Meritage Homes Corporation (NYSE:MTH) Q4 2023 Earnings Call Transcript
Meritage Homes Corporation (NYSE:MTH) Q4 2023 Earnings Call Transcript February 1, 2024
Meritage Homes Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Hello, and welcome to the Meritage Homes’ Fourth Quarter 2023 Analyst Call. [Operator Instructions] As a reminder, this conference is being recorded. It's now my pleasure to turn the call over to Emily Tadano, Vice President, Investor Relations and ESG. Please go ahead, Emily.
Emily Tadano: Thank you so much. Good morning and welcome to our analyst call to discuss our fourth quarter 2023 results. We issued the press release yesterday after the market closed. You can find it along with the slides we'll refer to during this call on our website at investors.meritagehomes.com or by selecting the Investor Relations link at the bottom of our homepage. Please refer to Slide 2 cautioning you that our statements during this call as well as in the earnings release and accompanying slides contain forward-looking statements. Those and any other projections represent the current opinions of management, which are subject to change at any time, and we assume no obligation to update them. Any forward-looking statements are inherently uncertain.
Our actual results may be materially different than our expectations due to a wide variety of risk factors, which we have identified and listed on this slide, as well as in our earnings release and most recent filings with the Securities and Exchange Commission, specifically our 2022 Annual Report on Form 10-K and most recent 10-Q. We have also provided a reconciliation of certain non-GAAP financial measures referred to in our press release as compared to their closest related GAAP measures. With us today to discuss our results are Steve Hilton, Executive Chairman; Phillippe Lord, CEO; and Hilla Sferruzza, Executive Vice President and CFO of Meritage Homes. We expect today’s call to last about an hour. A replay will be available on our website later today.
I will now turn it over to Mr. Hilton. Steve?
Steve Hilton: Thank you, Emily. Welcome to everyone listening on our call. I'll start with a brief discussion covering market trends and provide an overview of our recent company achievements. Phillippe will cover how our strategy drove our results and highlights of our operational performance. Hilla will provide a financial overview of the fourth quarter and 2024 forward-looking guidance. Home buying demand this quarter was healthy as rates retrieved below 7% in December. As we previously discussed, two of the largest population cohorts, the millennials and recently Gen Zs are having life events lean to increased levels of need-based housing that currently cannot be met by the constrained resale of home supply in the market.
These macro conditions are shifting buyer demand for move-in ready inventory into the new home space, giving us a competitive advantage with these consumer segments. Our fourth quarter 2023 sales orders increased 60% over last year's fourth quarter as we push through the tougher months of October and November and capitalized on market conditions in December when interest rates loosened. We delivered 3,951 homes in the fourth quarter of 2023, our second highest quarterly closings and achieved a record backlog conversion of 110%, which led to home closing revenue of $1.6 billion. Home closing gross margin for the quarter was 25.2%, which combined with SG&A of 10.7% resulted in diluted EPS of $5.38. We increased our book value per share of 17% year-over-year to $126.61 at December 31, 2023, and generate a return on equity of 17% for the full-year 2023.
Even with our higher ending book value, our price-to-book increased 56% year-over-year from 0.9x to 1.4x, reflecting impressive growth in shareholder value. As is well documented, mortgage rates have moderated recently and the general market expectation is for rates to either hold steady will move further down as the economy stabilizes into the balance of 2024. We believe this will make housing more affordable and continue to give people confidence that now is the right time to buy a home. Now on to Slide 4, our recent milestones. We continue to focus on our DE&I efforts and with the feedback we gathered from our employees, we launched our first three employee resource groups this past quarter, starting with a focus on multicultural women and family structures.
We hope that over time these employee-led groups will create inclusive and collaborative environments within the greater Meritage culture, it's for additional resource groups. While we pursue these DE&I initiatives for our team members is also humbling to see these efforts recognized externally, as well and in the fourth quarter, we joined the list of the U.S. News and World Report's Best Companies to Work For and the Phoenix Business Journal's Best Places to Work, an honor for us in our hometown. Given our long chain tradition to make a company-wide impact on philanthropic causes, we continue to work with two specific non-profits for a second year in a row. During the quarter, we packed over 250,000 meals for No Child Hungry and completed our Tree Planting Program with Arbor Day Foundation.
And to cap off the year, we received the Arizona Housing Fund’s Partner of the Year award, which is focused on addressing the homelessness crisis in Arizona. Lastly, in addition to earnings a spot-on Newsweek's list of America's Greenest Companies for 2024, we were excited to move into our newly built lead certified corporate headquarters in Scottsdale this quarter. With that, I'll now turn it over to Phillippe.
