Beazer Homes USA Inc (BZH) Q1 2021 Earnings Call Transcript

Good afternoon. And welcome to the Beazer Homes Earnings Conference Call for the quarter ended December 31, 2020. Today’s call is being recorded and a replay will be available on the company’s website later today. In addition, PowerPoint slides intended to accompany this call are available in the Investor Relations section of the company’s website at www.beazer.com. At this point, I will turn the call over to David Goldberg, Senior Vice President and Chief Financial Officer.

Thank you. Good afternoon. And welcome to the Beazer Homes conference call discussing our results for the first quarter of fiscal 2021. Before we begin, you should be aware that during this call, we will be making forward-looking statements. Such statements involve known and unknown risks, uncertainties and other factors, which are described in our SEC filings, which may cause actual results to differ materially from our projections. Any forward-looking statement speaks only as of the date this statement is made and we do not undertake any obligation to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. New factors emerge from time to time and it is simply not possible to predict all such factors. Joining me today is Allan Merrill, our Chairman and Chief Executive Officer. On our call today, Allan will review highlights from the first quarter, explain the basis of our confidence in the new home market and discuss our improving expectations for fiscal 2021. He will also describe two significant commitments we recently made as part of our ESG strategy. I will cover our first quarter results in greater depth and provide detailed expectations for the second quarter and full year of fiscal 2021. I will then update our expectation for continued growth in our land position, followed by a wrap up by Allan. After our prepared remarks, we will take questions in the time remaining. I will now turn the call over to Allan.

Thank you, Dave, and thank you for joining us on our call this afternoon. With an acute focus on health and safety, we generated outstanding operational and financial results in the first quarter. Operationally, orders were up more than 15% year-over-year, driven by a sales pace that was up more than 40%. In fact, both orders and our sales pace reached their highest first quarter levels in more than a decade, even as we intentionally slowed sales with price increases. We also expanded our lot supply, creating a path for future growth. Financially, we delivered big improvements in gross margin, adjusted EBITDA and net income. The strengthened demand for new homes has exceeded our expectation over the past six months. We have known that pent-up demand was building based on the disconnect between demographics and strong affordability on the one hand and anemic housing starts for most of the last decade on the other. What we did not anticipate was that a pandemic would be a catalyst for that demand to begin to materialize. Many consumers are now focused on improving their living situation, whether their motivation is more space, better space, outdoor space or an entirely new location; demand for housing has been excellent. The question on everyone’s mind is, how long will this strength last? Well, we believe it’s likely to persist for some time. From a supply perspective, our industry has delivered far fewer homes in the last 10 years than job growth and household formation would have predicted. We think this cumulative deficit is conservatively well above 1 million homes, which means that a few good quarters are unlikely to exhaust the need for new homes. So what about the durability of demand? Well, to buy a home, prospective homeowners typically need two things: income security in the form of a job and homes for sale that they can afford. With vaccines at hand, we are optimistic that economic and job growth may resume as soon as the spring. In that case, the concern about the durability of demand may be better seen as a question about affordability. Affordability ultimately boils down to mortgage rates and home prices. Although the Fed is on record supporting low rates for an extended period, we know we have to work hard to keep home prices within the reach of most buyers and that is exactly why our positioning is so important. We believe we are in the right markets with the best job growth. We are targeting the largest buyer segments, baby boomers and millennials, and we focus on delivering exceptional value at an affordable price, not competing primarily on price. Ultimately, this positioning gives us confidence that our pivot towards growth will allow us to fully participate in a strong housing market over the next several years. As we enter this spring’s selling season, we have an unusually high degree of visibility and therefore confidence in our likely full year results. That’s because the dollar value of our backlog is up nearly 60% compared to last year. So today, we are increasing our expectations for each of the objectives we outlined for fiscal 2021. Dave will provide more precise figures in his comments. But we now expect higher earnings and increased land activity this year, while exceeding earlier debt repayment objectives. In summary, we are going to make significant progress on our balanced growth strategy, which is designed to grow profitability faster than assets and revenue, and to create a more efficient and less leveraged balance sheet. Although ESG is receiving increased attention, it isn’t something new at Beazer. We have been addressing all three facets of ESG for years, because we see it as fundamental to fulfilling our purpose statement, which we have included on slide seven. Today, I’d like to draw your attention to the significant commitment we announced in our most recent proxy statement that will result in a reduction in greenhouse gas emissions. In short, we have committed that by the end of 2025, every home we build will be Net Zero Energy Ready. In numeric terms, it means all of our homes will achieve a Home Energy Rating System, or HERS, rating of 45 or less, which is an energy conservation standard that is far beyond most existing building and energy codes. At this level, our homes will generate as much energy as they consume by attaching a properly sized alternative energy system. Underscoring this commitment, we are a proud builder partner of the Department of Energy’s Zero Energy Ready Homes Program and we are the first national production builder to commit to building 100% of our homes in accordance with the program. Improving energy efficiency is so important that we have made it a part of our long-term compensation plans as well. Before turning the call back over to Dave, I want to talk about one more aspect of our ESG strategy, namely our commitment to social responsibility. We have a long standing relationship with Fisher House Foundation, an organization that builds homes where military and veteran families can stay free of charge while a loved one is in the hospital. Our work with Fisher House has had a profound impact on our employees, our customers and our partners, and it’s caused us to want to do more. To fund this ambition, last year we started a title insurance agency called Charity Title that will donate 100% of its profits to charity. By creating an innovative, dedicated funding source for our philanthropic efforts, we expect to be able to expand both our contribution levels and the number of organizations we can support. We encourage you to review the ESG materials contained in our proxy statement and 2020 annual report, which are available in the investor relations section of our website. With that, I will turn the call over to Dave.

