Forestar Group Inc. (FOR) Q2 2023 Earnings Call Transcript

Good afternoon, and welcome to Forestar's Second Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. I will now turn the call over to Ashley Dagley, Corporate and Securities Counsel for Forestar.

Thank you, John. Good afternoon, everyone, and welcome to the call to discuss Forestar's second quarter results. We appreciate your participation. Before we begin, please note that today's call contains forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. While Forestar believes these statements are based on reasonable assumptions, there is no guarantee that actual results will not be significantly different. All forward-looking statements reflect information available to Forestar at the time of this call, and we do not have any obligation to update or revise these statements publicly. For more information on factors that could result in material changes in performance, please refer to Forestar's Annual Report on Form 10-K and the latest quarterly report on Form 10-Q, both of which have been filed with the Securities and Exchange Commission. Our earnings release is available on our website at investor.forestar.com, and we plan to file our 10-Q early next week. After this call, we will upload an updated investor presentation to our Investor Relations site under Events and Presentations for your reference. Now, I will turn the call over to Dan Bartok, our CEO.

Thanks, Ashley, and we appreciate you filling in for Katie this quarter. Good afternoon, everyone. As always, we appreciate your interest in Forestar and taking the time to discuss our second quarter results. I am pleased to be joined on the call today by Jim Allen, our Chief Financial Officer; and Mark Walker, our Chief Operating Officer. Our second quarter results continue to demonstrate the strength and resiliency of Forestar's unique business model. Forestar generated $301.5 million of consolidated revenues, a gross profit margin of 18.5%, a pre-tax profit margin of 11.9%, and a return on equity for the trailing 12 months of 11.7%. Despite a transitioning housing market, sticky inflation and challenging comparisons to our exceptional quarter achieved a year ago, our operational discipline, manufacturing mentality, and cost management initiatives helped us maintain double-digit pre-tax profit margins and return on equity. Thank you to all of our valued team members for your efforts. Over the past five years, Forestar has undergone a remarkable transformation, becoming the largest pure play residential lot manufacturing company in the United States. We have built a platform and assembled a team that is flexible and focused. We have further strengthened our balance sheet and look to be opportunistic in ways that will continue to build shareholder value. Our strategic relationship with D.R. Horton, America's largest builder, has helped us capture market share quickly, and we are well positioned to expand our customer base. While builders have started to increase new home starts, from our perspective, there is still uncertainty about how the rest of the year unfolds. We are continuously monitoring the market and remain flexible to quickly adjust to builder demand. What sets Forestar apart from peers is our strong capital structure, our operational flexibility and a strong customer relationship, and, most importantly, an exceptional team to execute our plans. We will continue to navigate the short-term volatility while investing wisely for our future growth and striving to maximize returns. Forestar is better positioned than ever to serve current and new customers and to continue to consolidate market share. Jim will now discuss our second quarter financial results in more detail.

Thank you, Dan. In the second quarter, net income attributable to Forestar was $26.9 million, or $0.54 per diluted share, compared to $47.8 million, or $0.96 per diluted share, in the prior-year quarter. Consolidated revenues for the quarter totaled $301.5 million, which included $7.5 million in revenue from deferred development projects and $41.1 million in tract sales and other revenue, compared to $421.6 million of consolidated revenues during the second quarter 2022. We sold 2,979 lots during the quarter with an average sales price of $84,700. We expect continued quarterly fluctuations in our average sales price based on the geographic location and lot size mix of our deliveries. Our pre-tax income for the quarter totaled $35.9 million compared to $63.2 million in the second quarter of last year, and our pre-tax profit margin was 11.9%. Our gross profit was $55.9 million compared to $87.5 million in the prior-year quarter, and our gross profit margin declined 230 basis points to 18.5%. We incurred $900,000 of option deposits and due diligence write-offs in the quarter. Additionally, we recorded non-cash real estate impairment charges totaling $19.4 million, which reduced our gross profit margin by 650 basis points. The impairment charges were related to cost overruns in two projects that encountered adverse development conditions, one in Florida and one in Texas. Excluding those impairments, our gross profit margin would have been 25%. Gross margin was positively impacted by a legacy commercial tract sale and, to a lesser extent, increased margins on lot sales from development projects sourced by Forestar. In the second quarter, SG&A expense was $22 million or 7.3% as a percentage of revenues, compared to $24.3 million in the prior-year quarter. This was our fourth consecutive quarter reducing absolute dollars of SG&A expense. We will continue to focus on controlling our SG&A costs while ensuring that our infrastructure supports our business.

