Q1 2024 Forestar Group Inc Earnings Call

Participants

Anthony Oxley; President, Chief Executive Officer; Forestar Group Inc

James Allen; Vice President; Forestar Group Inc

Mark Walker; Chief Operating Officer, Executive Vice President; Forestar Group Inc

Presentation

Operator

Good afternoon, and welcome to Forestar's first-quarter 2024 earnings conference call. (Operator Instructions) Please note, this conference is being recorded.
I will now turn the conference over to Katie Smith, Director of Finance and Investor Relations for Forestar.

Thank you, John. Good afternoon, and welcome to the call to discuss Forestar's first-quarter results. Thank you for joining us.
Before we get started, today's call includes forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Although Forestar believes any such statements are based on reasonable assumptions, there is no assurance that actual outcomes will not be materially different. All forward-looking statements are based upon information available to Forestar on the date of this conference call, and we do not undertake any obligation to update or revise any forward-looking statements publicly. Additional information about factors that could lead to material changes in performance is contained in Forestar's annual report on Form 10-K and its most recent quarterly report on Form 10-Q, both of which are or will be filed with the Securities 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 Andy Oxley, our President and CEO.

Anthony Oxley

Thanks, Katie. Good afternoon, everyone. I'm joined on the call today by Jim Allen, our Chief Financial Officer, and Mark Walker, our Chief Operating Officer.
Before we discuss this quarter's results, I'd like to take a moment to introduce myself since this is my first quarterly public conference call. I joined Forestar at the beginning of the calendar year, transitioning from my prior tenure at D.R. Horton. While there, I served in numerous roles, the most recent being Senior Vice President of Business Development. In addition to being actively involved in D.R. Horton's relationships in strategic land banking and development, I oversaw opening new markets and M&A activity, including being involved in the D.R. Horton investment in Forestar.
I'm excited to have joined the Forestar team and the opportunity to serve in my new role as CEO. I have the utmost respect and appreciation for what Dan Bartok, the company's previous CEO, and the Forestar team accomplished with Dan at the helm. We thank him for his many contributions to Forestar during his six years of service.
Forestar's strong balance sheet, healthy pre-tax margins, and robust land portfolio position us well for future growth. With over 25 years of experience in land acquisition, development, and home building, I'm confident we will continue to expand Forestar's platform and operations to further strengthen our position as a leading lot developer. We remain focused on investing for future growth, turning our inventory, maximizing returns, and consolidating market share in the highly fragmented lot development industry.
Now, on to our results. We are pleased with our first quarter results, highlighted by net income increasing 84% to $38.2 million, or $0.76 per diluted share. Our pre-tax income increased 84% to $51.2 million, and our pre-tax profit margin improved 380 basis points to 16.7%. Our consolidated revenues increased 41% to $305.9 million, while lots sold increased 39% to 3,150 lots. These results reflected significant improvement in demand for finished lots compared to the first fiscal quarter of 2023, when lot -- when builders were reducing starts in anticipation of lower demand for new homes after mortgage interest rates rose rapidly.
Jim will now discuss our first quarter's financial results in more detail.

James Allen

Thank you, Andy. In the first quarter, net income increased 84% to $38.2 million, or $0.76 per diluted share, compared to $20.8 million, or $0.42 per diluted share in the prior year quarter. Consolidated revenues for the quarter increased 41% to $305.9 million, compared to $216.7 million in the prior year quarter.
Lots sold in our first fiscal quarter increased 39% to 3,150 lots, with an average sales price of $96,400. We expect continued quarterly fluctuations in our average sales price based on the geographic location and lot size mix of our deliveries.
Our pretax income increased 84% to $51.2 million, compared to $27.9 million in the first quarter of last year, and our pretax profit margin this quarter was 16.7%, compared to 12.9% in the prior year quarter. Our gross profit margin was 23.8%, up 280 basis points sequentially, and up 190 basis points from a year ago. Gross margin was positively impacted by the closeout of a legacy community during the quarter. Excluding the legacy community lot sales, our first quarter gross profit margin would have been 22.8%.
In the first quarter, SG&A expense was $28 million. As a percentage of revenue, SG&A expense improved 140 basis points to 9.2%, from 10.6% 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

As for current market conditions, the supply of new and existing homes at affordable price points is still limited, and demographics supporting housing demand remain favorable, despite elevated mortgage interest rates and inflationary pressures. Builder incentives have helped bridge the affordability gap for many homebuyers, and low resale supply continues to be a driver of buyers choosing new construction.
Supply of vacant developed lots, especially at affordable price points, continues to be constrained across our footprint, and Forestar is uniquely positioned to take advantage of the shortage of finished lots. Our ongoing focus is to develop lots for homes at affordable price points, demonstrated by our average sales price this quarter of roughly $96,000.
Availability of contractors and necessary materials has improved over the past several months, but we have not seen overall reductions in the cost of developing land. We will continue value engineering our projects and work with our trade partners to develop lots in the most efficient way possible.
Our development cycle times have continued to be infected by governmental delays. Homebuilders continue to compete to secure land and lot positions, and many are looking to replace current closed out communities to position for future growth. As a result, we are not seeing any softening in land prices. However, in most markets, we have seen an adjustment back to normal contract terms. Jim?

