquidity and one of the best capital structures in the residential lot development industry, which provides us with tremendous flexibility to navigate changing market conditions.

Our high turnover manufacturing strategy is fundamentally stronger than a traditional land developer and we are focused on strong execution which will lead to further value creation for our shareholders. Jim will now discuss our fourth quarter and fiscal 2022 results in more detail.

[Jim Allen, Chief Financial Officer]

Thank you, Dan. In the fourth quarter, net income attributable to Forestar increased 15% to $50.8 million or $1.02 per diluted share, compared to $44 million or $0.89 per diluted share in the prior year quarter. Consolidated revenues for the quarter totaled $381.4 million, which included $27.7 million of track sales and other revenue. We sold 3914 loss during the quarter with an average sales price of $88,800. We expect continued quarterly fluctuations in our ASP based on the geographic location, and lot size mix of our deliveries.

For the fiscal year, net income attributable to Forestar increased 62% to $178.8 million or $3.59 per diluted share, compared to $110.2 million for $2.25 per diluted share in fiscal 2021 consolidated revenues for the year total $1.5 billion, which included $36.8 million of track sales and other revenue.

During fiscal 2022, lots sold increased 11% to 17,691 lots, with an average sales price of $86,300. Katie?

[Katie Smith, Director, Finance and Investor Relations]

Our pre-tax income for the quarter increased 13% to $66.4 million, with the pre-tax profit margin of 17.4%. This was an improvement of 340 basis points over the prior year quarter. Our pre-tax income for the year increased 61% to $235.8 million, and our pre-tax profit margin improved 440 basis points to 15.5%. The prior year period included in $18.1 million of pre-tax loss on extinguishment of debt related to the redemption of the company’s 8% senior notes, excluding that charge, pre-tax income for fiscal 2022 increased 43% and our pre-tax profit margin improved 310 basis points. Dan?

[Dan Bartok, CEO]

Our gross profit margin was 23.4% in the fourth quarter, and was 21.3% for the year, representing an improvement of 530 basis points and 400 basis points over the prior year periods, respectively. Improvement in gross margin in both periods was primarily due to increased margins on lot sales from development projects sourced by Forestar, and to a lesser extent, high margin track sales during the fourth quarter.

Additionally, interest charged to cost of sales decreased by approximately 70 basis points for the quarter and 50 basis points for the year compared to the respective prior year periods, partially attributed to the refinancing of our senior notes last year.

SG&A expense as a percentage of revenues was 6.2% for the quarter and for the year. We will continue to focus on controlling our SG&A costs or ensuring that our infrastructure supports our business. Jim?

[Jim Allen, Chief Financial Officer]

We are pleased that we continue to make progress delivering more lots from project source by Forestar. 35% of lots sold in the quarter were Forestar-sourced, compared to 24% in the prior year quarter. In fiscal 2022, 35% of lots sold were sourced by Forestar up from 19% in fiscal 2021. Those percentages should continue to trend higher as more Forestar-sourced projects deliver lots.

842 lots or 22% of our fourth quarter deliveries and 2,796 lots or 16% of our fiscal year deliveries were sold to customers other than D.R. Horton, up from 11% and 7%, respectively. Included in our lots sold to other customers are 585 lots in the fourth quarter and 943 lots in fiscal 2022 that were sold to a lot banker who expects to sell those lots to D.R. Horton at a future date. We continue to target selling 30% of our lots to customers other than DR Horton over the intermediate term.

Additionally Forestar’s lot sold to D.R. Horton continue to grow as a percentage of D.R. Horton starts year-over-year and sequentially. Approximately one out of every five homes that D.R. Horton starts is on a lot developed by Forestar. Our mutually stated goal is for one out of every three homes that D.R. Horton sells to be built by – on a lot developed by us. Katie?

[Katie Smith, Director, Finance and Investor Relations]

Forestar’s underwriting criteria for new development projects includes a minimum 15% annual pre-tax return on inventory, and a return of the initial cash investment within 36 months. During the fourth quarter, we invested approximately $290 million in land and land development, of which, $270 million was for land development and $20 million was for land. In fiscal 2022, investments in land and land development totaled approximately $1.4 billion, of which, roughly 75% was for land development and 25% was for land.