Phillippe Lord : Thank you, Steve. I want to first thank our Meritage team for achieving yet another great year leading to our market share gains. Their hard work and dedication continue to change the lives of our customers and generate value for our shareholders. Turning to Slide 5, our sales orders for the fourth quarter were 2,892 homes, up 60% year-over-year due to a continuation of a stable housing environment. During the quarter, we leaned into our spec building strategy and through the slower months of October, November, we held true to our plan of pre-starting enough inventory to meet expected demand. This allowed us to capture volume in the quarter and replenish our supply for the upcoming spring selling season. 88% of the order volume in the fourth quarter of 2023 came from entry level homes, which has comprised over 80% of total sales orders since the second half of 2021.
ASP on orders this quarter of 415,000 was up 6% from prior year. The elevated quarterly cancellation rate of 39% in the fourth quarter of 2022 impacted both volume and ASP last year as canceled homes with higher sales prices reduced the average sales price reported. The fourth quarter 2023 cancellation rate was 13%, which is roughly in line with our historical averages. The fourth quarter 2023, average absorption pace of 3.6 per month improved from 2.2 in the prior year. We experienced normal seasonality this quarter with an expected slowdown in pace around the holidays. Despite all the uncertainty and twists and turns in 2023, we are proud to report that we still achieved our targeted average monthly pace of 4.0 net sales per month in 2023, which is our goal with our mixed shift, mostly comprised of affordable product.
While the last four years haven't followed this historical seasonality trend, it feels like we are starting to return to a more traditional sales pattern. In order to attain our targeted 4.8 sales pace, we adjusted pricing and made use of our full suite of incentives as needed on a community-by-community and home-by-home basis. As a builder, particularly an affordable builder, we have always offered a range of incentives to buyers. Historically, our consumers have opted to use incentives for closing costs, option upgrades, lot premiums, price concession, or a financing incentive. Since early 2022, rate locks and buy downs were the primary incentive choice as they were the most efficient way to solve for a payment. As rates have pulled back into the sixes, we are seeing customers once again pick the incentive, financing or otherwise, the best fits their needs.
The pullback in rate related incentive utilization has allowed us to offer less costly alternatives and has given us dry powder to increase pricing where the market has allowed it. In the fourth quarter of 2023, our average community count of 271 was essentially flat to prior year, and down 4% sequentially compared to the third quarter of 2023. We opened 28 new communities this quarter and 111 new communities during the year, turning over 41% of our communities since the start of the year. We remain focused on bringing new communities online in 2024 and growing our total community count. The strength of home buying demand in 2023 exceeded industry expectations and we closed out more communities throughout the year than we originally forecasted.
We still anticipate further choppiness, some small ups and downs over the next few quarters, but expect more meaningful growth in the second half of 2024 as we bring our existing land under development online. We own all the lots we need in order to grow our community count mid to high-single-digits year-over-year by the end of 2024 and almost all of what we need to grow our community count more meaningfully in 2025. Now moving to Slide 6. During the fourth quarter of 2023, we continue to achieve a balanced performance across our geographic footprint between East, Central and West region. All of the regions achieved year-over-year growth in volume and sales pace and saw an uptick in performance during the quarter into December. The Central region had the highest regional average absorption pace of 4.1 per month, compared to 2.6 last year.
Double-digit growth in average community count combined with a robust supply of move-in ready homes allowed the Central region to capture market share and grow its fourth quarter 2023 order volume by 72% year-over-year. The East region achieved an average absorption pace of 3.5 per month this quarter compared to 2.5 in the prior year. Given some of the tightest levels available existing homes for sale in these markets, we experienced the lowest cancellation rate in the East. With the strong start pace in Q4, the East entered the New Year with the highest volume of per store available move-in ready inventory, which we believe positions it to gain market share in the spring selling season. The West region had an average absorption pace of 3.0 per month, which was 88% higher than prior year fourth quarter of 1.6 as market conditions and buyer sentiment improved throughout the year, notably in our most challenged markets of 2022, including Arizona and Colorado.
As a testament to our spec building strategy, this quarter was also the first quarter in one of our newer markets, Salt Lake City, had available spec inventories to record both its first sale and closing. We have made concerted efforts over the last year to realign our geographic footprint more evenly across our markets, with an increased focus on our community count in the East region, which is comprised of Florida, Georgia, Tennessee and the Carolinas. These high-growth but lower ASP markets should generate a greater share of our business. Additionally, land acquisitions for the past several years in all of our markets has been focused on a lower price point to ensure sustained affordability for our product. The combination of the mix shift in both location and product type will be visible in our 2024 results and will be reflected in our ASP returning closer to the 400,000 level, which has been our long-term objective.