As for current market conditions, we continue to see improved contractor availability and pricing with front-end trades. Materials like concrete and transformers are still challenging to procure in certain markets. However, our teams are relentless problem solvers, and they continue to navigate this environment exceptionally well. We will continue to be proactive and work with our trade partners to control development costs. Our unique operating model and capital structure allows us to adjust the pace of development based on market conditions. We remain intensely focused on managing our development phases as we strive to deliver finished lots at a pace that matches market demand. Consistent with our emphasis on capital efficiency, we evaluate each project and the surrounding market conditions to determine the appropriate pricing and sales pace to maximize returns. We remain focused on developing lots for homes at affordable price points, demonstrated by our average sales price of roughly $85,000.

D.R. Horton is our most important and largest customer. However, we look to continue expanding our relationships with other homebuilders and have a goal of selling 30% of our lots to customers other than D.R. Horton over the intermediate term. 11% of our second quarter deliveries or 313 lots were sold to other customers, which includes 147 lots that were sold to a lot banker who expects to sell those lots to D.R. Horton at a future date. 18% of our deliveries in the prior-year quarter or 1,017 lots were sold to third-party customers, including the sale of 787 deferred development lots. In addition to growing by expanding our customer base, we have significant runway to grow our market share within D.R. Horton. Our mutually stated goal is for one of every three homes that D.R. Horton sells to be built on a lot developed by Forestar.

Forestar's underwriting criteria for new development projects includes a minimum 15% pre-tax return on average inventory, and a return of the initial cash investment within 36 months. During the second quarter, we invested approximately $185 million in land and land development, of which $170 million was for land development and $15 million was for land. Our investment this quarter was down 45% compared to the prior-year quarter. As land prices increased across most of our footprint, we proactively started to reduce our land investment in 2021 in anticipation of a slower housing market. We shifted our focus to the phase development of land that we already own. Despite elongated development timelines, inflationary pressures and slowing demand, our inventory balance has grown only 1% compared to a year ago, further demonstrating disciplined and strategic inventory management.

We continue to work with land sellers to extend closing dates and, in certain cases, we have opted to terminate contracts. Forestar's lot position at March 31 was 76,400 lots, of which 57,800 lots are owned and 18,600 lots are controlled through purchase contracts. The majority of our owned lots were placed under contract to purchase from land sellers before 2021, resulting in an attractive cost basis. Our lot position decreased by 5,900 lots or 7% sequentially and by 20,100 lots or 21% year-over-year. At quarter-end, we had 9,100 finished lots on hand. We are continuing to target a three to four year owned inventory of land and lots. 26% of our owned lots are under contract to sell, representing approximately $1.3 billion of future revenue. These contracts have $130 million of hard earnest money deposits associated with them. Another 30% of our own lots are subject to a right of first offer to D.R. Horton based on the executed purchase and sale agreements.

We are retaining significant liquidity and using modest leverage to keep our balance sheet strong while maintaining our disciplined approach when investing capital. We ended the quarter with over $650 million of liquidity, including approximately $285 million of unrestricted cash and $365 million of available capacity on our undrawn revolving credit facility. Total debt at March 31 was $707 million with no senior note maturities until fiscal 2026. Our net debt to capital ratio at March 31 was 25.2%, down from 29.9% in the prior-year period. We ended the quarter with $1.25 billion of stockholders' equity, and our book value per share increased to $25.01, up 12% from a year ago. Forestar's capital structure is one of our biggest competitive advantages and it sets us apart from other land developers. Other developers generally use project-level development loans, which are typically more restrictive, have floating rates and create administrative complexity, particularly in a rising rate environment. Our bonds provide us with operational flexibility and fixed cost debt, while our strong liquidity allows us to take advantage of attractive opportunities when they arise. Consistent with our last earnings call and as a result of the current market uncertainties, we are not providing guidance for fiscal 2023 at this time. We have been very strategic and disciplined and we are well positioned to react quickly to changes in market conditions.

