M/I Homes, Inc. (MHO) Q4 2023 Earnings Call Transcript

Good morning, ladies and gentlemen, and welcome to the M/I Homes' Fourth Quarter and Year-End Earnings Conference Call. At this time, all lines are in listen-only mode. Following the presentation we will conduct a question-and-answer session. As a reminder, this call is being recorded on Wednesday, January 31, 2024. I would now like to turn over the conference to Phil Creek. Please go ahead.

Thank you for joining us. Joining me on the call today is Bob Schottenstein, our CEO and President; and Derek Klutch, the President of our Mortgage Company. First, to address Regulation Fair Disclosure, we encourage you to ask any questions regarding issues that you consider material during this call because we are prohibited from discussing significant non-public items with you directly. And as to forward-looking statements, I want to remind everyone that the cautionary language about forward-looking statements contained in today's press release also applies to any comments made during this call. Also, be advised that the company undertakes no obligation to update any forward-looking statements made during this call. With that, I'll turn the call over to Bob.

Thanks, Phil. Good morning, and thank you for joining our call as we highlight our fourth quarter and full-year 2023 results. We had an outstanding year in 2023, one of the best in our 47-year history. We are particularly pleased with our results given the significant headwinds the housing industry faced as we entered 2023, as well as a rising interest rate environment throughout most of the year, together with inflationary pressures and general uncertainty within the economy. For the year, we had very strong income and returns. Pre-tax income equaled $607 million, with a pre-tax return of 15%. Gross margins for the year came in at 25.3%, the same as last year. We were pleased to see our gross margins hold steady notwithstanding the choppy market conditions and rising rates. Return on equity was a very solid 20.2%. The strength of our communities and product offerings, along with our selective and very targeted use of below-market financing incentives contributed to our strong fourth quarter and full-year sales performance. In the fourth quarter, we sold 1,588 homes, a 61% increase over last year, with significantly better per-community absorption rates. Clearly, as rates began to fall in the fourth quarter, we saw a pick-up in both traffic and demand. Notably, our December sales were the best month of the fourth quarter. For the full year, we sold 7,977 homes, an increase of 20% over 2022. Our monthly sales pace during the year averaged 3.3 homes per community, compared to a sales pace of 3.1 homes per community during 2022. And the quality of buyers that we are seeing continues to be strong with average credit scores of 747, and an average down payment above 18%. Our Smart Series, which is our most affordably priced product, continues to have a very positive impact, not just on our sales, but our overall performance. Smart Series sales comprised 53% of total company sales in the fourth quarter, compared to 52% in the fourth quarter a year ago. And I'm pleased to report that the improvement in traffic and demand we saw in the fourth quarter has continued as we begin this year, with our January sales exceeding last year. We are very optimistic about a good selling season. We continue to see improvement in our construction cycle time. During the fourth quarter, our cycle time improved by an additional 10 days sequentially. Year-over-year, our cycle time has improved by more than 60 days. Improvement in cycle time remains a major area of focus for us. In terms of deliveries, given that we began 2023 with roughly 15% fewer homes in the field, we were very pleased to close 8,112 homes for the year, which is a 3% decrease compared to 2022. Now, I will provide some additional comments on our markets. Our division income contributions in 2023 were led by Dallas, Tampa, Columbus, Orlando, Raleigh, Sarasota, and Charlotte; all had very strong years. New contracts for the fourth quarter in our Southern region increased by 44% and by 89% in our Northern region. For the year, new contracts increased by 18% in our Southern region and by 22% in our Northern region. Our deliveries decreased by 17% over last year's fourth quarter in the Southern region, comprising 1,171 deliveries or 58% of our total, while the Northern region contributed 848 deliveries, a decrease of 13% over last year's fourth quarter. For the year, homes delivered increased by 3% in the Southern region but decreased by 12% in the Northern region. Our owned and controlled lot position in the Southern region increased by 12% compared to last year. Owned and controlled lots increased by 3% in the Northern region. We have an excellent land position. Company-wide, we own approximately 24,400 lots, which is roughly a three-year supply. Of that total, 28% of the lots are in our Northern region, with the balance of 72% in the Southern region. On top of our owned lots, we control the option contracts for an additional 21,300 lots. So, in total, we own and control approximately 45,700 single-family lots, which is up 9% from a year ago and equates to about a five-year supply. Most importantly, about 47% of our lots are controlled pursuant to optioned contracts. This gives us significant flexibility to react to changes in demand or individual market conditions. With respect to our balance sheet, we ended the year with an all-time record $2.5 billion of equity, which equates to a book value of $91.00 per share. We also ended the year with $733 million of cash and zero borrowings under our $650 million unsecured revolving credit facility. This resulted in a debt-to-capital ratio of 22%, down from 25% a year ago, and a net debt to capital ratio of minus 2%. Before I conclude, let me just state we are in the best financial condition in our history. We feel very good about our business and fully expect to deliver another year of strong results in 2024.

