D.R. Horton, Inc. (DHI) Earnings Call Transcript & Summary

Good morning. Welcome. My name is Mike Rehaut. I'm the homebuilding analyst -- Senior Analyst for the homebuilding and building products sector for JP Morgan. We're pleased to continue our morning session of Day 2 of our 13th annual Homebuilding & Building Products Conference. With me, we have D.R. Horton, the largest builder in the United States. With me is CFO, Bill Wheat; and VP of Investor Relations, Jessica Hansen. As with our prior sessions, this will be about 35 minutes. We have some slides that are available on our conference -- digital conference book that the company will walk through, followed by some questions by myself, as well as, I'll be able to moderate incoming questions through our virtual capacity, our ask-a-question capacity for those dialed in and logged on to our conference book. You can click that feature, type in a question and I'll be happy to relay it to the company. So with that, I'll turn it over to Bill and Jessica, and we'll begin our -- begin the session.

Great. Thanks, Mike, and thanks to everyone that's in the virtual audience today, taking time to spend with us. Starting on Slide 2, it's a slide you're familiar with, forward-looking statements. We'll likely be making some of those today. So for additional information about issues that could lead to material changes in our performance, we would refer you to our annual report on Form 10-K and our most recent filed 10-Q, both of which are filed with the Securities and Exchange Commission. Moving on to Slide 3, pretty high level slide for those of you that already know us, D.R. Horton, this is on a trailing 12-month basis. We've had $18.5 billion of consolidated revenues, which has allowed us to generate $2.4 billion of pretax income, a very strong return on equity at 19.1%. And our homebuilding leverage puts us in a very strong position today, especially during uncertain economic times at 19.2%.

Moving on to Slide 4. Of course, all commentary these days around our business, well we can't really talk about the business without talking about the impact of COVID-19. So as we talked about on our earnings call in late April, our economic fundamentals of the housing market and of our business remained very strong through about mid-March, so near the end of our Q2. But then during the latter part of March and the first part of April, we began to see increases in cancellations and decreases sales volumes as an impact of COVID-19 and the restrictions that were put in place across a number of markets. We reported at the end of April -- near the end of April, where our results were that we had begun to see some improvement for the 2 weeks prior to our earnings release, and we have seen continued improvement on the remainder of April and into May. I'll talk about that in just a moment. I do want to mention one thing about our mortgage subsidiary. We've also seen some disruption in the mortgage market, and we're seeing lower pricing on the sales of our mortgages and the sales of our servicing rights from our mortgage company. And as we moved into April, our mortgage company has begun to retain servicing on some of the government mortgages that we are originating for FHA and VA. But the company is very well positioned in this environment with our balance sheet, with our liquidity, with our positioning with completed homes in inventory and our affordable price points, and we feel like we're in a great position to gain market share during this environment. Moving on to Slide 5, just our highlights. We did have a very strong first half of the year through the second quarter. Net income had increased 37%. And over the course of the year thus far, pretax income had increased 34%, and our net homes sold had increased 20% year-to-date. However, with the impact in March, the month of March, our homes sold only increased 6%. And we had seen an increase in our cancellation rate to 24% compared to 18% the year prior. Our earnings release was near the end of April, with several days remaining. And as of the time of our report, we reported that our month-to-date April sales were down 11% on a net basis as of that date. I'm here to report to you today, our complete month of April [Audio Gap] our net home sales were only down 1%. We did see additional cancellations near the end of the month, but we continue to see very good sales pace as well. So for the full month of April, our net sales were down 1%. They were down 6% in value, as we have seen the mix of our home shift, both geographically and from a product standpoint to a more affordable offering. And we are still continuing to see increased cancellations. Our cancellation rate for the month of April was 27% as compared to 19% from a year ago. So with net home sales down 1% but with increased cancellations, our gross sales were up in the month of April. And in May, thus far, it's still too early to say what our full month of May will be on a year-over-year basis. However, we have continued to see good demand each week with variability from week-to-week in both our sales pace and in our cancellations. But we believe with our positioning, we should be in a very good position to show good results in May and market share gains on a forward basis.