Thanks, Jim. Overall, I am pleased with the Forestar team's execution during a transitioning housing market. We have made remarkable progress building Forestar's platform, and our commitment to operational excellence enabled us to deliver strong margins and maintain competitive returns. I'm even more pleased with how well we are positioned and the strength of our balance sheet. We are the market leader in a highly fragmented and undercapitalized industry and remain confident about Forestar's ability to continue to execute well and consolidate market share. Forestar is well positioned to be the lot supplier of choice to homebuilders due to our broad geographic footprint, attractive land positions, strong balance sheet and, most importantly, our ability to execute. Looking forward, we continue to believe that D.R. Horton and many other homebuilders will shift their focus towards buying finished lots from third-party developers, instead of self-developing, and conversations with third-party builders have increased in recent months. While mortgage rates are down from peak levels seen in late 2022 and home price increases have moderated, home affordability remains a challenge for consumers. Forecasts expect 2023 U.S. single-family housing starts to decline between a range of approximately 15% to 30% compared to 2022. While we cannot control the macroeconomic backdrop or directly influence the demand for housing, we can and will stay focused on strengthening our platform and increasing operational efficiencies to drive future growth. We are closely monitoring each market, sub-market, and project as we strive to balance pace and price to maximize returns. Our goals have not changed. We still intend to double our market share to 5% over the intermediate term. We believe our market share gains will accelerate as land development financing remains expensive and less available for the majority of our competitors. We have a track record of solid execution and are focused on the long-term opportunity before us. When appropriate, we will leverage our platform and strong balance sheet to capitalize on opportunities that build shareholder value. With our experienced team that has successfully managed the prior market cycles, we are well equipped to navigate the current environment and further strengthen our industry-leading position. John, at this time, we'll open up the line for questions.

Thank you. At this time, we will be conducting a question-and-answer session. Our first question comes from Carl Reichardt with BTIG. Please proceed.

Thanks. Good afternoon, everybody. Thank you for the time. So, Dan, the commercial banking world has been roiled quite a bit since we last chatted. And while the builders, the large publics are capitalized not dissimilarly to you, I'm guessing a lot of small local land development peers of yours are fairly reliant on regional banks for secured financing. And I'm wondering whether or not you're noting to this point, any disruption, additional disruption in their ability to get financing, and whether or not that's an opportunity for you? And if so, what kind of opportunity could it be?

Well, we are hearing about problems in getting financing. The banks are clearly tightening up some of their lending standards and shying a little bit away from A&D financing. So, I think that does present some opportunities for us. We continue to look for those opportunities. And as I said in the remarks, that's really how we positioned ourselves. So, we have a really strong balance sheet and liquidity to take advantage of those opportunities when they arrive. So, we look forward to this year.

Okay. And then, you've said before the goal of trying to get return of cash on your deals 36 months after initial investment. I'm curious if you look back on the transactions you have completed over the course of your life running the company, what percentage of your deals have you actually achieved that goal of getting your cash out 36 months from initial investment?

I don't have that specific number, Carl, but I would say that on average, we are likely performing better than the 36-month target based on our returns and inventory turns. Except for the last couple of quarters, where our pace has slowed, we were exceeding our projections on inventory turns. Overall, I am confident that we can achieve that 36-month goal.

Thank you. I have one more question. We've discussed challenges with concrete and transformers, which we are aware of. However, I would like to direct this to Mark. How does the current availability of trades compare to what you experienced before COVID? Are we back to pre-COVID levels in terms of availability, or do we still have some distance to cover regarding subcontractors who can work with you? Thank you.

Hey, Carl. I think contract availability is definitely freeing up. I don't think we're back to pre-COVID availability yet. I think some of those contractors in the past let's call it two quarters were essentially finishing work on developments. And I think that we're starting to see some pricing considerations on front-end parts of our business as well as contractor availability freeing up. So, we feel good about the opportunity of the contractors coming back to the market as well as being able to see some type of pricing incentives. We have seen costs stabilize.

Great. That's perfect. I appreciate it all. Thanks so much.

Thanks, Carl.

The next question comes from Truman Patterson with Wolfe Research. Please proceed.

Hey, good afternoon, everyone. Thanks for taking my questions. Historically, whenever I look at you all, you've been able to ramp kind of the back half of the year lot deliveries versus the first half, and perhaps a part of that was you all were in growth mode. But given the current better-than-expected demand environment with the homebuilders, do you think that's still a likely scenario to play out this year? Or are there other items to consider builders having a larger land bank or even your own internal development pipeline?