While this shift will create some pressure on our leverage in the short-term, we believe this is the right strategy for Meritage given the demographics we are targeting. There is a lack of supply of homes at this price point, which should drive higher absorption pace and elevated demand, both of which will translate into proved long-term returns. Now turning to Slide 7. With over a third of our closings this quarter also sold intra quarter, we achieved a backlog conversion rate of 110%, which is once again a company record and notably higher than our ongoing target of 80% plus. Our streamlined operations enable us to build homes more efficiently and achieve one of the quickest cycle times in the industry. Historically, it has taken us four to five months on average to build a home and while our cycle times remain roughly the same from Q3 and Q4 at about 140 calendar days, it improved about six to seven weeks on a year-over-year basis and is nearing our long-term run rate goals.
Given our strategy, as the production environment continues to stabilize, we will reset our backlog conversion targets. With the solid demand we're experiencing, we continue to accelerate starts to replenish and build up our specs to ensure sufficient move-in ready inventory for the 2024 spring selling season. Our quarterly starts of approximately 4,000 homes in the fourth quarter were up from about 2,000 in the prior year and are consistent with our quarterly cadence for most of 2023. As part of our business model, we align our starts with our expected next quarter sales pace. Our spec-only strategy gives us the flexibility to ramp up in a strong demand environment or pull back starts in an uncertain environment as we did in the second half of 2022, so we do not overbuild and erode margins or compromise customer expectations.
We had approximately 5,900 spec homes in inventory as of December 31, 2023, up 20% from about 4,900 specs as of December 31, 2022. This represented 22 specs per community this quarter, which equates to six months of supply on the ground. We are intentionally at the upper end of our optimal level of 4- to 6-months’ supply of spec inventory as we prepare for the spring selling season. Q1 2024 starts pace will be dictated by the demand we see over the upcoming weeks. Of our home closings this quarter, 92% came from previously started inventory, up from 79% in the prior year. 19% of total specs were completed as December 31, 2023. Our targeted run rate for completed specs is approximately one-third and as a result of elevated demand today, we are still working to achieve that goal.
Our ending backlog as of December 31, 2023, totaled approximately 2,500 homes, down from about 3,300 in the prior year as our cycle times drop and our intra quarter sales to closing percentage increased. Our total backlog of 2,500 plus move-in ready inventory of nearly 5,900 units provides a universe of approximately 8,400 homes, more than two quarters supply as we enter the 2024 spring selling season. I will now turn it over to Hilla to walk through additional analysis on our financial results. Hilla?
Hilla Sferruzza : Thank you, Phillippe. Let's turn to Slide 8 and cover our Q4 financial results in more detail. Fourth quarter 2023 home closing revenue was $1.6 billion, reflecting 13% lower home closing volume and 5% lower ASPs compared to prior year. The decrease in ASP on closings was due to more costly financing incentives and geographic mix. Home closing gross margin was 25.2% in the fourth quarter of both periods. This year's home closing gross margin benefited from improved cycle time and lower lumber costs, which were partially offset by increased financing incentives and higher lot costs. Although full year direct cost per square foot in 2023 were slightly higher than 2022, cost declined in the second, third and fourth quarter, ending this year lower than last year.
About half of these savings were derived from lower lumber and the balance from our concentrated efforts to rebid all costs with our trades. Looking forward to 2024, as Phillippe mentioned, there has been a pullback in customer utilization of financing incentives this quarter and as rates continue to decline, we expect this trend will continue. We expect to harvest savings from lower incentive costs as home from recent sales start to flow through our financials in a quarter or two. However, homes in our newer communities also have higher lot costs services from elevated land development spend over the past two to three years, which is muting the pickup from lower financing incentives. And as we're covering the topic of home financing, we wanted to share this quarter's customer credit metrics.
As expected, our buyer profile remained relatively consistent with our historical averages. Our FICO score is near 740, DTI is around 41, which is slightly more elevated than what we have seen historically, although it's in line with our mix shift to primarily all entry level at this time. LTVs remained in the mid-80s and almost all of the buyers who utilized our mortgage company which is around 80% to 85%, received some type of financing incentive. Fourth quarter 2023 home closing margin included $3.2 million of terminated land deal walkaway charges compared to $4.2 million in the prior year. Prior year fourth quarter home closing gross margin also included non-recurring charges of $10.9 million in warranty adjustments related to two specific cases, which were partially offset by $5.4 million in retroactive vendor rebates.