Thanks, Allan. Looking at the first quarter compared to the prior year, new home orders increased 15% to 1,442, despite a lower community count. Sales pace was up over 40% to 3.5 sales per community per month. Homebuilding revenue increased about 2% to $424 million on flat closings. Our gross margin, excluding amortized interest, impairments and abandonments, was 22.1%, up approximately 230 basis points. SG&A was down approximately 60 basis points as a percentage of total revenue to 12.7%, driven by controlling overhead expenses. This led to adjusted EBITDA of $43.6 million in the quarter, up nearly 50% and exceeding 10% of revenue. Total GAAP interest expense was down about 3%. Our tax expense for the quarter was about $4.1 million for an effective tax rate of 25.5%. As a reminder, on a cash basis, our deferred tax assets offset substantially all of our tax expense. Taken together, this led to $12 million of net income from continued operations or $0.40 per share, up over three times versus the same period last year. Looking to second quarter, we expect the following versus the prior year. New orders should be down slightly. While we expect sales pace to be up, we do not expect it to fully offset our reduced community count as we focus on increasing margin and returns. Closings are likely to be down 10% to 15%. There are a couple factors impacting our expectation for closings next quarter. First, given the strength and demand, we have fewer spec homes to sell and close this quarter. And second, we are balancing cycle time pressures with our commitment to delivering exceptional customer experience. Our ASP is expected to be approximately $390,000. We note that the change in our ASP is reflective of our pricing power or margin opportunity, as we are constantly adjusting features and product mix to retain affordability. In fact, this quarter we had two segments with lower ASPs and substantially higher margins. As we described last quarter, increases in lumber prices in September and October would create a modest headwind on gross margin for the second quarter. Despite this, we expect gross margin to go up slightly versus the same quarter last year. SG&A as a percentage of total revenue should be down at least 50 basis points, reflecting the benefits from topline leverage. We expect EBITDA to be up more than 20%. Interest amortized as a percentage of homebuilding revenue should be in the low 4s. Our tax rate is expected to be about 25%. And combined, this should drive net income and earnings per share up more than 60%. At the start of our fiscal year, we provided our expectation for our full year results. Given our first quarter performance, as well as our positive outlook, we are now able to increase each of those expectations. First, we previously expected EBITDA to be up slightly versus the prior year. We now expect EBITDA to grow at a double-digit rate to over $220 million, much faster than the growth in assets or revenue. This improvement is largely driven by increased profitability, as we expect gross margin to be up at least 50 basis points versus the prior year in the second half of fiscal 2021. Second, we targeted double-digit earnings per share growth on our last call. At the low end, this would have represented EPS of less than $2 per share. We now expect earnings per share of at least $2.50. And finally, we committed to reduce debt by more than $50 million last quarter. We now intend for that to be closer to $75 million. We expect to end fiscal 2021 with a book value per share in excess of $22. And our expected level of profitability, our return on average equity for the full year should be approximately 12%, and if you exclude our deferred tax assets, which don’t generate profits, our ROA should be over 17%. During the quarter we spent $110 million on land acquisition and development, and ended with nearly $500 million of liquidity, up more than $200 million versus the prior year. We expect land spending to accelerate in the remaining quarters of 2021, ultimately exceeding the $600 million we initially anticipated, funded by our cash from this liquidity and cash from operations. On slide 12, we depict our expectations for near-term community count, which we still anticipate will likely trough in the 120s later this year. We expect community count growth will be evident in fiscal 2021, as we benefit from our increased land spending. Last quarter, we said 2021 would be an important inflection year, as we allocated more capital to growth and expanded our use of options. The initial results of this effort were evident in the first quarter as we grew our active lots by about 8% to over 18,000. And importantly, we control 42% of our active lots through options at quarter end, a 7-point sequential increase. Given our current pipeline of deals, we expect to continue to grow our land position as you move through the remainder of the year. With that, let me turn the call back over to Allan for his conclusion.