Thanks, Bob. Our new contracts were up 35% in October, up 92% in November, and up 64% in December, for a 61% improvement in the quarter overall. Our sales pace was 2.5 in the fourth quarter, compared to 1.8 in last year's fourth quarter, and our cancellation rate for the fourth quarter was 13%. As for our buyer profile, 53% of our fourth quarter sales were to first-time buyers, compared to 58% a year ago. In addition, 62% of our fourth quarter sales were inventory homes, compared to 64% in last year's fourth quarter. Our community count was 213 at the end of 2023, compared to 196 at the end of '22. During the quarter, we opened 20 new communities while closing 11. And for the year, we opened 76 new communities. We currently estimate that our average 2024 community count will be about 10% higher than 2023, delivering 2,019 homes in the fourth quarter, which represented 59% of our backlog compared to 53% a year ago. As we stated in our third quarter conference call, we entered the fourth quarter with 1,200 fewer homes in the field than a year ago. And at December 31, we had 4,400 homes in the field versus 4,500 homes in the field a year ago. Revenue decreased by 20% in the fourth quarter to $973 million. Our average closing price for the fourth quarter was $471,000, a 4% decrease compared to last year's fourth quarter average closing price of $492,000. Our gross margins were 25.1% for the quarter, up 250 basis points year-over-year. And for the full year, our gross margins were flat at 25.3%. Our SG&A expenses increased by 4% in the fourth quarter due primarily to higher incentive compensation, increased real estate taxes on our inventory levels, and the cost of having more communities. Interest income increased to $8.3 million for the quarter due to our higher cash balances, and our pre-tax income was 15.1% versus 15.4% last year, and our return on equity remained strong at 20%. During the fourth quarter, we generated $153 million of EBITDA, and for the full year, we generated $648 million of EBITDA. We generated $552 million of cash flow from operations this year compared to generating $184 million last year. Our effective tax rate was 24% in the fourth quarter compared to 21% in last year's fourth quarter, and our effective rate for the year was 23%. We expect 2024's effective tax rate to also be around 23%. Our earnings per diluted share for the quarter decreased to $366 per share from $465 per share in last year's fourth quarter, and decreased 6% for the year to $1621 from $1724 last year. During the fourth quarter, we spent $25 million repurchasing our shares, and for the year, we spent $65 million. We currently have $128 million available under our repurchase authorization. In the last three years, we have repurchased 9% of our outstanding shares. Now, Derek Klutch will address our mortgage company results.

Thank you, Phil. In the fourth quarter, our mortgage and title operations achieved pre-tax income of $4.7 million, down $5 million from 2022, on revenues of $19.7 million, down 13% over last year, primarily as a result of lower pricing margins, lower average loan amounts, and fewer loans closed. For the year, pre-tax income was $38.4 million, and revenue was $93.8 million. Loan-to-value on our first mortgages for the quarter was 82% in 2023, the same as 2022's fourth quarter. 66% of loans closed in the fourth quarter were conventional, and 34% were FHA or VA. This compares to 79% and 21% respectively for 2022's same period. Our average mortgage amount decreased to $383,000 in 2023's fourth quarter compared to $392,000 in 2022. Loans originated during the quarter decreased by 7% from 1,497 to 1,387, while the volume of loans sold increased by 9%. As mentioned earlier, the borrower profile remained solid with an average down payment of over 18% for the quarter and an average credit score on mortgages originated by M/I Financial of 747. Our mortgage operation captured 88% of the business in the quarter, an increase from 77% in 2022's fourth quarter. We maintain a separate mortgage repurchase facility that provides us with funding for our mortgage originations prior to the sale to investors. As of December 31, we had a total of $166 million outstanding under this facility, which expires in October of this year. The facility is essentially a 364-day mortgage repurchase line that we extend annually. Now I'll turn the call back over to Phil.