There were no similar items in the fourth quarter of 2023. Excluding all the non-recurring items, adjusted home closing margin was 25.4% and 25.7% for fourth quarter 2023 and 2022, respectively. As we frequently shared, our long-term target of at least 22% gross margin is about 200 bps above our historical average. We continue to strengthen our relationships with national vendors, streamline operations, and reduce cycle times. We are evaluating how the pieces of the strategy come together in a stable environment, and we'll be reassessing if our 22% goal has any opportunity for further improvement. SG&A in the fourth quarter of 2023 was 10.7% of home closing revenue compared to 8.4% in the fourth quarter of 2022. The 230 bps deterioration in leverage was primarily a result of increased performance-based compensation, higher commission rates, and lower home closing revenue leverage.
We're actively working to reduce our SG&A and expect to see an improvement to 10% or better in 2024. Our longer-term SG&A target is 9.5% as our volumes are expected to grow over the next several years. The fourth quarter's effective income tax rate was 23.2% this year compared to 23.3% in 2022. The rate in both periods includes energy tax credits on qualifying homes under the internal revenues inflation reduction act. All in, lower home closing revenue and greater overhead costs led to a 24% year-over-year decline in fourth quarter 2023 diluted EPS to $5.38. As for full-year 2023 results compared to 2022 orders were up 12%, closings were down 1%, and our home closing revenue decreased 2% to $6.1 billion. We had a 380 bps decline and home closing gross margin to 24.8%, primarily due to more costly incentives, increased lot costs, and slightly higher full year direct costs.
SG&A as a percentage of home closing revenue was 10.2% in 2023 versus 8.3% in 2022, as a result of higher commissions and marketing costs reflecting the different sales environment, increased performance-based compensation and insurance spend and a greater investment in technology. Net earnings declined 26% to $738.7 million. As we turn to Slide 9, we had a disciplined approach to balance sheet management. We had nothing drawn on our credit facility cash of $921 million, and net debt-to-cap of 1.9% as of December 31, 2023. Our net debt-to-cap remains well below our max ceiling, which is in the mid 20%. We also generated $355.6 million in operating cash flow and $59.7 million in total cash flows for full year 2023. Our healthy balance sheet allows us to pursue a comprehensive capital allocation plan that's focused on long-term shareholder value expansion through both growth in the business and returning capital to shareholders.
While our goal is to consistently payout dividends and repurchase stock, on the internal front when the economy is strong and growing, we look to allocate more cash to land acquisitions and development, and when there's volatility or uncertainty in the market, we pull back some of our spend and hold a higher cash balance. We strategically deployed capital across four categories: investments in land, share repurchases, cash dividends and periodically debt redemption. In the fourth quarter of 2023, we accelerated our investments in internal growth with $654 million spent on land acquisition and development, which was up 86% from the prior year and our highest ever quarterly spend. We increased land spend throughout the year as market conditions improved and demonstrated the resiliency in demand, spending a total of $1.9 billion on land acquisition and development in 2023.
We expect full-year 2024 land spend to increase to $2 billion to $2.5 billion as we develop our own land and ramp-up our lot portfolio for community count growth. This quarter, we bought back nearly 25,000 shares of common stock or 0.1% of our shares outstanding at the beginning of the quarter for $4.1 million even with the stock price run up. This brings our full-year 2023 repurchases to $59 million, buying back approximately 438,000 shares or 1.2% of shares outstanding at the beginning of the year. Our approach to buybacks has been consistent since we started the buyback program about five years ago. Our first objective is to neutralize annual dilution from new equity issuances, which can occur either pro rata each quarter or faster or slower based on market conditions.
Second, we gauge the market for other share repurchase opportunities throughout the year. While we do have annual targets related to repurchases, the amount and timing each quarter may vary based on what we're seeing in the market. Over the past five years, we repurchased 10% of our stock, cumulatively 3.7 million shares, on average 3% below our stock price, totaling $315 million. We will continue this buyback strategy in 2024 and beyond. $185 million remained available under our authorization program at December 31, 2023. This quarter, we spent $9.8 million on our quarterly cash dividend payment of $0.27 per share. We initiated cash dividend at the beginning of 2023, totaling $39.5 million returned to shareholders for the year. In the coming weeks, we will be resetting the 2024 quarterly cash dividend amount and we'll be sharing that externally once approved.
