Earnings Call Transcript - GRBK Q1 2022

Operator, Operator

Good afternoon, everyone, and welcome to Green Brick’s Partners Earnings Call for the First Quarter Ended March 31, 2022. Following today’s remarks, we will hold a question-and-answer session. As a reminder, this call is being recorded and will be available for playback. A slideshow supporting today’s presentation will accompany today’s webcast and is available on Green Brick Partners' website, www.greenbrickpartners.com. From the homepage, please select reporting and presentations under Investor Relations and then navigate to the presentation named First Quarter 2022 Investor Call Presentation. The company reminds you that during this conference call, it will make various forward-looking statements within the meaning of the Safe Harbor provisions of the United States Private Securities Litigation Reform Act of 1995, including its financial and operational expectations for 2022 and the future. Investors are cautioned that such forward-looking statements are based on current expectations and are subject to risks and uncertainties that could cause actual results or outcomes to differ materially from those set forth in our forward-looking statements. These risks are set forth in our first quarter earnings press release, which was released on Tuesday, May 03, 2022, and the risk factors described in the company’s most recent annual and quarterly filings with the Securities and Exchange Commission. Green Brick Partners undertakes no duty to update any forward-looking statements that are made during this call. In addition, our comments will include non-GAAP financial metrics. The reconciliation of these metrics and the other information required by Regulation G regarding these metrics can be found in the earnings release that Green Brick issued yesterday and the presentation available on the company’s website. Now, I would like to turn the conference over to Green Brick’s CEO, Jim Brickman. Mr. Brickman, please go ahead.

Jim Brickman, CEO

Okay. Thank you, operator. Good afternoon and welcome to our first quarter 2022 earnings call. With me today are Rick Costello, our Chief Financial Officer, and Jed Dolson, our Chief Operating Officer. We're pleased to report yet another outstanding quarter highlighted by 68% year-over-year total revenue growth and 135% year-over-year EPS growth. Our quarterly gross margins of 27.8% were our highest since the first quarter of 2015, and our quarterly SG&A leverage of 9.4% in Q1 was the second best in our history after the record best in Q4 of last year. I would like to thank our entire Green Brick team for consistently delivering superb results under a challenging supply chain and labor market. In a moment, I'll pass things over to Rick, who will go through Q1 2022 highlights. Jed will then provide an update on our capital allocation. And finally, recognizing a rising interest rate environment, I will also share some thoughts on supply and demand fundamentals. I'll now turn the call over to Rick Costello, our Chief Financial Officer. Rick?

