Forestar Group Inc. Q4 FY2023 Earnings Call

Good afternoon, and welcome to Forestar's Fourth Quarter and Fiscal 2023 Earnings Conference Call. Please note, this conference is being recorded. I will now turn the call over to Ashley Dagley, Corporate Securities Council for Forestar.

Thank you, John. Good afternoon, and welcome to the call to discuss Forestar's fourth quarter and fiscal 2023 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 filed with the Securities and Exchange Commission. Our earnings release is on our website at investor.forestar.com, and we plan to file our 10-K late next week. After this call, we will post an updated investor presentation to our Investor Relations site under Events and Presentations for your reference. Now I will turn the call over to Dan Bartok, our CEO.

Thanks, Ashley. 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 fourth quarter and fiscal year results. I'm pleased to also be joined on the call today by Jim Allen, our Chief Financial Officer; and Mark Walker, our Chief Operating Officer. The Forestar team finished the year strong, highlighted by net income increasing 43% from the prior year quarter to $72.4 million or $1.44 per diluted share. Pre-tax income in the fourth quarter increased 44% to $95.4 million, and our pre-tax profit margin was 17.4%. Revenues for the quarter increased 44% to $549.7 million, while lots sold increased 27% to 4,986. While our fourth quarter performance was substantially stronger than a year ago, the first half of fiscal 2023 was challenging. Despite the challenges and volatility that occurred this year, we maintained double-digit returns and a strong pre-tax profit margin of 15.4%, while generating $364 million of operating cash flow and increasing our liquidity to $1 billion. Our book value per share increased 14% from a year ago, and our return on equity was 13.2%. As we begin fiscal 2024, Forestar is well positioned, both financially and operationally to capitalize on builder demand for finished lots. We will continue to focus on investing for our future growth, turning our inventory, maximizing returns and consolidating market share in the highly fragmented lot development industry. Jim will now discuss our fourth quarter and fiscal 2023 financial results in more detail.

Thank you, Dan. In the fourth quarter, net income increased 43% to $72.4 million or $1.44 per diluted share compared to $50.8 million or $1.02 per diluted share in the prior year quarter. Revenues for the fourth quarter increased 44% to $549.7 million compared to $381.4 million in the prior year quarter. The current quarter includes $64.1 million in tract sales and other revenue and $4.3 million in revenue from deferred development projects. Lots sold during the quarter increased 27% to 4,986 lots with an average sales price of $97,400. We expect continued quarterly fluctuations in our average sales price based on the geographic location and lot size mix of our deliveries. For the fiscal year, net income decreased 7% to $166.9 million or $3.33 per diluted share compared to $178.8 million or $3.59 per diluted share in the prior year. Revenue for fiscal 2023 totaled $1.4 billion, which includes $132.2 million of tract sales and other revenue and $29 million in revenue from deferred development projects. During fiscal 2023, lots sold decreased 21% to 14,040 lots with an average sales price of $91,000.

Our fourth quarter pretax income increased 44% to $95.4 million compared to $66.4 million in the prior year quarter and our pretax profit margin was 17.4%, consistent with the prior year quarter. Our gross profit margin this quarter was 21%, down 200 basis points sequentially and 240 basis points from a year ago. Pretax income for fiscal 2023 totaled $221.6 million compared to $235.8 million in fiscal 2022, and our pretax profit margin for the year was 15.4%. Our gross profit margin for the year was 21.2%, down 10 basis points from the prior year. During fiscal 2023, we recorded $19.4 million of non-cash real estate impairment charges to cost of sales, reducing our pretax profit margin by 140 basis points and our gross profit margin by 130 basis points. Excluding real estate impairment charges for fiscal 2023, pretax profit margin and gross profit margin were 16.8% and 22.5%, respectively. Jim?

In the fourth quarter, SG&A expense was $26.4 million or 4.8% as a percentage of revenues compared to $23.7 million and 6.2% in the prior year quarter. For the year, SG&A expense was $97.7 million or 6.8% as a percentage of revenues, up 60 basis points from 6.2% in the prior year. We will continue to focus on controlling our SG&A costs while ensuring that our infrastructure supports our business.