James Allen

D.R. Horton is our largest and most important customer. 16% of the homes D.R. Horton started in the past 12 months were on a Forestar developed lot.
With a mutually stated goal of one out of every three homes D.R. Horton sells to be on a lot developed by Forestar, we have significant opportunity to grow our market share within D.R. Horton. We also continue to work on expanding our relationships with other homebuilders. Ten percent of our first quarter deliveries, or 316 lots, were sold to other homebuilders, which includes 124 lots that were sold to a lot banker who expects to sell those lots to D.R. Horton at a future date. Seven percent of our deliveries in the prior year quarter were sold to third party customers. Katie? Forestar's underwriting criteria for new development projects remains unchanged at a minimum 15 percent pre-tax return on average inventory and a return of our initial cash investment within 36 months. During the first quarter, we invested approximately $450 million in land and land development, split equally between land development and land acquisition. Given the strong demand for finished lots, this quarter's investment was almost double the prior year quarter. We still expect our investments in land acquisition and development to total $1.5 to $1.6 billion in fiscal 2024, subject to market conditions. Our lot position at December 31st was 82,400 lots, of which 55,400 lots are owned and 27,000 lots are controlled through purchase contracts. At quarter end, we have 7,300 finished lots on hand. We continue to target a three to four year owned inventory of land and lots and remain focused on managing our development in phases to deliver finished lots at a pace that matches market demand, consistent with our emphasis on capital efficiency. 30 percent of our owned lots are under contract to sell, representing approximately $1.6 billion of future revenue. These contracts have $141 million of hard-earned money deposits associated with them. Another 32 percent of our owned lots are subject to a right of first offer to D.R. Horton based on executed purchase and sale agreements. Jim? We have significant liquidity and are using modest leverage to keep our balance sheet strong. We ended the quarter with approximately $840 million of liquidity, including an unrestricted cash balance of $460 million and $380 million of available capacity on our undrawn revolving credit facility. Total debt at December 31st was $705 million, with no senior note maturities until fiscal 2026, and our net debt to capital ratio was 14.9 percent. We ended the quarter with $1.4 billion of stockholder's equity, and our book value per share increased to $28.21, up 15 percent from a year ago. Four Star's capital structure is one of our biggest competitive advantages, and it sets us apart from other land developers. Project-level land acquisition and development loans are less available today and have continued to become more expensive, impacting most of our competitors. Other developers generally use project-level development loans, which are typically more restrictive, have floating rates, and create administrative complexity, especially in a volatile rate environment. Our capital structure provides us with operational flexibility, while our strong liquidity positions us to take advantage of attractive opportunities when they arise. Andy, I'll hand it back to you for closing remarks. Thanks, Jim. We are pleased with Four Star's start to fiscal 2024. Our team maintained double-digit revenues while continuing to deliver growth with strong profitability. Elevated mortgage interest rates continue to impact affordability, but the underlying fundamentals of a housing shortage remain in place. We believe the low supply of existing homes will continue to drive buyers to new construction, and our strong relationship with D.R. Horton provides a clear path for growth. Our guidance for fiscal 2024 remains unchanged. Based on current market conditions, we expect to deliver between 14,500 and 15,500 lots and generate $1.4 to $1.5 billion of revenue. We are closely monitoring each market as we strive to balance pace and price to maximize returns in each project. We are the market leader in a highly fragmented and undercapitalized industry and uniquely positioned to take advantage of builder demand for finished lots. There is a significant opportunity to expand our presence in markets that we operate in, and our goal remains the same, to double our market share to 5% over the intermediate term. We expect to aggregate significant market share over the next few years while maintaining a disciplined approach when investing capital to enhance the long-term value of Four Star. John, at this time we'll open the line for questions. Thank you. At this time we will be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment please while we poll for questions. Our first question comes from Truman Patterson with Wolf Research. Please proceed. Hey, good afternoon everyone. Andy, congrats on the role. Look forward to working with you in the future. I realize you've only officially been in the role a short time here, but now that you're officially in the seat, are there any kind of big picture initiatives, shifts in how you're thinking about the business coming from the largest builder to now the largest land company? I'd love to hear just any thoughts there. It seems like the healthy growth initiatives that Four Star had laid out previously, doubling market share, seems like those are largely unchanged. So any commentary there would be helpful. Thank you very much. I appreciate the opportunity to be here. Our goal does not change, as you said. Our goal is to achieve a 5% market share as quickly and efficiently as we can. So we're looking to grow the business. Perfect. And then