Rick Costello, CFO

Thanks, Jim. Hi, everyone. Let me first reiterate our appreciation for our teams whose efforts have led to outstanding outcomes for our shareholders, and this quarter was no different. We'll start by please turning to Page 4 of the presentation. Our total revenues in Q1 2022 increased 68% year-over-year to $394 million, and our residential units revenue increased 68% year-over-year to $365 million, driven by higher closing volume and higher ASPs. During the quarter, we delivered 658 homes to homebuyers, 27.5% more compared to last year. And because of strong demand and metered sales, ASPs also went up 32% year-over-year to $552,000. As of the end of March, we had 1,423 homes in backlog, and the ASP of those backlog homes was up 24% to $609,000 year-over-year. We expect ASP for closings during the balance of 2022 to range each quarter between the $552,000, which was the Q1 actuals of closings, and the ASP of our current backlog. During Q1 of 2022, we continued our proactive metering of home sales as I suggested. We believe that by metering sales and selling homes later in the process, we will improve the mix of specs versus pre-sold backlog homes, which will lead to more efficient operations, higher gross margins, and less risk of unmatched construction costs. Due to that metering process, net home orders decreased 45% over the record prior-year period, but were up 26% sequentially from Q4 of 2021. Also, our cancellation rate of 8% was in the range of the last two years, which has been between 6% and 12.3%. So thanks to strong pricing power and operating efficiency, SG&A leverage improved by 420 basis points year-over-year to 9.4%, which was our second best operating leverage, only surpassed by the 8.8% last quarter. Turning to slide 5, our gross margin reached 27.8%, again, our highest level since the first quarter of 2015. Gross margin was up 240 basis points year-over-year and up 160 basis points sequentially. As you can see on the comparative bar chart versus our mid-cap and small-cap peers, we continue to have some of the best gross margins in the industry. We believe that our focus on price over pace will continue to sustain our gross margins at levels higher than most of our peers. We also believe that our position as the third largest builder in DFW allows us to better control both cost and cycle times. Further price increases of our homes have continued to be accepted by our buyers. So when we combine our unit growth, ASP growth, and improvement in both gross margins and SG&A leverage, our first quarter bottom line diluted EPS was up 135% year-over-year; that's approximately double our growth rate in revenues. Moving on to page 6, let's take a quick look at the critical measure of return on equity. Our annualized ROE in Q1 was 28.8%, up from 25.9% in all of 2021. The rest of the slide highlights several key areas where we are performing exceptionally well to drive our risk-adjusted returns on equity. The first is our diversified product mix. Excluding Challenger Homes, we have seven different brands under Green Brick with price points up to $1.2 million. As Jed will discuss a little bit deeper, over 80% of our closings in the first quarter were from infill communities, which are targeted homebuyers who are more financially secure and less sensitive to interest rates. These communities, which include Trophy, are located in light constraint submarkets, face lower levels of competition, and allow us to charge higher prices. As Jed will discuss later, our results and our ROE are higher in these neighborhoods. The second factor is our disciplined capital allocation. Prudent underwriting has yielded outsized returns on land and development in the form of higher gross margin as we develop lots rather than paying retail via our off-balance sheet financing arrangements. As at quarter end, we have just under 27,000 lots owned and controlled. Most of these home sites are located in what we describe as very strong markets of DFW, Atlanta, and Austin. Jed will discuss our capital allocation in more detail in a moment. The third factor is our gross margins. As we just mentioned, our gross margins of 27.8% during Q1 were our highest since Q1 of 2015. And our quarterly SG&A leverage of 9.4% in Q1 was the second best in our history after our record best last quarter in Q4. Last but not least of the factors is our strong balance sheet. The bar graph here demonstrates our commitment to maintaining one of the lowest debt-to-capital ratios amongst mid-cap and small-cap peers. Combined with our healthy liquidity and significant operating cash flows, we believe that we're in a strong and flexible position to grow. With these strategic initiatives and a seasoned team in place, I'm confident that we're well positioned to maximize shareholder value as we have done historically. With that, I'll turn it over to Jed Dolson, our COO. Jed?

Jed Dolson, COO

Thanks, Rick. I would like to address our approach to capital allocation. Please turn to slide 7. We continue to exercise an approach that includes one, investing significantly in lot growth; two, executing the organic growth of our builder subsidiaries; and three, expanding in new markets while maintaining our disciplined approach to investment. We do not lower our hurdle rate of 20-plus percent internal rate of return. We do not assume financial leverage or price increases to homes, and we are not aggressive with sales absorption assumptions. Further, we include appropriate cost contingencies in estimating our development and vertical construction costs. This disciplined capital allocation allowed us to identify what we believe are strong opportunities with our announced expansion into Austin. We expect to start home construction in Austin in early 2023. During 2021, we increased Green Brick's lots owned and controlled by almost 100%, far exceeding the growth of any of our peers. Many of these lots were contracted in 2020 or early 2021 at attractive prices. Because of early moves in accessing and underwriting deals, we have an abundant lot position. It was funded at better pricing than today to sustain growth while maintaining a low debt-to-capital ratio. During 2022, we are focused on developing land in our high-growth submarkets. We continue to estimate that our total spend on land development will be approximately $285 million for 2022. In doing so, we expect to complete and deliver over 4,300 finished home sites in 41 communities to our builders at an attractive cost basis during the year. As we have discussed on recent calls, we have accumulated almost 9,000 future home sites for Trophy Signature Homes in six communities that individually exceed 800 lots. These larger, longer-life communities are in submarkets that we believe have long-term growth potential at very affordable prices. In the case of these Trophy communities, the lots have an average cost of under $8,000 per undeveloped lot. Additionally, a growing proportion of our horizontal land development is being funded by the low cost of Capital Municipal Development District bonds. During Q1 of 2022, our lot count declined slightly as we started almost 900 homes. This was our highest quarterly start since Q2 of 2021. We also closed the sale of about 1,100 home sites in a $27 million transaction of unfinished lots that produced a profit of $6.8 million and an internal rate of return of 162%. As of Q1 2022, over 80% of our home closing revenue came from infill locations, including many of Trophy communities. Infill locations are A and B submarkets that are largely built out. The classification is based on a variety of subjective factors such as quality of schools, proximity to jobs, and the existence of infrastructure for a quality of life. These submarkets have a limited supply of both lots and new and existing homes. Trophy has a strong presence in these infill locations in cities like Frisco and Allen, Texas, as well as McKinney, Texas. This was intentional to get Trophy operating at higher volumes than if we had focused entirely on entry-level and first-time move-up locations. Despite our strong operating results, we continue to see a disconnect between our positive view of the business as compared to our stock price performance. Consequently, during Q1 and April of 2022, we completed a total of $50 million in stock repurchase at a weighted average price of $20.66 per share. These repurchases have combined to fully utilize the $50 million amount previously authorized and represent the repurchase of 4.8% of outstanding shares as of the start of the year. We expect these repurchases to be about 5% accretive to earnings per share in all future periods. We understand that the market wishes to take a dim view of our sector and our stock price. While we do not believe we can persuade the market to change its view in the near term, we can add substantial long-term value to our shareholders by buying shares back at what we believe is a deeply discounted price. To that end, our Board of Directors just authorized an additional $100 million for stock buybacks. Despite our repurchase program, our debt to total capital was still only at 28.8% at the end of Q1, and we expect it to remain within our long-term targets for the foreseeable future. We believe this is a great use of capital that further strengthens income per share and returns capital to our shareholders. Now I will turn it over to Jim.