As land prices continue to increase across most of our footprint during the year, we reduced our land investment by 59%. And primarily focused on the space development of land we already own, demonstrating our management team’s discipline and experience navigating through market cycles.

Forestar’s lot position at September 30th was 90,100 lots, of which, 61,800 lots are owned, and 28,300 lots are controlled through purchase contracts. Our lot position decreased by 6,900 lots or 7%, both sequentially and year-over-year. 55% of our own lots were sourced by Forestar up from 52% a year ago, and the majority of our owned lots were put under contract prior to 2021. At quarter end, we had 5,500 finished lots on hand. We’re continuing to target three years to four years of owned inventory of land and lot. Dan?

[Dan Bartok, CEO]

We expect demand for residential lots will continue to moderate in the coming months as homebuilders align starts to a new sales pace. 31% of our owned lots are under contract to sell, representing approximately $1.5 billion of future revenue. These contracts have $136 million of hard earnest money deposits associated with them.

Now the 31% of our owned lots are subject to a right of first offer to D.R. Horton based on executed purchase and sale agreements. We remain intensely focused on managing our development and phases to ensure finished lots are delivered at a pace that matches market demand consistent with our emphasis on capital efficiency.

We evaluate each project and the surrounding market conditions as we determine the appropriate pricing and sales pace to maximize returns. Over the past year, our inventory balance has grown only 6% despite elongated development timelines and inflationary pressures, further demonstrating discipline and strategic inventory management. As a result, we generated $108.7 million in cash flow from our operating activities during fiscal 2022. Jim?

[Jim Allen, Chief Financial Officer]

We are maintaining a strong balance sheet with significant liquidity and modest leverage and we plan to maintain our disciplined approach when investing capital to enhance the long-term value of Forestar. We ended the year with approximately $620 million of liquidity, including $260 million of unrestricted cash and $360 million of available capacity on a revolving credit facility after the reduction for outstanding letters of credit.

We recently amended our revolving credit facility, extending the maturity by one and a half years to October 2026. Total debt at September 30th was $706 million with no senior note maturities until fiscal 2026. Our net debt to capital ratio at year end was 26.9% compared to 35.2% in the prior year period, demonstrating our continued focus on disciplined capital management. We ended the year with $1.2 billion of stockholders’ equity, and our book value per share increased to $24.08, up 18% from a year ago.

Forestar’s capital structure is one of our biggest competitive advantages. Most traditional land developers are encumbered by project level financing, which makes it more difficult to react to changing market conditions, while adding complexity and administrative costs. Our strong liquidity and corporate level financing enable us to operate effectively to changing economic conditions and positions us to be strategic when attractive opportunities present themselves.

We know these are times to leverage our financial strength. At a time when our competitors may be struggling, we are incredibly well positioned to emerge from a slowdown in housing even stronger than before. Having a growth plan is one thing, but having the capital operational flexibility, strong customer base and experienced team is another. We have those key pieces in place to execute our plan. Dan, I’ll hand it back to you for closing remarks.

[Dan Bartok, CEO]

Consistent with our last earnings call, we expect the environment will remain challenging due to rising mortgage interest rates, persistent inflation, continued municipality delays and shortages of certain materials. However, our teams are relentless problem solvers, and they continue to navigate this environment exceptionally well. We will continue to be proactive in the areas that we can control.

As a result of the current market uncertainties, we are not providing guidance for fiscal 2023 at this time. We will reevaluate providing annual guidance when we have sufficient visibility in the market conditions. We have been very strategic and disciplined, and we are well positioned to adapt quickly to the short term challenges that are before us. We remain very optimistic about Forestar’s ability to continue to make progress towards our goals of gaining market share and increasing returns.

We continue to 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. With our broad geographic footprint, attractive land positions, strong balance sheet, most importantly, our experienced team, Forestar is well positioned to be the lot supplier of choice to homebuilders.

I will conclude by saying our leadership team has managed to market cycles before. We have been disciplined in inventory management and are focused on maintaining strong liquidity. We are working with our customers to adapt to current market conditions in a way that is beneficial to all. We will be strategic in our approach and we’ll leverage our platform to take advantage of opportunities that will build shareholder value. I’m incredibly proud of the high performing Forestar team and we’re prepared for the challenges ahead.