Thank you, Dave. The first quarter of fiscal 2021 was very productive for Beazer, as we increased our sales pace, grew our backlog and improved both gross margins and SG&A, while expanding our lot position in a highly efficient manner. Even better, we expect this operational momentum to persist through the fiscal year in a new home market characterized by healthy demand and constrained supply. In November, we described fiscal 2021 as an inflection year, where we expected to modestly improve profitability while investing for future growth. In fact, it is shaping up to be much more than that, allowing us to raise our expectations for profitability, investment and debt reduction. Ultimately, 2021 should demonstrate our opportunity to improve shareholder returns from our balanced growth and ESG strategies. I want to thank our team again for their ongoing efforts. I am confident that we have the people, the strategy and the resources to create durable value over the coming years. With that, I will turn the call over to the Operator to take us into Q&A.

Thank you. Operator provided instructions for participants. And our first question will be from Jay McCanless with Wedbush. Your line is open.

Hey. Good morning or good afternoon. Thanks for taking my questions. The first question I had: I like to see you are getting a little more aggressive on the debt repayment. But with the run that you have seen in the stock this year, is there any thought to maybe raising some equity and attacking what you have got for ’21 and ’22 to repay?

Yeah. Jay, I would tell you we, from a capital allocation perspective, are always considering every opportunity that’s in the market. The stock has certainly had a good run. We are paying attention to it and will let you know if we act. But nothing is planned right now; we will keep our options open.

Okay. And then in terms of the community count, glad to see that it’s still looking like the end of this year when that bottoms out. Any geographic preference or a little more biased to one geography over another?

Jay, good afternoon. Not really. I am pretty excited about the pipeline across all of our geographies. We are finding things to do everywhere. We went through a hard process of rationalizing markets over the last five to 10 years, and so we are in places that we know we can grow and I am seeing a path in each of those markets. On any given quarter, deal flow is subject to the vagaries of the way deals become available and how they move through our process. But I think if you look at it over a year or two, you are going to see us get bigger in every one of our markets.

Got it. And then in the West order growth was a little bit slower than the other two regions. Was that a function of just community timing or is there anything to point out?