Jim Brickman, CEO

Okay. Thanks, Jed. The strong results Rick discussed earlier are a validation of the excellent execution by the Green Brick team, operating in the best markets in the country, as well as a strong housing market. Although we expect higher mortgage rates to have some impact on demand over the long term, we continue to believe that demographic shifts in our very strong high growth markets, together with record low existing housing inventory, will sustain the healthy housing market. Slide 8 is a chart that we brought back into our slide deck to remind everyone of the most important secular change of the current generation. The graph represents an irreversible demand of over four million millennials who will enter their prime home buying years over the next decade. After under supply in the market since the end of the Great Recession, the homebuilding industry will continue to benefit from the increased desire of this demographic to own a home. Additionally, specific to Green Brick, our markets continue to experience some of the strongest demographic inflows and job growth in the country. DFW, our largest market, wrapped up the largest population gain of any U.S. metro area from July 2020 to July 2021, according to the Census Bureau. Demand continues to be solid in all of our markets in the first quarter and in April. Despite higher qualification ratios due to rate increases, we continue to see well-qualified homebuyers searching for homes in our submarkets. When we release a new home site for sale, our sales agents know they have a large inventory and ready and willing buyers. They select their buyers from the list who have the best ability to go to contract and then qualify for closing. The average FICO scores of our buyers during the first quarter in April were over 746, with a debt-to-income ratio of about 34%. As Jed discussed, closing revenues from higher-priced infill A and B locations represented over 80% of our total closing dollars in Q1. Those buyers typically have better credit scores, higher incomes, and are less susceptible to interest rate increases. They also have a greater ability to one, buy down the interest rate; two, qualify for a jumbo portfolio loan, such as a five-year or seven-year arm; and three, put more down payment at closing to reduce their loan without increasing their monthly payment. On the other side of the equation, the supply of both new homes and existing homes for sale continues its dive to historic lows across the country, as shown on Page 9. Homebuilders are capturing a higher portion of home sales than in prior periods. Yet they also face the inability to oversupply the market because of the lack of inventory and the lack of a qualified workforce. As a result, we believe that the shortages in both resale and new single-family homes will likely stay very low. With these tailwinds at our back, along with our operating strengths and our strong balance sheet, we remain confident and opportunistic in our ability to grow and enhance shareholder value. Last but not least, I would like to welcome Lila Manassa Murphy as our newest Independent Director to Green Brick Partners' Board of Directors. Ms. Manassa Murphy brings more than 25 years of diverse investment management experience, as well as a strong background in matters related to sustainability, finance, accounting, and risk management. We are very fortunate to have her joining our Board. In closing, I would like to extend a big thank you again to the entire Green Brick team. We are excited about what the future holds for Green Brick. This concludes our prepared remarks. We will now begin the Q&A session.