And from time to time, we may pay down all or portions of our public debt as we did in the third quarter of this year. For full-year 2023, we strategically deployed a total of $2.2 billion in capital spend activities, comprised of $1.9 billion in land spend, $150 million for a partial debt redemption, $59 million on share repurchases and almost $40 million of cash dividends. This compares to $1.5 billion in land spend and $109 million in share repurchases in fiscal 2022. On to Slide 10. In the fourth quarter of 2023, we ramped up our land approvals by putting about 7,600 net new lots under control to position us for future community count growth. As a reminder, in the fourth quarter of 2022, we intentionally pulled back on new land acquisitions to assess how the markets were adjusting to the elevated rate environment.
During that time, we didn't place any new lots under control and terminated land deals of roughly 3,700 lots that no longer met our underwriting standards. This quarter was the first quarter since early 2022 where we meaningfully put more lots under control than home starts. As of December 31, 2023, we owned or controlled a total of about 64,300 lots, equating to a 4.6-year supply, which compared to approximately 63,200 total lots or a 4.5-year supply as of December 31, 2022. As a reminder, our target is 4- to 5-year supply of lots. The new lots added this quarter represent 43 future communities, all for entry-level product. In our pipeline, we also have another approximately 28,000 lots where due diligence is still ongoing. About 72% of our total lot inventory at December 31, 2023 was owned and 28% was optioned, similar to the prior year where we had a 73% owned inventory and a 27% owned lot position.
I want to take a moment to reiterate that our land financing strategy has remained consistent for the past decade or so. We have always been focused on balancing strong returns, while ensuring we had sufficient liquidity to fund future land spend. You've heard us note in the past that we do not have an artificial target for the percentage of option land. While that's still true, we wanted to clarify that we're not opposed to land banking. We just haven't had the need to pull that lever over the past four years as we had excess liquidity. As a reminder, in the early 2000s, about 90% of our assets were off book and we were one of the most active builders in the land banking space. We still have very deep land banking relationships that we continue to cultivate and we'll activate them as needed.
As we look into the next couple of years and expect a period of high growth, we don't expect to finance all acquisition and development with our own capital, and we plan to leverage these relationships with our land bankers to ensure we grow responsibly. As we structure our long-term capital plan of balancing growth, shareholder returns and key metrics required keep our investment grade status, we're comfortable that we have a methodical path to meet our cash needs without taking undue risk. Finally, I'll direct you to Slide 11 for our guidance. We believe our nearly 5,900 specs give us dry powder for spring selling season, and will allow us to capitalize on improving consumer sentiment from the pullback in mortgage rates. Our targeted focus on the affordable entry-level segment and more balanced shift in our geographic footprint to our newer markets in the Southern U.S., will result in a reduction in ASP in 2024 into the low 400s, which we believe is the right long-term trajectory for our business.
For the full-year 2024, we are projecting total closings to be between 14,000 and 15,000 units, home closing revenue of $5.8 billion to $6.2 billion, home closing gross margin around 23% to 23.5%, SG&A of 10%, which will spike in the first quarter from certain accelerated compensation arrangements and lower revenue leverage than the subsequent quarters, an effective tax rate of about 22.5% to 23% and diluted EPS in the range of $16.50 to $18.10. As for Q1 2024, we are projecting total closings to be between 3,320 units, home closing revenue of $1.2 billion to $1.3 billion, home closing gross margin of 23.5% to 24%, an effective tax rate of about 22.5% to 23% and diluted EPS in the range of $3.30 to $3.60. The first quarter EPS guidance is inclusive of about $70 million of costs to unwind a rate lock, which will be incurred through our Financial Services segment.
With that, I'll turn it over to Phillippe.
Phillippe Lord : Thank you, Hilla. With January in the books, we are off to a strong start and we are feeling positive about the spring selling season. We had a nation-wide sales event in January and it feels like potential homebuyers are excited about the industry environment and are comfortable pivoting to the new home space where inventory is more plentiful. We will report back on the spring selling season on our next call in April. To summarize on Slide 12. We believe our available spec inventory and anticipate growth in computing account in the second half of the year, coupled with our focus on pace over price, position us favorably in the industry to grow our market share. While still earning outsized return, we have remained true to our strategy supporting our spec building model and disciplined land purchases, and with all the flexibility we have incorporated, we have specific levers we can pull to maximize risk -- minimize risk during uncertain times, and quickly maximize opportunities during high growth periods.
Our capital allocation strategy is disciplined and likewise flexible so we can toggle between cash priorities with a singular purpose of long-term shareholder and value creation. With that, I will now turn the call over to the operator for instructions on the Q&A. Operator?
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