No. We mentioned in the script that we used price, in part to control demand, and we did have some exposure to that in a few of our Western markets. So that was part of it as well. We have such a big backlog in some of those markets that we wanted to be careful about adding to that backlog, so that we could in an appropriate way get the starts out there and keep that customer experience. I would say it was probably more on the near-term sales side related to the change in order growth than community count.

Okay. That’s all I had. Thank you for taking my questions.

Thanks, Jay.

Our next question will be from Alan Ratner with Zelman & Associates. Your line is open.

Hey, guys. Good afternoon. Congrats on the strong performance and thanks for the update on the ESG initiatives. That’s certainly noteworthy and congratulations on the efforts there. My first question relates to the land market. I think a common theme we are hearing from a lot of builders is that the industry is picking up the pace of land acquisition pretty sharply over the last three to six months and you guys are obviously in the mix there. Some builders are talking about doing certain things to remain competitive and avoid some of the inflation that’s going on in the market, whether that means buying larger deals, whether that means maybe going a little bit further out to reduce lot costs. So I am curious: A, can you talk a little bit about the inflation you are seeing, and B, have you changed either your underwriting standards or the targeted land at all to deal with the competitive nature of the market today?

Alan, you are absolutely right. The markets are very competitive. I will give you an oversimplification. Where we are seeing particular enthusiasm is like a barbell: very small bespoke deals that private builders can be all over are super aggressively priced, and deals where there are 200 or more lots that are in the obvious submarkets where there are currently a lot of permits are incredibly highly priced. Where we have found success and really have a good footprint for us is 50 to 150 lots in most of our markets. If somebody is doing 2,000 units in a market, they can’t waste time on 75 or 80-lot deals; they have to do many more in a year. We find that there is a window in many of our markets for that mid-size deal. So deal size is really the thing we target. We ask ourselves why we are able to be successful in this location: did we simply pay the most, or do we have an ability to extract more value from that site? Another part of the strategy is that we are not very adventuresome. When we know a submarket, when we have the trades and the realtor relationships in an area, that’s an opportunity for us to know what a price is and make sure we are not letting somebody else into our kitchen. Where you start getting into new submarkets and new buyer profiles, you have to be very cautious, because the other team gets paid to win deals and we can end up paying what I refer to as the 'dumb tax' in a new area. We are definitely not changing our underwriting numerics; we haven’t eased up at all. If anything, I think we have been pretty effective with our options strategy. The key for us is sticking to what we know and finding deals that are meaningful for us but may be a bit smaller than those the very biggest builders pursue.

Got it. That’s really helpful color there. Second question: I’d love your thoughts on single-family rental. I know you dipped your toe in the water there a few years ago, and as far as I am aware, you are not really active in the space today. But a lot of builders are aggressively either raising capital for that initiative or acting as a GC for operators. Your comment earlier about a 1 million starts threshold or underbuilding: I have heard different opinions on how to think about single-family rental in that equation, because clearly there’s a lot of single-family homes being built for that purpose. I am curious: are you seeing any competitive pressure from that yet? Do you view that as competition for your communities if you see a development across the street or do you view that more as just shifting from apartment demand today?

That’s a big topic. To give some context, we were early in this in 2010, when we started our Pre-Owned Rental Homes company. We simply didn’t have the capital then to scale it fast enough, and I think we did the right thing by creating value for our partners and ourselves and then selling it to one of the big public REITs, who have done well with that portfolio. I am respectful of the degree of difficulty of operating in that space: being a landlord is a different business. So we are humble about the degree of difficulty. Regarding competition, it plays at a few levels. It plays in the land market: there are scenarios where we have been outbid for an asset by someone whose intention was to turn it into a rental community. So yes, that is a source of demand for land and it is competitive in that way. For a lot of our buyers, they have made a decision to become homeowners and are not wavering between renting and owning; they are ready to own for value creation, wealth building and autonomy. So I view rental options as primarily competing with other rental options. It’s a great option: many renters would be much better served in a newly built home rather than an older used home. But the cost of production and land for those homes means the monthly rent creates an important yardstick for us to measure our monthly payments against. If anything, I have been pleased to see the rental rates those communities require, because in virtually every instance the pretax PITI ends up being below that rental rate. That supports the case for why this is an attractive time to be a homeowner. It’s a major factor and we take it seriously. We have sold lots to rental operators and bought lots that were originally intended for rental operations that they decided we were better suited to develop for ownership. So we are close to it, but I don’t feel any urge to start a new rental business; we are excited about growing our core homebuilding business.