So turning to Slide 6. Our next few slides really outline why we've been able to report the results we've reported in these uncertain times and a little bit weaker market conditions and some of the outperformance that we've demonstrated. First, our broad geographic footprint, which is reflected on Slide 6. We're in 89 markets in 29 states today and have a very strong footprint really at Texas across to Florida, up into the Carolinas, which generally are very affordable housing markets to begin with. Haven't been impacted as dramatically by some of the shutdowns as other parts of the country, and demand has still held up relatively better in this part of the country and particularly the western markets. Moving to Slide 7. Very diverse product offerings and price points. But as most of you are aware, we do have a very large focus on the entry level, first time and first-time move-up buyer. Very focused on having affordable price points at all different pieces of the business for any buyer that's in the market today. So on a trailing 12 months basis, 67% of our homes closed were under $300,000, representing our focus on affordable product offerings. Then probably most importantly, on Page 8, is our people. We point to our people a lot as the hallmark of our business and our biggest competitive advantage. Homebuilding is a very local business. And so having a tenured -- long-tenured experienced operators in each of our local markets, we believe, is very important. Our division presidents, on average, have been with us for approximately 15 years. So they've definitely lived at least a cycle or two and know how to navigate difficult economic conditions. Our city managers, which manage our smaller markets that roll up to a larger metro area and report to a division president, who've been with us greater than 10 years. And then at the very top of our management team, our executive team and our regional presidents have been with us approximately 27 years, which, as Bill touches on the next slide, you'll see that really, our executive team and regional presidents have averaged the life of the company since we went public in 1992.

Speaking to that, on Slide 9 shows what this company has accomplished since we went public in 1992. Over the last 28 years, this company has grown from 1,200 closings of the day we went public to nearing 60,000 closings a year. And the team that Jessica just talked about has been the -- who has accomplished this. We've operated through cycles, and through cycles we have continuously gained market share. Even through the worst days of the financial crisis, this company gained share as we've improved return, and we feel like we're in a great position as we are in this unusual time. Moving forward, we expect to gain share on a continual basis. When we look to Slide 10, really where market share matters the most is at the local level. And on a trailing 12-month basis or the prior year, we were #1 in the top 5 markets in the United States in terms of market share. You can see on the left-hand slide of -- side of the slide, the differential in the market share between D.R. Horton and the second largest builder in each market. But then across the top 50 markets, we still feel like there is tremendous potential for us to continue to gain share. As of the latest reporting period, we were #1 in 13 of the top 50 markets. So that still leaves a significant number of markets where we still have the opportunity to become the #1 builder. We're top 5 in 31 of the 50 markets. So still opportunity there as well. So on Slide 11, we highlight our operational focus. We are continuing with our strategy of remaining very consistent in how we approach the business community by community. We have always been a builder that builds homes on spec and keeps a number of completed homes in inventory, and that's serving us very well during this market, and we've seen that work very well through cycles over the long course of history. So we're continuing to manage our business at the local level and the community level by starting homes, selling homes and adjusting our inventory levels to match the demand that we see in each market in order to maximize returns on our inventory investments. We expect with our approach, we'll continue to consolidate market share. And we expect that we have not changed our underwriting hurdle, so we expect it will continue to generate strong returns, and we continue to work on our adjustment of our land pipeline to increase the portion of our land pipeline that's auctioned through expanding relationships with land developers, including Forestar.