As for current market conditions, the supply of new and existing homes at affordable price points remains limited and demographics supporting housing demand remain favorable despite higher mortgage 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. The supply of vacant developed lots, particularly at affordable price points, continues to be constrained across our footprint. And we are uniquely positioned to take advantage of the shortage of finished lots. We are focused on developing lots for homes at affordable price points, demonstrated by our average sales price this year of roughly $90,000. The availability of contractors and necessary materials has improved over the past several months, but we have not seen overall reductions in the cost to develop land. We will continue to value-engineer our projects and work with our trade partners to develop in the most efficient way possible. Homebuilders continue to compete to secure land and lot positions. Many are looking to replace current closeout 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 more normal contract terms.

D.R. Horton is our largest and most important customer. 15% of the homes D.R. Horton closed this year run a 4-star developed lot. Our mutually stated goal is for one out of every three homes that 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 are also working to expand our relationships with other homebuilders and have an intermediate-term goal of selling 30% of our lots to builders other than D.R. Horton. We sold lots to 26 unique customers in fiscal 2023 compared to 22 customers in the prior year and 14% of our fourth quarter deliveries or 684 lots were sold to other homebuilders. Jim?

Forestar's underwriting criteria for new development projects remains unchanged at a minimum 15% pretax return on average inventory and a return of our initial cash investment within 36 months. During the fourth quarter, we invested approximately $340 million in land and land development, of which $210 million was for land development and $130 million was for land. For the full year, we invested approximately $980 million, of which $780 million was for land development and $200 million was for land. In fiscal 2024, we currently expect our investments in land acquisition and development to total $1.5 billion to $1.6 billion. Mark?

Our lot position at September 30 was 79,200 lots, of which 52,400 lots are owned and 26,800 lots are controlled through purchase contracts. 6,400 of our own lots are finished. We continue to target a 3- to 4-year owned inventory of land and lots, and remain focused on managing our development phases to deliver finished lots at a pace that matches market demand, consistent with our emphasis on capital efficiency. 29% of our owned lots are under contract to sell representing approximately $1.3 billion of future revenue. These contracts have $121.4 million of hard earnest money deposits associated with them. Another 32% 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 $1 billion of liquidity, including an unrestricted cash balance of $620 million and $380 million of available capacity on our undrawn revolving credit facility. Total debt at September 30 was $695 million with no senior note maturities until fiscal 2026 and our net debt-to-capital ratio was 5.5%. We ended the quarter with $1.4 billion of stockholders' equity, and our book value per share increased 14% from a year ago to $27.43. Forestar'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, which impacts the majority of our competitors. 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 capital structure provides us with operational flexibility while our strong liquidity positions us to take advantage of attractive opportunities when they arise. Dan, I will now turn it back over to you for closing remarks.

Thanks, Jim. We are pleased with the Forestar team's execution during fiscal 2023, delivering strong profitability and maintaining double-digit returns. Thank you to all the Forestar team members for your efforts this year. The fourth quarter was especially strong with our delivery of almost 5,000 lots. The variability we experienced throughout fiscal 2023 illustrates the quarter-to-quarter fluctuations that can occur in the demand and the delivery of finished lots. It also illustrates Forestar's ability and its flexibility to adjust to market changes. The current interest rate environment and market factors create a challenging backdrop as we position the company for the next several years of increasing market share. We are the market leader in a highly fragmented and undercapitalized industry and we are uniquely positioned to take advantage of builder demand for finished lots. Our goal remains the same, to double our market share to 5% over the intermediate term. We will continue to aggregate significant market share over the next few years while maintaining our disciplined approach in investing capital to enhance the long-term value of Forestar. We have a track record of solid execution and will utilize our platform and strong balance sheet to capitalize on opportunities that build shareholder value. With our experienced team that has successfully managed through prior market cycles, we are well equipped to navigate this dynamic environment while investing for our future growth and further strengthening our industry-leading position. John, at this time, we'll open the line for questions.

Thank you. The first question comes from Carl Reichardt with BTIG. Carl, please proceed.

