FORESTAR GROUP INC.

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Transcript : Forestar Group Inc., Q1 2023 Earnings Call, Jan 24, 2023

24.01.2023 | 23:00

Presentation Operator Message
Operator (Operator)

Good afternoon, and welcome to Forestar's First Quarter 2023 Earnings Conference Call.

[Operator Instructions]

I will now turn the call over to Katie Smith, Director of Finance and Investor Relations for Forestar.

Presenter Speech
Katie Smith (Executives)

Thank you, John, and good afternoon, everyone, and welcome to the call to discuss Forestar's first quarter 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.

Our earnings release is on our website at investor.forestar.com, and we plan to file our 10-Q tomorrow. After this call, we will post an updated investor presentation to our Investor Relations site under Events & Presentations for your reference.

Now I will turn the call over to Dan Bartok, Forestar CEO.

Presenter Speech
Daniel Bartok (Executives)

Thank you, Katie, and good afternoon, everyone.

As always, we appreciate your interest in Forestar and taking the time to discuss our first quarter results. In addition to Katie, I am pleased to be joined on the call today by Jim Allen, our Chief Financial Officer; and Mark Walker, our Chief Operating Officer.

Mortgage rates rose at a record pace during 2022. As a result, housing affordability has been severely impacted. New home sales fell 15% in November from a year ago and December housing starts were down 25% from a year ago. Despite those headwinds resulting in a revenue decline of nearly 50%, our gross profit margin increased 390 basis points to 21.9%, and our pretax profit margin was 12.9%. The real story here is the transformation that Forestar has undergone over the past 5 years. We have become 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. We have a strategic relationship with D.R. Horton, America's largest builder and we have positioned ourselves to expand our customer base as we consolidate market share. The housing market is going through a period of transition. We are disciplined and have been proactively reducing land acquisition over the past 18 months. We've been stating development activity at our projects to be prepared for when the demand for residential lots increases.

Our flexibility enables us to quickly adjust to meet the needs of our customers. We continue to strive to maximize returns while we plan and prepare to return to periods of rapid growth. Having a growth plan is one thing, but we have the capital structure, the operational flexibility, a strong customer relationship and most importantly, the team to execute that plan. Forestar is better positioned than ever to serve current and new customers and consolidate market share.

Jim will now discuss our first quarter financial results in more detail.

Presenter Speech
James Allen (Executives)

Thank you, Dan. In the first quarter, net income attributable to Forestar was $20.8 million or $0.42 per diluted share compared to $40.5 million or $0.81 per diluted share in the prior year quarter. Consolidated revenues for the quarter totaled $216.7 million compared to $407.6 million during the first quarter of 2022. We sold 2,263 lots during the quarter, with an average sales price of $90,100. We expect continued quarterly fluctuations in our average sales price based on the geographic location and lot size mix of our deliveries.

We expect demand for residential lots will continue to be impacted in the coming months as homebuilders align starts to a new sales pace. Our pretax income for the quarter totaled $27.9 million compared to $53.5 million in the first quarter of last year. Our pretax profit margin of 12.9% was 20 basis points lower than last year, driven by reduced operating leverage.

Our gross profit margin was 21.9%, representing an improvement of 390 basis points over the prior year period. In the first quarter, SG&A expense was $22.9 million were 10.6% as a percentage of revenues compared to $21.5 million in the prior year quarter. While our SG&A expense as a percentage of revenue was higher than we would like, the absolute dollars were down 3% sequentially and has decreased for the last 3 quarters. We will continue to focus on controlling our SG&A costs while ensuring that our infrastructure supports our business. Mark?

Presenter Speech
Mark Walker (Executives)

As for current market conditions, we are starting to see greater contractor availability with front-end trades and continue to stage development on a project-by-project basis. Despite single-family home starts falling, roughly 25% in December from a year ago, our cost to develop a residential life continue to climb. Materials like concrete, cement and transformers are still challenging to procure. 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 develop cost control development costs. We evaluate each project in the surrounding market conditions as we 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 sale price of roughly $90,000. Over the past 12 months, our inventory balance has grown only 5%. Despite elongated development timelines and inflationary pressures further demonstrating discipline and strategic inventory management. Jim?