Thanks, Derek. As far as the balance sheet, we ended the fourth quarter with a cash balance of $733 million and no borrowings under our unsecured revolving credit facility. Our credit facility matures in late-2026, and our public debt with interest rates below 5% matures in 2028 and 2030. Our total home building inventory at year-end was $2.8 billion, which was flat with the prior-year level. During 2023, we spent $344 million on land purchases and $512 million on land development, for a total land spend of $856 million. This was up from $837 million in 2022. As of December 31, '23, we had $715 million of raw land and land under development, and $721 million of finished unsold lots. We own 8,724 unsold finished lots. We have a very strong land position at year-end, controlling 46,000 lots. We own 24,400 lots, which is about a three-year supply. Of the lots controlled, 53% are owned, which is about a five-and-a-half years' supply. As of the end of the year, we had 592 completed inventory homes, about three per community, and 2,023 total inventory homes. As for total inventory, 912 were in the Northern region, and 1,111 in the Southern region. And on December 31, '22, we had 485 completed inventory homes and 1,827 total inventory homes. This completes our presentation. We'll now open the call for any questions or comments.

Thank you. Ladies and gentlemen, we will now conduct the question-and-answer session. Your first question comes from Alan Ratner from Zelman & Associates. Your line is now open.

Hey, guys, good morning. Congrats on a great year.

Thanks, Alan.

And thanks for all the detail. Your margins have been pretty stable in this 25% range for the last several quarters. As you think about '24, I know you're not going to give specific guidance, but how are you thinking about the moving pieces of margin, the outlook on material and labor inflation, land inflation in terms of what's going to be flowing through, and then, ultimately, directionally, what your views are on pricing now given what seems like a pretty healthy start to the spring selling season so far, any ability to push price? So, if you could just talk about those three buckets, I think it'll help us directionally.

Yes, I believe that on the cost front, the situation has stabilized significantly, including in land development. Last year, we were quite worried about inflation impacting land development. While there has been some inflation, it seems to be moderating to an extent. Although there is still some pressure on concrete prices, overall, I feel positive about the current cost situation in terms of decreasing inflation and limited increases. A year ago, we anticipated that margins would come under considerable pressure due to high rates and decreased demand. However, even though we had to make selective expenditures targeting specific communities to enhance marketability, we were pleasantly surprised that our margins remained steady at just over 25%. Forecasting margins is quite challenging, and opinions vary widely. However, as I assess current demand, traffic trends, website engagement, and on-the-ground feedback, even the markets that were underperforming earlier last year are now showing stronger signs. We are hopeful about maintaining margins at this level, although it's uncertain if they will actually increase. We are excited about the number of new communities we plan to open. It has been reflected in the slight decrease in average selling price; we are introducing more affordable product offerings which we believe can drive stronger sales pace and healthy margins moving forward. That said, we won't know for sure until we see it in practice. Overall, I feel optimistic about the housing market, demand levels, and our capacity to generate solid returns. We don't anticipate much erosion and may even get fortunate with a slight uptick, as we’re not seeing as much cost pressure as we did a few years ago. Additionally, most of the supply chain disruptions that were prevalent after COVID seem to have largely been resolved.

It’s very encouraging to hear that and I hope the momentum continues. Congratulations on maintaining margins.

Exactly. I believe we're not the only ones experiencing this, which is reassuring. When you're the only one facing something, it raises questions about whether it’s positive or negative. However, there seems to be a lot of momentum in the industry right now, and hearing what other builders have recently mentioned aligns with our perspective.

And Alan, just a couple more things just kind of follow-up on what Bob said, the stores we opened last year ended up performing better in terms of pace and margin than we anticipated. And we talked about our current estimate of this having on average 10% more stores. Over half of those expected openings are in the first-half of this year, which again will not only help us with sales but also with closings this year. So, we're very excited about the new stores we're opening also.