Thank you, everyone. I believe I understood correctly that you are anticipating land and development spending next year to exceed 50% compared to this last fiscal year. Could you share some insights about the allocation between acquiring new lots and developing existing lots? Also, will there be any major changes in the geographic distribution, such as new markets or a focus on existing markets?

Yes, we are currently seeing significant opportunities, and we anticipate that our land expenditure will increase considerably compared to last year. Our last quarter likely reflects what you can expect from land spending. While I don’t have a detailed breakdown of the split between development costs and land expenditure, we do plan to utilize some of our liquidity to strengthen our balance sheet this year. Regarding our markets, we are primarily focused on deepening our presence within the markets we already operate in. Our teams are in place, and we will continue to invest in them as we expand our platform. However, I don't foresee us opening many new markets. Recently, we re-entered Seattle and made a deal in West Virginia, specifically in the western suburbs of D.C. We may re-enter one or two more markets, but the majority of our efforts will be on building our market share in the areas we are already established.

Okay. And then, Jim, you've said this before, you've all said this before, the fluctuation in average revenue per lot or lot prices. And we know it's going to bounce around. Could you give us some type of lower bound and upper bound of the kind of numbers that we might expect based on the lots that you're anticipating on delivering in '24 or even just the pipeline that you have delivering in '24 or beyond?

I can't say that we have a specific range for that. Our average lot price does fluctuate due to our focus on returns rather than margins. There will always be variations in lot prices and margins based on factors like geography or lot size. However, I can't provide a precise range. You can observe the changes we've experienced this year, as there can be quite a difference even from last quarter to this quarter.

Yes. I'll add a little bit. What's interesting is when you look back at the year versus any individual quarter, Carl, our average selling prices this year were up about 6% or 5% from the prior year. And then last year, it was up about 5% or 6% from the year before that. If I was doing the chart, I would probably assume something in that range for next year. But again, it could fluctuate clearly, from quarter to quarter, it's going to fluctuate based on what we're doing in a given market, but over a year that's probably right.

Okay. That was my default if you didn't answer it. And then if I could sneak one more in. So the guidance on deliveries for '24 sort of matches up more or less with your biggest customer in terms of their delivery volume. Obviously, there's timing differentials, and I know that. So is that basically to say that you expect that outside of your largest customer in terms of sales to other builders, you'd grow them at a similar rate as to what you grow your business to D.R. Horton? Or do you expect that mix to fluctuate more distinctly in 2024 in terms of expanding that base since I know you want to do that?

Yes. At this point, looking at the year in front of us, I would assume that it's going to stay, the mix is going to stay pretty much the same to be honest with you. I think we're getting a lot more interest from other builders as I think their development partners are also having difficulty getting financing. But overall, when I look at the lots that we'll be delivering in '24, that's all stuff we own already and in development. So I would expect that pro rata share would stay pretty flat.

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

Hey, good afternoon everyone. I apologize, my phone has been cutting out. So if this is a duplicate. But I did want to follow up on one of Carl's questions. When we're looking at your fiscal fourth quarter lot pricing, it increased like 10% year-over-year to $97,000. And if I'm looking at your '24 guidance, it looks like ASPs remain at that level moving forward. Is there any geographical mix shift or perhaps consumer mix shift? I'm thinking larger lots more of a move-up focus or is this kind of a true pricing power that you're currently recognizing?

Yes. I think it's true pricing power. I mean with inflationary costs are going up, obviously, it's market by market, community by community, again, geography and just the mix of the lots themselves. But we are again pricing our lots to market and trying to phase our deliveries in tune, but if we can grab additional returns, we'll go out and grab additional returns. But I don't think it's anything particular to lot size sell for the fourth quarter, geography.

I think fourth quarter is mostly geography. That spike is not a run rate. It was clearly a mixture of some more expensive lots.

Okay. Got you. And then just looking at your closings range of 14.5 to 15.5 lot sales. Trying to understand what would get us towards kind of the lower end or the higher end of that range. And I'm thinking really whether there are any development or municipal delays that are kind of built into this or if it's just purely a function of market demand and potentially changing interest rates or anything along those lines?