Presenter Speech
James Allen (Executives)

7% of our first quarter deliveries were sold to customers other than D.R. Horton compared to 11% in the prior year quarter. In the trailing 12 months, 16% of our deliveries were sold to other customers, and we continue to target selling 30% of our lots to customers other than D.R. Horton over the intermediate term. Additionally, Forestar's lots sold to D.R. Horton continue to grow as a percentage of D.R. Horton starts year-over-year and sequentially. Approximately one out of every 5 homes that D.R. Horton starts is on a lot developed by Forestar. Our mutually stated goal is for 1 out of every 3 homes that D.R. Horton sells to be built on a lot developed by us. Katie?

Presenter Speech
Katie Smith (Executives)

Forestar's underwriting criteria for new development projects includes a minimum 15% pretax return on average inventory and a return of the initial cash investment within 36 months. During the first quarter, we invested $237 million in land and land development, a reduction of 38% compared to the prior year quarter. $205 million was terrain development and $32 million was for land. As land prices continue to increase across most of our footprint during the last 18 months, we proactively started to reduce our land investment in anticipation of a slower housing market and primarily focused on the phased development of land that we already own.

We are working with land sellers to extend closing date. And in certain cases, we have opted to terminate contracts. Our unique operating model allows us to adjust the pace of development based on market conditions, and we remain intensely focused on managing our development in spaces as we strive to deliver finished lots at a pace that matches market demand consistent with our emphasis on capital efficiency. Mark?

Presenter Speech
Mark Walker (Executives)

Forestar's law position at December 31 was 82,300 lots, of which 61,500 lots are owned and 20,800 are controlled through purchase contracts. Our lots position decreased by 7,800 lots or 9% sequentially and by 21,000 lots or 20% year-over-year. We incurred $2.4 million of option deposits and due diligence write-offs in the quarter. At quarter end, we had 7,600 finished lots on hand. The majority of our own lots were placed under contract to purchase from land sellers prior to 2021, resulting in an attractive cost basis. And we had no inventory impairments during the quarter.

We are continuing to target a 3- to 4-year owned inventory of land and lots. 30% of our owned lots are under contract to sell, representing approximately $1.5 billion of future revenue. These contracts of $148 million of hard earnest money deposits associated with them. Another 29% of our own lots are subject to a right of first offer to D.R. Horton based off executed purchase and sale agreements. Jim?

Presenter Speech
James Allen (Executives)

We are maintaining a strong balance sheet with significant liquidity and modest leverage, and we plan to maintain our disciplined approach when investing capital to enhance the long-term value of Forestar. We ended the quarter with over $580 million of liquidity including approximately $215 million of unrestricted cash and $365 million of available capacity on our revolving credit facility after the reduction for outstanding letters of credit.

Total debt at December 31 was $706 million with no senior note maturities until fiscal 2026. Our net debt to capital ratio at December 31 was 28.7% down from 33.9% in the prior year period. We ended the year with $1.2 billion of stockholders' equity and our book value per share increased to $24.50, up 15% from a year ago.

Forestar's capital structure is one of our biggest competitive advantages. Most traditional land developers are encumbered by project level financing, which makes it more difficult to react to the market while also adding complexity and administrative costs. Our strong liquidity and corporate level financing enabled us to operate effectively through changing economic conditions and positions us to be strategic when attractive opportunities present themselves. We have significant flexibility to navigate the upcoming year. Katie?

Presenter Speech
Katie Smith (Executives)

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 will reevaluate providing annual guidance when we have sufficient visibility into market conditions. We have been very strategic and disciplined and we are well positioned to adapt quickly to the short-term challenges that are before us and the housing industry. Dan, I will hand it back to you for closing remarks.

Presenter Speech
Daniel Bartok (Executives)

Thank you, Katie. Forestar will continue facing difficult comparisons to our fiscal 2022 results as the housing industry adjusts throughout 2023. We have made remarkable progress building Forestar's platform, which enabled us to maintain strong returns and margins during a challenging quarter. 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're closely monitoring each market, submarket and project as we strive to balance pace and price to maximize returns. We are the market leader in a highly fragmented and undercapitalized industry and are optimistic about Forestar's ability to continue to execute well, consolidate market share in any operating environment.

I would like to add on to Jim's earlier comment about our capital structure being a big competitive advantage because it is our team that is our biggest advantage. I could not be more proud than to be a part of this team. Their knowledge and experience and the way that they have dealt with the challenges of this past year are truly remarkable.

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. With our broad geographic footprint, attractive land positions, strong balance sheet and most importantly, our experienced team, Forestar is well positioned to be the last supplier of choice to homebuilders.

We are planning for the long term and have a track record of solid execution. We proactively and methodically started to implement our downturn playbook over 18 months ago by adjusting our pace of new land acquisition in preparation for today's current environment. When appropriate, we will leverage our platform and balance sheet to take advantage of opportunities to build shareholder value. Our flexibility enables us to quickly adjust to meet the needs of our customers.