That's great. Thanks for that addition there, Phil. Second question around spec versus BTO, I mean Smart Series has obviously been a huge focus of yours for the last several years. I think if I heard you correctly, the share of spec sales actually ticked a little bit lower this quarter year-on-year. And I guess I'm curious as you think about the landscape today, with cycle times normalizing, resale inventory still incredibly low but maybe starting to tick up a little bit. Does that change your thinking at all as far as the mix of your business that's spec versus BTO? Are you starting to see consumers show some more interest there?

Yes, that's a great question. I'll let Phil provide a bit more detail. We've noticed an increase in our subdivision business, although this doesn't apply universally to every subdivision. On average, our plan involves having more specs than we did three or four years ago, and we've ramped up our specs for all the reasons you mentioned. Additionally, as we look at our mix with Smart Series and townhomes, which are becoming a larger portion of our overall business, this will also lead to more specs. These townhomes, particularly four-unit and six-unit buildings, are the most common types. Starting a building with one or two sales automatically means you have three or four specs in place. Phil, do you have anything else to add?

Yes, regarding spec levels, we're generally selling between 50% to 60% of specs depending on the month. One positive aspect is that the gross margin on specs is quite similar to that of to-be-built homes in some markets. Overall, we're pleased with our spec levels. We're increasing the number of attached townhouses and smaller single-family detached homes, which naturally leads to having more specs as we approach the range of 2,200 to 2,400. As our store count increases, that averages to about 10 per store. Having two, three, or four finished specs also appears to be a solid number for us.

Per community.

Per community. So, we do feel good about our spec levels. We want to make sure that we have what we need.

Makes sense, all right. Well, appreciate it all, and best of luck in the New Year.

Thanks, you too.

Your next question comes from Jay McCanless from Wedbush. Your line is now open.

Hey, Jay.

Hey. Good morning, everyone. Hope you all are doing well. Bob or sorry, Phil, if you don't mind, what was the monthly order pace through 4Q and maybe any color you can give us on January?

I'll take the last part of that first and then Phil will give you the pace. Somewhat surprisingly, well, just to start over. What I mentioned was, is that the increase in demand and traffic that really sort of intensified during the fourth quarter resulted in December being our best month of the quarter. That has continued, and that increase in traffic and demand. While technically January is not over, our January sales will exceed last year's. We're very pleased with the way the year is starting up and optimistic about the selling season. Phil can give you the details on pace.

Yes, sales pace, Jay, in the fourth quarter, it was 2.5. In the fourth quarter last year, it was 1.8. And again, in the third quarter, we were at 34. So, again, we have been improving pace and have a big focus on that. Hope to continue improving that.

Great. And then, could you talk about the community count? Because you all guided, I think to like 225 maybe and you came in at 213 maybe what's going on there? And I know you said you're going to open 50% of the new stores in the first half of '24, I mean is it going to be a pretty big step up in, in the total community count in the first quarter sequentially?

Yes, Jay. Again, overall, we expect our community count this year to be on average up about 10%. Last year, we were a little short of where we thought we would be at year end, primarily because about 10 stores were delayed. Most of them are just flattening into this year. We do expect over half the stores we're opening this year to be in the first half. So, if you look at that the year in general, we ended the year with 213. We expect to get to that 225 type level by the middle of the year. And again, the second half of the year gets a little more difficult because it is taking a little longer to develop land and those types of things. But we do feel comfortable saying today we think we'll be up 10% on average.

Okay, all right. And then, I guess, Alan already asked you the gross margin question, but just maybe what type of pricing power are you seeing currently? Maybe what percentage of your communities during Q4 were you able to raise prices, raise base pricing?

I think pricing power is limited. If we can continue to stay at this 25% gross margin level this year, we're going to have a phenomenal year. And that's our goal. I don't know that I can say with any kind of certainty whether we will be able to grow margins. I think that the balance between demand and price right now within the market generally is really good. And like I said before, a year ago, I thought margins were going to fall off by 100 or 200 basis points due to the higher rates and so forth. And that didn't happen last year. We were really pleased that our margins held steady. I think that strong performance is, I think, a testament to our people and our product and our communities. But I think that, knowing what we know today, I'm not sure how much pricing power we'll see, but I think we'd be thrilled. I think there's a good possibility that our margins will remain, as we talked about with Alan, in this 25% range.