Yes. I think on the lower end, we will continue to focus on returns and ensuring that we are actively moving lots and that the subdivisions are engaged. The current interest rate environment makes it somewhat difficult to predict how the rest of the year will unfold. However, I believe we've made an informed estimate. We have taken into consideration our understanding of the challenges in various municipalities as we formulate our forecast. Therefore, I feel positive about that range. There is potential for upside; if we have lots in development and a strong inventory of finished lots, a decrease in rates coupled with an increase in home sales could position us to really reach the high end of that range.

Okay. Perfect. And if I could squeeze one more in. You all brought up value engineering, your lot positions. Could you just elaborate on that a little bit?

Yes. As we plan our projects, we aim to maximize efficiency in both timing and cost. We focus on value engineering our plans upfront to achieve better costs. We have been disciplined in phasing our developments and remain flexible to either ramp up existing projects or slow down when necessary. From a value engineering perspective, this is connected to timelines and calls. We evaluate this for every project and during our due diligence, even after acquiring an asset as we phase it. This is a daily practice for our teams.

Up next, we have Mike Rehaut with JPMorgan. Please proceed.

Hi everyone, good afternoon. Doug Wardlaw here for Mike. You mentioned during this call your advantage in the industry due to your scale compared to other competitors. I was curious if you could share any trends you observed during the quarter as rate volatility evolved over the summer. Additionally, what are your expectations for early 2024 regarding continued rate volatility?

You're a little fuzzy on the speaker here, but are you looking more from a lot demand standpoint or from a development competition standpoint?

More so from a development competition standpoint.

We are definitely noticing opportunities arising as other developers struggle to secure financing, and their financing costs have increased. This could lead to deals they had secured that they now cannot finalize or develop, or even instances where their banks are refusing to extend further financing. This past quarter, we observed more of this than in previous quarters. It seems to be a trend that may persist as the high-interest rate environment continues and banks remain cautious. From our perspective, we are seeing an increase in opportunities to acquire positions that others are unable to follow through on.

The next question comes from Anthony Pettinari with Citi. Anthony, please proceed.

Good afternoon. Looking at the full year guidance, I realize you haven't provided a full year forecast for the last four or five quarters. Can you explain what is giving you the confidence to provide the outlook for next year, especially considering the ongoing rate volatility and macro uncertainty?

I believe it's due to a couple of factors. Last year, we faced many supply chain issues and difficulties in obtaining final approvals and deliveries at the municipal level. Now, we have a clearer understanding of those impacts, which allows us to assess the situation more accurately than before when it felt more uncertain, hence our decision not to provide guidance previously. The other factor is the interest rate environment. If someone had told me that builder sales would remain this strong with mortgage rates nearing 8%, I would have found it hard to believe. However, the market suggests that builders are still successfully selling homes and determining the right market price. This gives us more confidence in the builders' ability to deliver even amid higher interest rates. Both of these factors contribute to our positive outlook for providing guidance at this time.

Okay. That's very helpful. And then just in terms of the full year guide, understanding the business is choppy. Is there a way to think about kind of quarterly cadence of deliveries implied in the full year guide? Is there any kind of seasonal dynamic that we should kind of keep in mind? Or any kind of specific cadence kind of baked into your current contracts?

It's difficult to make any predictions. However, when I reflect on the past few years, our fourth quarter has consistently been our strongest quarter. I'm not sure if there's a contractual basis for that or how deliveries are scheduled. It simply seems that when I analyze the data, a trend becomes apparent. That said, it really fluctuates; just look at how varied the last four quarters have been this year. I can't provide a reliable pattern.

We have reached the end of the question-and-answer session. And I will now turn the call over to Dan Bartok for closing remarks.

Thank you, John. And thanks to everyone on the Forestar team for your focus and hard work as we enter fiscal 2024, continue to stay disciplined, flexible and opportunistic, while focusing on consolidating market share. We appreciate everyone's time on the call today and look forward to speaking with you again in January to share our first quarter results. Thank you.

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