with your gross margins, I realize they can be lumpy kind of quarter to quarter. I believe you all said current quarter was about 22.8% excluding a closeout community, which is relatively elevated higher end of history. Could you all help us understand whether there were any other kind of items or one-time items during the quarter where this might not be repeatable at this level? Or is it a little bit more sustainable given your all's cost advantages versus the smaller peers where there's tighter lending conditions, higher cost of capital, et cetera? Hi, Truman. As you know, we don't provide guidance with respect to margins. And we underwrite returns, not margins. So it does create some variability in margins from quarter to quarter depending on which projects deliver lots within the quarter because we have a mix of, you know, projects with higher or lower margins. However, I mean, we can provide some historical context. And if you look at maybe the last nine quarters adjusted for impairments and, you know, kind of unusually high legacy lot or land sales, our margins have fluctuated between 18% to 23% for the last nine quarters. In the last five quarters, it's been 21% to 23%. If you look at last year's, our fiscal year, we reported 21.2%. But if you exclude the impairments that we recognized in the last fiscal year, that would have been 22.5% compared to the 22.8%, you know, for this quarter. So you can see that our margins have actually been fairly consistent for the last couple years, you know, kind of in that low 20s range. Yeah, and Truman, this is Katie. There wasn't anything else in the quarter that was significant enough to call out. Okay, that's very helpful. And if I could sneak another one in on kind of the other sides of returns at an enterprise level, if you will, but your lot delivery guidance over the next few quarters kind of implies flattish year over year, if I'm doing the math right. It seems like perhaps given some of the growth in the industry, is that, you know, a reality? Or, you know, on the flip side, did you all perhaps pull forward some sales into 1Q, and now you might have a little bit of a developed lot shortage, if you will, or a gap, if you will, just hoping to understand kind of the puts and takes of the guidance. Well, you know, first quarter was a good quarter, but, you know, it's still early in the year. Based on, you know, the current market conditions, our current lot positions, our development timelines, you know, we still believe that $14,500 to $15,500 is a realistic range. Yeah, Truman, that's Mark. We also expect, you know, new home starts to align with new home sales. So if home builder sales accelerate, we could be at the higher end of our range, but we're going to monitor the spring selling season, remain flexible to capitalize on any market upside. I was saying that there could be a bottleneck in achieving that upside that could be related to finished lot deliveries, particularly related to government approval delays. Yeah, we alluded to it in our scripted remarks, but we've continued to see delays from municipalities, land development, so that could definitely be the bottleneck. Gotcha. Understood. Thanks for your time, and good luck in the next couple quarters. Thank you. Thank you. The next question is from Carl Reichert with BTIG. Please proceed, Carl. Thanks, everybody. Andy, official welcome. Katie, good to have you back, too. Thank you. Can I go back to something Mark mentioned about normal contract terms and sort of a movement back that direction? Can you expand on that a little bit by what you mean by normal contract terms and what was really abnormal prior? Yeah, so we're seeing more takedown schedules than we were seeing before, less bulk closings, things of that nature. So although it was increasingly difficult today, those normal contract terms have kind of gone back to what was historically the case for I would tell you a decade. And so we're getting land sellers that are getting a little bit more realistic. I'll give you an example. So if you had a big project and you were going to go bulk a large project, they're now giving you time between your takedowns to take that land down over time versus having to bulk purchase that project. That's probably one of the big normalizations in contract terms. We've also seen more normalized due diligence timeframes. So instead of 30 days, you're getting 60 or 90 days. Okay. So more efficient. It takes longer but easier to manage and more efficient for you all in terms of capital deployment and receded capital. Is that the way to think about it as opposed to lumpier? Okay. Great. Thank you. And then if I can get to Truman's question a different way on the guide for the year. So do you have lots that you think right now you'd anticipate finishing in the next two quarters that would be available for sale that don't have a buyer or contract yet? And if so, what's that number? I don't have the specific number of lots that are going to be finished that aren't under contract right now. I can probably get that for you. I'd have to check. But we definitely do have stuff that's under development that's not been put under contract yet. In a four-star source project, we aim to have those under contract anywhere from three to six months before delivery. And so there's definitely still opportunity to put stuff under contract that's going to close in the back half of the year. Okay. All right. Great. Thank you, Katie. And then last question. You did another deal with a lot banker who's working with your largest customer. And I'm curious about whether or not that's a potential growth area for you, whether a lot banker will be working with Horton or not. We've certainly talked to plenty who are trying to deploy more capital and looking for opportunities. Can you