Operator, Operator

Thank you. Ladies and gentlemen, we will now start the question-and-answer session. Our first question comes from Mike Rehaut with JPMorgan. Please go ahead with your question.

Doug Wardlaw, Analyst

Hi, good afternoon, guys. Doug Wardlaw on from Mike. I was just wondering if you could give a little bit more color on the supply chain and if you view it as getting better or worse during the next few quarters. I know you touched on it a little bit. And if it's getting worse, are there any distinct examples of what you've been having more trouble getting supply up?

Jim Brickman, CEO

Jed, why don't you take that, because you really deal with our builders on an operating basis the most.

Jed Dolson, COO

Sure, Jim. I would say the supply chain is staying about the same. I think our suppliers have improved their ability to monitor where shipments are. The problem is we get so many of our shipments from out of the country, and when there are container shortages or ports shut down, stuff can be going very smoothly for months, and then a shutdown on the port can cause us to be out of a particular material. So, I do think the ability for these suppliers to track it has greatly improved as COVID has persisted, but we are still seeing some hiccups.

Jim Brickman, CEO

Mike, this is Jim. One of the things we're doing, particularly at Trophy, is we're limiting, because this housing demand still is very strong, we're limiting the amount of offerings and SKU numbers to customers to combat that. So, basically, we're going to our suppliers frequently and saying what four materials can you assure us that we're going to have rather than trying to get aid in the SKU and having problems with four items.

Doug Wardlaw, Analyst

Great. And then lastly, if you guys could just touch on kind of the cadence of orders and closings throughout the previous quarter?

Jed Dolson, COO

We saw orders in Q1 continue to be very strong. As we mentioned, 80% of our revenue for the quarter came in A and B locations where we continue to meet our sales expectations. We were also contending with increases in lumber costs throughout Q1. We still don't have visibility on how that looks for the year, so we're very cautious not to presell too many homes.

Operator, Operator

Our next question comes from the line of Carl Reichardt with BTIG. Please proceed with your question.

Carl Reichardt, Analyst

Thanks. I hope everyone is doing well. Can you share how Trophy performed this quarter in terms of orders compared to the mid and higher-end brands? I might find this information in the Q, but I haven't reviewed all of it yet, so I apologize if this is already addressed. I'd appreciate your insights on the different segments.

Jed Dolson, COO

Yes, I can answer that, Carl. This is Jed. Trophy, in its A and B market locations, performed exceptionally well, probably even better than our sister companies or subsidiaries. And in the far-out locations, we, for the quarter, oftentimes saw double-digit sales per month per community.

Carl Reichardt, Analyst

So, there's no alteration in the trajectory of Trophy demand-wise, except the fact that you've slowed sales across the board. Can you talk Jed about what you feel like you'd need to see in order to take the governors off of the incoming order volume? Is it a catch-up in starts relative to when you can close? I mean, you have a better knowledge of costs, and/or are there some other elements that would enable you to remove those covenants on Trophy or the other?

Jim Brickman, CEO

But we've caught up with starts, which Jed can speak to. Carl, if you take a look at our start pace, it’s great, and we think you're going to see stronger order growth. One of the things that really skewed the year-over-year comps was we sold almost 1,000 homes in Q1 of 2021. So that was a very tough comp to follow up on. In hindsight, if we had any idea of supply chain bottlenecks that that gigantic sale quarter would generate, we probably would have behaved differently a year ago, but in terms of start, we're back ramped up to a much greater start pace with our stock base now.

Jed Dolson, COO

We did just under 900 this quarter, which we haven't done that since Q2 of last year. So that's a much preferred start pace for us, and that's pretty much normalized. It's really that houses getting to the stage of construction that is governing when we can release those to the sales floor. I mean, we are seeing no catch-up in existing home inventory or builder inventory. It's just not happening in any of our markets; it's still incredibly low. The interest rates mean that the sales team might have to go deeper into their pile of folks if they have to call, but they know who to call because they know who can qualify and who has a good debt-to-income ratio. So being in the higher price points for so much of our inventory really insulates us in that regard as well, which is just nothing on the existing home market.