I'm not sure if I can address the likelihood of that, but I can tell you that we have arranged our inventory to prepare for an increase. Currently, we have over 9,000 finished lots available, and with additional lots under development, we've been actively working on staging different phases over the last six months, and even throughout the previous year. We have lots that are already graded and others where we've installed pipes and have temporarily paused work, allowing us to deliver lots much more quickly than during a regular first phase cycle. Therefore, we're ready to accelerate our efforts. In fact, due to the strong demand we are experiencing, we are not just maintaining our previous pace, but are gradually increasing our development activities again. However, this will be assessed on a project-by-project basis, taking into account the inventory available, the builders' sales rates, their pace of new starts, and ensuring that we have enough lots available for each builder in all our projects.

Perfect. Thank you. And then, you mentioned previously that some smaller private developers you've been hearing about financing tightening, if you will. But are you actually seeing any land price relief yet or distressed deals come into the market? I understand that it likely varies across geographies. Just any color on specific markets to call out.

I can't say that we're really seeing big discounts on land prices yet. We're definitely seeing availability. The builders have dropped a lot of contracts over the last year. So, deals that maybe we looked at and got outbid on before we're seeing back again and kind of reengaging with sellers. As far as them getting pricing at big discounts, I think we're able to get them at maybe what we may have offered a year ago versus what we got outbid on, but we're not really seeing the discounts yet. And what we may not? I mean, if the market really does continue to recover the way it is, we may not see those huge discounts that we're hoping for.

Perfect. All right. Well, thank you for your time, and good luck in the coming quarters.

Great. Thanks, Truman.

The next question comes from Anthony Pettinari with Citigroup. Please proceed.

Hi. This is Asher Sohnen on for Anthony. Thanks for taking my question. ASP per lot fell mid-single digit quarter-over-quarter. I just wonder, is that a function of just sort of the inherent lumpiness of your business? Or is that a result of lot prices starting to follow home prices downwards?

No, it's really just due to mix, the geographic and lot size mix from quarter-to-quarter.

Thank you for that information. It's in line with my thoughts. Regarding gross margins, is the sequential decline primarily due to mix? If so, how should we consider the gross margin mix trajectory in the second half of the fiscal year?

Our gross margin was significantly affected by two impairments taken this quarter. While we reported 18.5%, the impairments had a negative impact of 650 basis points. If we account for those, the margin would be closer to 25%. On a positive note, we also had a legacy commercial tract with very high margins during the quarter. Excluding both of these factors, our normalized margin for the quarter was between 22% and 23%.

Thanks. That's very helpful. I'll turn it over.

The next question is from Mike Rehaut with J.P. Morgan. Mike, please proceed.

Hi, guys. This is Doug Wardlaw on for Mike. You guys mentioned as you've gone through this banking crisis, the private developers have been seeing financing tie in. Moving forward and a scenario in which we go into a mild recession. Do you guys see yourself still in kind of the forefront of being able to take over some of those projects despite the environment worsening? Or it would be something where you'd have to kind of maintain and stay in the sidelines and evaluate?

Well, as we see those opportunities, we are underwriting and engaging and trying to see if there's a deal there that hits our metrics. So, we're not standing on the sidelines. We are actively looking forward and engaging on opportunities as they arise.

Got it. Great. In terms of pricing on a regional basis, has there been any difference in trends from last quarter to this quarter? And where do you see that moving as the year progresses?

Pricing in terms of ASP or development costs?

Yes, in terms of ASP.

Yes, I think our ASP is pretty stable. I mean, again, as Jim said, it's going to move quarter-to-quarter based off the size and different types. But we think at the moment, we feel like the ASP is going to be pretty stable for the rest of the year.

Got it. Thank you.

Okay. It seems there are no further questions in the queue. I would now like to hand it back to Dan Bartok for any closing remarks.

Thank you, John. And thank you to everyone on the Forestar team for your focus and hard work. I'm proud of the results the team achieved this quarter. We will stay disciplined, flexible and opportunistic as we continue to consolidate market share in fiscal 2023. We appreciate everyone's time on the call today, and look forward to speaking with you again in July to share our third quarter results. Thank you.

This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.