Our team has managed through market cycles before, and we are well positioned to navigate these challenging market conditions. John, at this time, we'll now open up the line for questions.

Question and Answer Operator Message
Operator (Operator)

[Operator Instructions]

Our first question is from Truman Patterson with Wolfe Research.

Question
Truman Patterson (Analysts)

First, you all been trending close to 20% of Horton starts or orders over the past year. You mentioned your stated goal of supplying about 1/3 of their lot needs. Do you think you all continue to increase that percentage throughout 2023? Or given the current housing backdrop, do you kind of run into a steady state, digest the current environment, see where home and lot prices ultimately settle?

Answer
Daniel Bartok (Executives)

Yes. Thanks, Truman, and thanks for the question. It will be an interesting year. I think everybody is looking forward to seeing how it plays out. I don't expect that our market share within Horton will decrease. I expect that it will increase, but is that going to be going from 1 out of 5 homes or 1 out of 4 during this year that, that would probably be pretty aggressive, but I do expect to continue to see some increase in our market share within Horton.

Question
Truman Patterson (Analysts)

Okay. Okay. Got you. And then -- are you all actually seeing any opportunities to buy discounted land or distressed deals or is it still just a bit too early? I got the impression on the call that perhaps you're not ready to deploy capital yet and maybe there's some further downside?

Answer
Daniel Bartok (Executives)

Yes. We're starting to see opportunities more particularly though in deals that we may have either passed on before or were somebody outdid us and now those deals are coming back around when they've been dropped. But as far as seeing anything that I would call distressed or severely discounted. I haven't really seen that yet, but we're looking hard for them.

Question
Truman Patterson (Analysts)

Got you. Understood. And then one final for me. Which markets do you think have the greatest lot constraints and we'll just say are least susceptible to potential impairments in the industry, and which markets are maybe more oversupplied more at risk? I'm asking because right now, new home pricing, we guesstimate is kind of down about 10% from the peak nationwide.

Answer
Daniel Bartok (Executives)

I don't really see that any market is oversupplied. Again, nothing at all compared to what we saw back in '07, '08 time frame. So I think it's still really hard to get lots entitled and they get lots developed. So again, I don't see anything being oversupplied. I think as far as riskiest markets, I think, is the ones that ran up the most and are probably going to be a little slower to bounce back. And the one I would point to would be -- I think the ones that you hear are everybody talk about, right, which is Arizona, Denver. And we kind of got out of the Northwest. So we kind of missed some of the stuff that happened up in Salt Lake and Washington and Boise. But I'd say, for us, probably the 2 that we look at most carefully Arizona and Colorado.

Question and Answer Operator Message
Operator (Operator)

The next question is coming from Carl Reichardt with BTIG.

Question
Carl Reichardt (Analysts)

I just wanted to follow up on Truman's. You had $90,000 on a sort of average revenue per lot rate this quarter. Obviously, the markets changed to some degree, the Southeast has remained reasonably decent, Texas has been good. The West has slowed a lot. As you're thinking about your mix of deliveries in '23, recognizing you're not giving guidance, do you think it's going to adjust appreciably from what it was in '22 geographically speaking?

Answer
Daniel Bartok (Executives)

It's always challenging to what product mix is going to sell and what dates. $90,000 I think, is probably the highest we've hit on a quarter, but we also had some sales in the West. We did -- we sold our last lots up in the Seattle market. Again, we might reenter that market when it's more attractively priced again. And then we had some other Western type sales that maybe skewed that number a little higher than usual. So I would expect, overall, our ASP will probably not increase from 90, but will probably trend down a little bit this year.

Question
Carl Reichardt (Analysts)

All right. And then regarding your comments on the potential for opportunities, you talked about some builders may be looking more at finished lot transactions as opposed to doing self-development. Besides deals that you passed on before that are now coming back to the market, is there any sense that you're seeing now, some of those vertically integrated builders want to move towards not developing their own given they sort of need it for margin. And are you seeing other developers out there not looking at new deals, so not only dropping deals, but just effectively disappearing from the market at all, that kind of firm level distress yet.

Answer
Daniel Bartok (Executives)

Yes. I think clearly, I've seen that the smaller developers are having a hard time getting new financing on new projects and are probably negotiating with their banks on their existing deals. That's my sense. We are seeing some developers that have put a couple of packages together. But again, I don't think they're feeling overly stressed yet, that may happen. I think -- I guess we'll see what happens here with the spring selling season about to begin. But we are definitely seeing a slow-up in transactions by developers.