Right. And I guess from a competitive standpoint, saw a lot of your larger competitors pretty aggressive on both base price discounts and incentives during the calendar fourth quarter of '23. I guess, what are you seeing now relative to what was going on a month ago? And do you feel like the pace of incentives may have to start picking up again if mortgage rates don't start coming down?

Well, I actually have a slightly contrary view on that. I think first of all, it's very market-specific. I mean, it's cliche, but every market is different. I think that in a number of instances, we're starting to see incentives declined; ours have. The slight decline in mortgage rates that we've seen over the last 90 days has made it so that you don't have to spend as much where needed to provide a rate in either the low 6s or the high 5s. And you'd rather not spend anything on that, but that's what we have been doing. And the net result of that has resulted in our 25.3% gross margins. If demand continues to stay like it does, like it is now, I'd like to think that builder behavior will respond accordingly and not see as much of a need for incentivizing. That's sort of how we are thinking about it.

Jay, also as Bob mentioned, every subdivision is a little different because we're definitely in the subdivision business. If you look at the 213 communities we have going into this year, like we said, 76 of them opened in '23, and over 100 of them opened in '22. So, how you open, what model you have, what the specification levels are of those houses, all those things, how many specs do you want? Again, we are not driven solely by volume. Obviously, we want to continue to grow and think we are positioned to grow. But again, when you have $3 billion, $4 billion, $5 billion of revenue, 15 basis points, 25 basis points mean a whole lot. So, we really try to focus on every subdivision, not get too far ahead of ourselves, and ensure we're focused on who the buyer is. So, every subdivision really is a little different. We don't do blanket things like, let's do interest rate buy downs everywhere. Some customers need an interest rate buy down for the payment help. Some customers need closing cost help. So, again, we try to deal with it more on a rifle approach as opposed to just a shotgun across the board.

Sure. Any notion of what you're going to spend on land acquisition and development this year?

Well, we definitely expect to spend more. We did spend a little more in '23 than in '22. The majority is continuing to be on land development. Land development costs, as Bob said, it's not going up the way it was. The good news is it's kind of stabilizing. But we do want to continue to grow and have more stores. So, we do expect to be spending more on land this year.

Look, I think we've said this before. Our goal is to grow the business. We are very bullish about housing and we are really bullish about our business. And our growth goals are 5% to 10% per year, hopefully closer to 10%, and that remains our strategic outlook.

Got you. And then, just one other question because we've heard some builders talking about it, and this is kind of relative to what you said, Bob, about gross margins being flat at this 25-ish level. And land prices, we've heard have been going up for some of the builders. Labor prices seem to be going up. I guess, what are the levers you're going to have to pull? Is it going to be maybe reduction in the other input costs that are coming in that keep your gross margin flat around this 25 level, Bob, especially with land prices seeming to move up? I guess, what are the things you're going to have to do to maintain it at this 25% level?

Continue to produce really high-quality affordable products, whether it's attached or detached and in well-located communities. You probably would like a more magical answer, but I think that's what it goes back to. Well-located communities will sell, and they will sell at really good margins. If the majority of our communities check the box of being exceptionally well-located, we think they do, and we think we can maintain our margins that way. That's what happened in 2023, and we expect it to happen in 2024.

And you also know, Jay, I mean, we're just getting started in Nashville. We closed our first house in Nashville in the fourth quarter. We just opened for sale our second community in Nashville. So, we're excited about that. Our new Fort Myers Naples division is also getting additional stores opened for sales and closings. So, we're excited about those two markets contributing to our results.

Got you. Then one more and I'll turn it over. When you think about an attached home versus a detached home, just rough average, is there a gross margin differential on a perfect basis between those two?

No.

Okay.

No, we haven't altered our approach to underwriting. Each community is evaluated to meet specific benchmarks, and we're not pursuing attached products with lower margins. That isn’t our objective. Ideally, with the current pace, our results will at least match or exceed what we achieve with single-family homes. Additionally, we have a significant amount of move-up products that are performing well for us. We're not overly reliant on one aspect of our business; however, about half of our operations are structured to be very affordable.

Got you. Okay. I'll jump back in the queue. Thanks, guys.

Thanks, Jay.

Thanks, Jay.

There are no further questions at this time. Mr. Creek, please proceed with your closing remarks.

Thank you for joining us. Look forward to talking to you next quarter.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.