Jim Brickman, CEO

The kind of the Q1 of 2021 again, we have seen strong sales. There we finally have pushed through the pipeline and the cadence of our starts and sales pace were going to be much more normalized, which is going to help operate our business more efficiently.

Carl Reichardt, Analyst

That's great. Yeah. It's very helpful. And if you don't mind me asking one more, Jed, you walked through a number of elements that sort of get land underwriting and how you're thinking about new transactions? And you talked about no price increases, talked about contingency budgeting, sales pace. Can you talk a little bit about what you're thinking on just core gross margin from these communities? And I'd just be interested, if you could compare to what you're underwriting today versus maybe what you looked at three, four, or five years ago. It's just a circular way of asking, do you think that relatively high margins, maybe not peak margins, but high margins are sort of the future of Green Brick relative to the margins you may have earned three, four, or five years ago or relative to the margins that we think of as more typical for the homebuilding industry?

Jed Dolson, COO

We are currently introducing some communities to the market that we purchased in the summer of 2020. It has taken almost two years to bring these communities to market, and we are seeing margins that significantly exceed what we reported for Q1. Overall, we are optimistic about margins, and compared to four or five years ago, we believe they will remain high.

Jim Brickman, CEO

Thanks.

Operator, Operator

Our next question comes from the line of Alex Rygiel with B. Riley. Please proceed with your question.

Alex Rygiel, Analyst

Thank you and congratulations on a very nice quarter here. With interest rates rising and gross margins being very strong for a number of years here, can you talk, and you touched upon a number on your prepared remarks, but can you go back through and sort of defend or talk to, sort of why you think margins can be maintained at a fairly high level for some time to come?

Jim Brickman, CEO

This is Jim. I believe the situation varies from neighborhood to neighborhood in high-demand markets, which currently make up a large portion of our income and will gradually decline as we expand Trophy. Many of these cities are already heavily developed. When I began my career, competing with existing homes was a significant aspect to consider as a builder, but in our major revenue streams, we face very little to no competition from existing homes. We anticipate that margins will remain quite high in these key infill locations that are crucial for our financials. For example, if someone purchased a home in one of these infill markets over the last three years at an interest rate of around 3%, and now it's at 5% with home prices rising by 20%, that creates a strong disincentive to move. Therefore, we expect the existing inventory to keep decreasing and to be even less prevalent in the future. In these areas, competition from other builders is limited. We are optimistic about this situation. As Trophy expands, that aspect is less predictable, but we have acquired this land at a favorable price, and we have a good supply of future lots that are also competitively priced. We believe we can sustain healthy margins in these regions as well.

Alex Rygiel, Analyst

You mentioned some of the very interesting points there. As interest rates rise, there could be a tendency for existing homeowners to stay put. Can you talk about that a little bit more? And is that a big reason why you have less concern about the new construction market rolling over in a rising rate environment?

Jim Brickman, CEO

Well, it’s even more complicated than that because you compound the fact that apartments in all of our markets are basically as full as they've ever been. The replacement cost of apartments is high as it's ever been. So that's not a viable alternative for a lot of consumers, and they just don't have a lot of good choices, unfortunately. We think that's going to maintain high margins in our industry. It's just on the flip side of it is just not a really good time to be a consumer buying a house or a lot of other things right now.

Jed Dolson, COO

And now, what's peculiar to Green Brick is the fact that we're in such strong high growth markets. The population and job growth in our markets are leading the country, and in these situations with so many people coming in and taking whatever supply there is, then you've got those people that have to move because they want to get their kids in the right school or they need a bigger house. So, many people still need to get a house that has two offices because they're both, if they're not working from home, they're now doing a lot more work from home. So, there are many factors that just naturally cause attrition and turnover in the home inventory, and we see it in great numbers, specifically because we're in DFW and Atlanta and Challenger, in Colorado Springs. You just see the demand is very unique. We have more pricing power because of that.

Alex Rygiel, Analyst

Great. Thank you very much.

Operator, Operator

Our next question comes from the line of Jay McCanless with Wedbush. Please proceed with your question.

Jay McCanless, Analyst

Hey, good morning. So, my first question is, if we look at the closing growth in the quarter versus last year, could you break out for Trophy versus the other brands what the growth rate in closings was versus last year?