As far as builders, the conversations over the last couple of months have been interesting. People are looking for positions in areas that they're not in yet. But I think everybody's get ready to pull the trigger. Again, I think we're going to really see over the next 8 to 12 weeks, what happens with sales and therefore, builders' desire to ramp up starts again?

Question and Answer Operator Message
Operator (Operator)

The next question is coming from Anthony Pettinari with Citigroup.

Question
Asher Sohnen (Analysts)

This is Asher Sohnen on for Anthony. ASP per lot rose 2% quarter-over-quarter, which seems somewhat out of line with what we're seeing in terms of home prices what they're doing. So is that largely due to delivery of lots with prior pricing kind of already put under contract in the time of those deliveries? And then if so, was there any renegotiation of prices between you and builders baked into that number? And then if not, should we start to expect like renegotiations to be a price headwind over the balance of the year.

Answer
James Allen (Executives)

This is Jim Allen. With respect to the $90,100 ASP for the quarter, I think the increase there probably had more to do with mix than anything, as Dan mentioned. I guess with respect to renegotiating, I'll let Dan you want to add.

Answer
Daniel Bartok (Executives)

Renegotiating -- we're seeing builders come to us looking for some flexibility with terms, not so much pricing, but maybe to take down. So pricing right now is held pretty steady.

The other thing that we'll mention is $90,100 for an ASP, it puts us in a sweet spot, we think, for affordable pricing, where builders want to be with highest demand is in the marketplace. So we have not seen that yet on the pricing side, but we have had builders come back to us and when I talk about terms.

Answer
Katie Smith (Executives)

This is Katie. I'll add on to that, too. When a builder comes to us and wants to renegotiate a takedown, we're typically getting something in return for that. So whether it be a larger earnest money deposit or a higher escalator on those lots. So there is a little bit of an offset as far as price whenever we do decide to extend the takedown schedule.

Question
Asher Sohnen (Analysts)

Great. That's really helpful. And then just sort of following up on that then. So as you sort of write up new contracts for lots that are sort of coming through the pipeline that haven't been contracted yet, what has pricing looks like trending there? Is it sort of still stable kind of following underlying land prices not yet coming down? Or are you starting to test to give up a little bit of price there.

Answer
Daniel Bartok (Executives)

I think we look at that project by project, market by market. They all have unique characteristics. So when we set pricing for finished lots, we're looking at all the intangibles for each market. But right now, our pricing is out steady.

Question and Answer Operator Message
Operator (Operator)

Our next question is from Mike Rehaut with JPMorgan.

Question
Douglas Samuel Wardlaw (Analysts)

Douglas Wardlaw on for Mike. Last quarter, you guys mentioned that you were any closer to any potential impairments after the quarter. And I was just curious after this most recent quarter, that mindset has changed. And if not, how do you envision the rest of the year going in terms of maybe getting to kind of the warning zone on the potential impairment?

Answer
James Allen (Executives)

Well, we regularly review and monitor projects for indicators of impairment. We had no impairments for the quarter. We did write off some due diligence costs and earnest money related to deals that we decided not to close on. At this point, as Mark said, our margins and our pricing has held up pretty well. We've seen a little bit of compression in margin, which we expected probably a little bit early to say what to expect for the rest of the year. That will be more contingent on general market conditions and what happens with rates. But at this point, we don't see widespread impairments. We may have isolated impairments as we go through the year, but we don't see it at this point on a widespread basis.

Question
Douglas Samuel Wardlaw (Analysts)

Great. And with that, I'm just following up on what you said in terms of margins. So relative to your expectations at the end of 4Q, you haven't seen more and less of the margin compression you expected?

Answer
James Allen (Executives)

Sequentially, gross margin came down a little bit this quarter, but it's held up pretty well. Our pricing has held up well. We have lost operating leverage due to reduced volume. So we certainly have a higher SG&A as a percentage of revenue than we'd like. But as I said earlier, our SG&A expense was down 3% sequentially and has decreased for the last 3 quarters.

Answer
Katie Smith (Executives)

Gross margins this quarter pretty much in line with what we expected.

Question and Answer Operator Message
Operator (Operator)

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.

Answer
Daniel Bartok (Executives)

Thank you, John. 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. We look forward to speaking with you again in April to share our second quarter results. Thank you.

Question and Answer Operator Message
Operator (Operator)

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

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