I really appreciate your thoughts on that and it will be interesting to watch unfold over the next few years. So thank you.

Thank you. And the next question will be from Julio Romero with Sidoti & Company. Your line is open.

Hey. Good afternoon, everyone.

Hey, Julio.

So you mentioned you expect growth to be up slightly in the quarter even with those headwinds. Can you just talk about that, is that a function of product mix or maybe lumber or any other different costs? Any additional color?

Julio, I think you broke up a little on the question, but I understand you were asking about second quarter gross margin and our expectation. We discussed lumber timing: lumber price increases in September and October affect margins. In terms of having a year-over-year increase, we still had good pricing in the market. Given the visibility we have from our backlog, we are comfortable with the price and cost match that allows us to get margin increases in the second quarter.

Understood. I will hop back in the queue. Thank you.

I think it’s important to point out, Dave, that we will do better in the second quarter than we did last year, but it won’t be like the first quarter. That lumber headwind is there, so we will be up but by a lot less.

Yeah.

Our next question will be from Alex Barron with Housing Research Center. Your line is open.

Thank you. Good afternoon, guys. Great job in the quarter. I had a question about the interest expense or the margin related to the interest expense. I am guessing your comments around margins going up 50 basis points is that outside of the impact of your interest capitalization and all that?

Just to be clear, Alex, the comment was a slight increase on a year-over-year basis in gross margin in Q2 and up more than 50 basis points in the back half of the year, and yeah, that’s excluding interest.

Okay. Now if we focus on the interest that’s running through cost of goods sold, obviously you guys have been paying down the debt and last year the interest that ran through cost of goods sold was higher than the interest incurred. Should we expect the interest in cost of goods sold to start narrowing a little bit more than interest incurred this year?

Alex, we have talked about this before. Remember the interest amortized through cost of goods sold is a function of the capitalized balance and our inventory turnover. As the capitalized balance starts to move down, you will see those two numbers converge. It’s going to take some time; it’s not going to be right away. But you will eventually get to that point; we expect some convergence over time.

To be more precise, I would expect the interest in cost of goods sold will exceed our interest incurred again this year.

Yes.

Okay. Got it. But the general trend is moving in that direction, which is good. Now on your comments about the orders being flattish, I am guessing—and you can correct me if I am wrong—that has more to do with the drop in community count. So two questions: one, where do you see the inflection point for community count going up, and if that’s not the reason, are you guys just limiting sales at this point because of starts or some other factor?

You are 100% right. We expect our pace will be stronger in Q2 this year than Q2 last year. But it is very unlikely that the increase in pace will fully offset the reduction in community count, which is why we probably won’t match last year’s total orders. Absolutely we are being careful at the community level about releases—not so much to manage community count but to maximize the value of every asset. Given the scarcity of homes in our markets, selling a little bit slower and exercising pricing power to capture higher margins makes sense. Every community in each market has a slightly different set of issues, but the macro approach is definitely slowing sales with price, which dampens the pace a bit. In terms of when the inflection point for community count will occur, making projections a couple of quarters out is difficult because of the vagaries of land development. We know we will trough in the 120s mid-to-late this year and we know that next year we will have a higher community count, but I can’t be precise about timing.

Okay. Got it. Thanks a lot.

Thanks, Alex.

There are currently no other questions.

Okay. I want to thank everybody for joining us for our first quarter call and we will see you for our second quarter call. This concludes today’s conference call. Thank you very much.

Thank you. And that does conclude today’s call. We appreciate your participation today and you may disconnect. Thank you.