Matt, at this time, we’ll open the line for questions.

[Operator]

Certainly. Ladies and gentlemen, the floor is now open for questions. [Operator Instructions] Your first question is coming from Carl Reichardt from BTIG. Your line is live.

[Carl Reichardt, BTIG]

Thanks, everybody. You talked about opportunities, Dan and Jim, too. I’m curious if you’re starting to see some of your peers on the development side begin to drop deals? Are they turning to you to potentially take them? And or where are the geographic markets where you think peers might be struggling the most at the moment?

[Dan Bartok, CEO]

No, we are starting to see some opportunities. I can’t say that they’ve been extremely attractive yet. But we think that they will get better as time continues to move on here. But yeah, we’re definitely seeing deals being dropped. We’re seeing opportunities where other developers are having issues with their loans that are kind of looking at the need to get out of their positions. But again, I think that we still have a little time to go before they get extremely attractive.

[Carl Reichardt, BTIG]

Okay. Thanks, Dan. And then you talked about the continuation of delays and getting lots actually through the development process itself. Obviously, the builders are starting to tell us that the frontend trades for them for the vertical construction side are getting easier to find. Are you seeing that same thing being true now where at least you know folks like excavators, pavers, whoever that you use to actually get the communities up and running are starting to loosen up. And is that likely to help you at all from a price or a development pace ability in ’23?

[Dan Bartok, CEO]

Yeah I think it’s exactly where we are seeing that the frontend contractors are loosening up that primarily in the dirt moving side of things, but you know pipe and transformers and electric company getting out there to get last minute still has not loosened up. I don’t think it’s getting any worse. But I don’t think we’re really starting to see it improve much right now. And yeah, I think as the year goes on and more these crews that don’t have somewhere to send their people to the next job then we’ll start to see some cost efficiencies.

[Carl Reichardt, BTIG]

Thank you, Dan. I’ll get back in queue. Thanks.

[Dan Bartok, CEO]

Okay, thanks.

[Operator]

Thank you. Your next question is coming from Mike Rehaut from JP Morgan. Your line is live.

[Mike Rehaut, JP Morgan]

Yeah and good afternoon. Thank you offering the mic. You guys touched on this a little bit earlier. But I’d love to know if you can give further color on how your efforts are progressing regarding growing your non-DHI business? And do you know what this can look like in maybe two years to three years roughly?

[Dan Bartok, CEO]

Well, we are making progress. You know we never expected it to be a sharp increase, but we are definitely making progress with other builders. And again, our goal for maybe the next two years or three years is to get up to that 30% of our business going to builders other than Horton. And frankly, I think you know some of these tougher times that we’re having right now will only help builders want to buy finished lots rather than the self-developing lots. So I think we’re on the trend. I like what we’re seeing and I think these next two years will be very beneficial for us.

[Mike Rehaut, JP Morgan]

Great, thanks. And then I know you guys you don’t give guidance for 2023. But is there any way to give a little bit of insight as to how you’re thinking about gross margins over the next few quarters and certain things you’re looking out for as 2023 progresses?

[Dan Bartok, CEO]

Yeah you know we know it’s going to be a challenging year, there’s going to be you know the builders are definitely trying to reset their start paces you know we’re going to probably be renegotiating from start paces on lot takedowns. And we’ll probably see a little bit of margin compression, but it’s just too early to really tell you know what extent that will be, so far we’ve been able to deal with you know slowing pace and not really giving up margin, but at some point that may come back to us.

[Mike Rehaut, JP Morgan]

Got it. Thanks guys.

[Operator]

Thank you. Your next question is coming from Anthony Pettinari from Citi. Your line is live.

[Anthony Pettinari, Citi]

Good afternoon. You know you’re – you continue to trade well below book and I’m just wondering, is there you know a threshold on margins or home prices or volumes or whatever metric, you choose, where you would have to start thinking about potential impairments. But just wondering you know if you can directionally talk about risk of impairments? And maybe help how far you are away from that as we think about ‘23 and potentially softer market?