talk about what that opportunity might be? And then I should sidecar onto that also because I always ask about single-family rental and how that business looks, if it looks interesting at all or is that still sort of a one-off? I'll start and I'll let somebody else chime in if they need to. But, I mean, as far as the opportunity with land bankers, it's not really our decision. You know, we're not marketing our lots to land bankers. But if one of our customers wants to use a land banker to step in as an intermediary, we're completely fine with that. It just, you know, enhances our capital efficiency and gets that inventory off of our balance sheet. So we're pretty indifferent if there's a land banker that's stepping in on behalf of a builder, as long as, you know, we have all of the checks and balances in place. And as it relates to the part of your question on build for rent, yes. We do think that that is a sustainable part of our business. If we can have portions of a larger community, which we could improve our pace through selling to a customer that has build for rent components or multifamily components, you know, that's something that we would absolutely entertain. Okay. I appreciate it all. Thanks very much. Thanks, Carl. The next question comes from Anthony Petinari with Citigroup. Please proceed. Hi, this is Asher Sonin on for Anthony. Thanks for taking my question. I think you've talked, you know, in the past about, you know, the capital structure offering competitive advantages, but I'm just wondering, you know, have you seen any concrete kind of like maybe opportunities in the land market come up, come about, or any sort of like concrete evidence? That's sort of coming to fruition or maybe that that'll take a little bit longer. Yeah, we're not seeing any really concrete evidence. What we do see, it does give us a little bit more of a competitive advantage having the liquidity at hand, competing against another developer. And at times too, you know, the other builders are using that developer in a much smaller fashion than they're using us. They know that we have the liquidity and they'd rather look to us to develop the lots versus the other, let's call it local or regional developer. There has been times too, where maybe that developer gets into a capital constraint on the following phase. And so some builders will look to us to see if we can step in and purchase that additional phase to keep, prevent them from gapping on their home sales. Great. And then just separately, obviously, you know, you're not, you're not guiding to gross margins for the year, but I'm just wondering, you know, I think, you know, previously we talked about increased force source lots driving kind of a gross margin headwind. Are you sort of seeing that drive? Sorry, tailwind rather. Are you seeing that tailwind kind of materialize in 2024? Is that maybe more of a 2025 story? Well, we could see it in 24. Definitely. You know, we're the four-star source. Lots does give us, does give us more optionality, I guess, for the project. I don't know that. I don't know that we'll see. I mean, we have seen significant increases in development costs as well. So, you know, I don't know that we're going to continue to see increased margins as a result of that, because we're always trying to, trying to match price and pace or balance price and pace to improve our returns. So it's, it's really not just about, you know, the sales price or margin. It's really more about our returns. Great. That's helpful. I'll turn it over. Once again, if you have a question or a comment, please indicate so by pressing star one. The next question comes from Mike Rehat with JP Morgan, please proceed. Hi guys, Doug Wardlaw from Mike. I was wondering if you could kind of speak to any potential regional trends you've seen over the recent months, especially with the kind of rate volatility that we've experienced, if there's been any particular regions where you've seen strength or weakness. I know that we've seen a particular weakness, Texas and Florida remain strong for us. They've been a stronghold for a long time. Great. And then in terms of you guys touched on, you know, difficulty with municipalities and getting approval there. Is there any kind of vision moving forward when you see that easing up a tad, or is that something that you expect to be a problem for the business moving forward? I guess for the foreseeable future in 2024. That's a great question. Historically, it's always been a challenge. It's been delayed even further. I would tell you in the past 12 to 24 months, a lot of it's turnover within those departments themselves. You get some folks with less experience that are now in that role versus more folks with seasoned experience. It's a daily battle out in the field with our folks that like anyway, I'll refrain from saying that, but it's, I don't know that it's going to ease up anytime in the foreseeable future, but again, I think it's market to market in terms of where we're seeing those governmental delays. Some areas we see it, some we don't. So it really fluctuates across the United States. And we we've been accounting for those delays in our underwriting. So we've been looking at it, you know, extended timelines and the underwriting to make sure that we're still going to be able to achieve our returns. Got it. Thank you guys. We have reached the end of the question and answer session. I will now turn the call over to Andy Oxley for closing remarks. Thank you, John. And thank you to everyone on the four star team for your focus and hard work. We will stay disciplined 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 April to share our second quarter results. This concludes today's conference and you may disconnect your lines at this time. Thank you for your participation.