Jim Brickman, CEO

We don't provide brand closings by brand.

Jay McCanless, Analyst

If we look at your backlog and thinking about rate locks in this environment, some of the builders have talked about what percentage of their buyers in backlog have locked. Do you guys have that data, and maybe give us an idea of what customers are doing around the rate lock issue and higher rates? And what, if anything, your mortgage partner has been able to provide?

Jim Brickman, CEO

Yes, about 40% of our buyers have rate locks. We have the ability to push that up. One of our lending partners today came up with a 150-day labor rate lock, and you know that we're continuing to monitor that almost on a daily basis.

Jed Dolson, COO

Yes, and Jay, the other part of that too is, again, we have more well-heeled customers because of our submarkets being a lot of infill, as we suggested. They can do and have been, and we have seen a lot of them starting to move into five-year and seven-year owned products where, instead of paying 5.0X percent, they're paying for the quarter percent for five or seven years.

Jay McCanless, Analyst

Got it. And then I guess if you think about pricing power in the quarter and then also, I think maybe in the press release there were some commentary about improved results moving into the next quarter. Should we expect unit closings to be in line or maybe higher than what we saw in the first quarter, just given that your spec starts have ramped back up now?

Jed Dolson, COO

Well, the starts that have just ramped up now are going to be obviously benefiting future quarters, but in Q2, if you look back in time, you'll see the large number of starts that we did have in Q2 of 2021 because of all of the sales growth that we had in Q1 of 2021. So it's just coming around. I know we typically in our industry see Q4 being the biggest quarter, but we have so many starts back then that are rolling into the closing queue now.

Jim Brickman, CEO

Jay, we really needed in a perfect world, we would have started more homes in the third and fourth quarter of 2021, and we didn't have the capacity to do that. We got those homes started, and I think you're going to start to see that benefit in the second quarter.

Jay McCanless, Analyst

Got it. And then just on pricing power. Have you been able to raise prices across most of your brands and products or if you have a percentage of communities where you've raised prices during the quarter that would be great.

Jim Brickman, CEO

Yes. Our pricing power, we have been consistently able to more than offset the input costs. Obviously, trees don't grow to the sky and that's going to hit a peak, but we haven't seen that peak for us yet, and we're keeping our fingers crossed.

Jed Dolson, COO

Thanks, Jay.

Bill Dezellem, Analyst

Thank you. Appreciate that. Let me just make sure that we are hearing things correctly that essentially, you're saying that things are different this time in part because of the low inventory of both existing homes and new homes being built but in part because this low inventory is taking place at a time when we had a big jump in mortgage rates. And so that issue will not be able to be corrected. And layer on top of that, that you are looking at high growth markets where you have lots of population inflow. Is that basically the long and short of it?

Jim Brickman, CEO

Bill, that was so good. I think you're going to do my job in the next call.

Jed Dolson, COO

That was really good, Bill.

Bill Dezellem, Analyst

But that is the net of what you're saying?

Jim Brickman, CEO

Yes, there is a net, and I think you're really the other factor that we're seeing is that homes are less of a discretionary purchase, because you're also facing 15% rent increases in many markets.

Operator, Operator

Ladies and gentlemen, this does conclude our question-and-answer session. We do have a very follow-up question from the line of Alex Barron. Please proceed with your question.

Alex Barron, Analyst

I wanted to give somebody else's shot, but I guess maybe not. One last one. In terms of pricing power versus rising rates, do you feel that the pricing power remains intact at this point, or are you guys being more careful given that affordability obviously is getting impacted by daily interest rate increases? How are you approaching the pricing as you release houses?

Jed Dolson, COO

Yeah, this is Jed. We're approaching it submarket-by-submarket, neighborhood-by-neighborhood. In the upper infill locations, we think pricing power is still very strong. We think in the perimeter locations, we were very aggressive in Q1, and we're probably going to be more moderate for the remainder of the year in our pricing increases.

Jim Brickman, CEO

Okay, gentlemen, best of luck for this year. Thank you.

Jed Dolson, COO

Thank you.

Operator, Operator

Ladies and gentlemen, this does conclude our call. You may disconnect your lines at this time and have a wonderful day.