[Jim Allen, Chief Financial Officer]

Well our margins are still strong. I mean I think we’re still a long, long way from any kind of widespread impairments you know if we see some margin compression during the year you know there may be isolated projects maybe that you know might have impairments. But at this point, we just you know, we’re not seeing it.

The only impairments you know we have or we have had in the year, we had one during the year that was just kind of an isolated incident, but it was really more around earnest money and you know maybe writing off due diligence costs for deals that we decide not to pursue, that’s really more likely.

[Dan Bartok, CEO]

You know, again, you know – over half of the lots we own today, we contracted to purchase before 2021. So we really have pretty low land bases relative to the current you know the more recent market expectations. You can really see you know, our purchasing of new land really fell significantly this past year. So I feel like we’re in pretty good shape to kind of weather the storm.

[Anthony Pettinari, Citi]

Okay, that’s very helpful. And then just given the rise in rates and affordability is obviously top of mind for homebuyers and builders. You know are there levers you can pull for projects in development? You know have you started to shrink watt sizes or you know any other changes to projects to drive greater affordability for the final home price?

[Dan Bartok, CEO]

Well, you know we’ve always focused on the affordable segment. So I think that we’ve already been in that position of a relatively small lot prices and affordable market. So I think from a project positioning, I feel really good about it. You know, it’s – for us, it’s more about controlling that inventory flow, rightsizing phases you know we started even over a year ago started working on smaller phases, that expectation of you know kind of slower demand. So I think it’s really about controlling our capital flow and our – Jim like to call it a capital efficiency and making sure returning our inventory quickly.

[Anthony Pettinari, Citi]

Okay, that’s very helpful. I’ll turn it over.

[Operator]

Thank you. Your next question is coming from Carl Reichardt from BTIG. Your line is live.

[Carl Reichardt, BTIG]

Thanks, I’m back. Thanks for the additional time guys. So, Dan, if we do see a really significant slowdown in business, does this accelerate the pace at which you can actually self-source deals do you think? And then the thinking is that, if things do slow down, it does accelerate your pace that your margin come out, when things do get better on a ramp pretty nicely or is – is the significant slowdown more likely to slow your ability to sell-source deals and make you more reliant on Horton?

[Dan Bartok, CEO]

I think it’s the former that’s what we’ve kind of been playing for. That’s why we built our – kept our strong liquidity position slowed up land buyers, we believe there’s going to be some significant opportunities that come our way. And again to me so [inaudible] this is about that positioning and that’s been part of our strategy along, Carl.

[Carl Reichardt, BTIG]

That makes sense, just wanted to be sure. And then can you expand a little bit on the 585? Lot that you sold to a lot banker, maybe talk a little bit about what – if there’s a big difference in margins or price or take down terms with a customer like that then there would be with a traditional builder?

[Dan Bartok, CEO]

You know there was really no change, it was really an assignment of a contract that we had in place to sell lots. And it was a bulk take transaction. I think rather than buying those lots in bulk, the builder inserted a lot banker into the middle of I’m involved in the environment you know and more of a takedown. So it was really a matter of the builder living up to the terms of the original contract with us. So we found that to be a positive.

[Carl Reichardt, BTIG]

Okay. And then just trying for the follow-up, Dan. Was this transaction contemplated in your original guidance of 17,000 lot deliveries for the full year?

[Dan Bartok, CEO]

Well, we definitely took the original contract into account. And how we set that guidance, and again, rather than the builder closing them directly, they just inserted a lot banker in between again, they performed on the contract as it was originally contemplated.

[Carl Reichardt, BTIG]

All right, all right. That’s what I got. Thanks very much. Appreciate it.

[Dan Bartok, CEO]

Yeah, thanks.

[Operator]

Thank you. Showing no further questions, that concludes our Q&A session. I will now hand the conference back to Dan Bartok for closing remarks. Please go ahead.

[Dan Bartok, CEO]

Thank you, Matt. 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. We will stay disciplined, flexible and opportunistic as we consolidate market share in fiscal 2023. 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]

Thank you, ladies and gentlemen. This concludes today’s event. You may disconnect at this time and have a wonderful day. Thank you for your participation.