So turning to Slide 12 is just a very brief summary about Forestar, as Bill just mentioned. Forestar is a publicly traded residential lot manufacturer that currently operates in 50 markets and 21 states. Forestar has helped us accelerate our ability and our strategy to increase the portion of our lots that we control through option contracts or through purchase contracts with third parties. Forestar was off to a very strong start to the first half of the year, delivering over 4,000 lots and generating over $400 million of revenue. And they've been raising capital really over the last 12 to 18 months to support the growth that they've got in the future. So most recently, in February, they very opportunistically and well-timed the capital markets and issued $300 million of senior notes, due 2028. And that has now put them in a very strong financial flexible position to also navigate through difficult economic conditions in terms of liquidity of almost $800 million. They do expect to opportunistically raise additional growth capital in the coming years. But because of the strong liquidity position today, they can be opportunistic and waived until market conditions have improved and we have better visibility to their business. Net debt to cap, very flexible, under 20% today, and they don't have a senior note maturity until fiscal 2024. And as you heard D.R. Horton talk about a lot since our initial ownership position in state we took in Forestar, our long-term goal is ultimately to deconsolidate Forestar from D.R. Horton's balance sheet, however, we're not in any hurry to do so. We're building a long-term strategic relationship. Very excited about Forestar's progress to date in building out their people on their platform, and our ownership position today is 65%. Turning to Slide 13. Forestar has helped us in this regard and our ability to continue to increase our lots controlled through option contracts. It's one component of improving our returns. And so we have one of the industry-leading returns on equity today at just over 19% on a trailing 12-month basis, and we would expect to maintain a strong ROE in the mid- to high teens going forward.

On Slide 14, we highlight our capital and cash flow priorities. We will continue to maintain a balanced, disciplined, flexible and opportunistic position focused on enhancing our long-term value. We have a strong balance sheet with leverage less than 20%, ample liquidity and low leverage, and that gives us significant flexibility to withstand difficult economic conditions. Our top priority is to continue to invest in our homebuilding business. As we see demand in each of our communities each day, we're making sure that we're investing in our homes and then having lots in position to deliver homes. And we feel like, with where demand is right now, we're starting to gain some visibility that we did not have 6 to 8 weeks ago. So that will continue to be a priority to invest in the homebuilding business. We do continue to move forward with our DHI Communities platform, which is our multifamily rental company. We have paused our existing projects that had not started yet, but we are continuing construction with those that are under construction and lease-up today, we have 4 total projects currently either under construction or in the lease-up process today. We do and are committed to maintaining conservative homebuilding leverage and strong liquidity. In early May, we had the opportunity to access the public debt markets, and we did issue $500 million of 2.6% senior notes due in 2025, and that gives us additional cushion in our liquidity during this time when visibility is a bit more limited, but it also provides us essentially a prefunding of our next debt maturity, which is in December of 2020, $400 million. We've also remained consistent with our dividends to our shareholders. We believe our visibility to our business, our health of our business is such that our Board was confident in declaring a consistent dividend for the current quarter, and would expect to do that for the remainder of the year. And then with respect to our repurchase of common stock, we have been on a consistent repurchasing program and it reduced our share count by about 3% over the last 2 years. In the short run, while we manage through some uncertain times, we are going to cautiously manage our level of share repurchases until we get a bit better visibility into market conditions and our future results and our investment opportunities. And so in our current quarter, our third fiscal quarter, which will end in June, we do not expect to repurchase any shares in the current quarter.

Turning to Slide 15. This represents our homes in inventory at the end of March. So we have 33,400 homes in inventory. We're very well positioned to deliver homes, both during and after the pandemic, our spec position and being probably the biggest spec builder in the market today. We really do see it as a strong advantage. Buyers that are in the market currently in the midst of this pandemic seem to have a larger sense of urgency. And the buyers that are in the market today are qualified. They know what's going on. So they have certainty of their job, and for whatever reason because of what they had to live through, these recent weeks would like to get in a home sooner rather than later. So having some completed specs and homes closer to completion available for those buyers has proven to be a very strong position for D.R. Horton to be in today. Turning to Slide 16. This reflects -- I mentioned that we've been shifting more of our lot ownership position to ownership but our controlled position to controlling more lots through third parties and purchase contracts with third parties, so ultimately buying more finished lots from those third parties. At 64% controlled at the end of March, that's the highest percentage we've been at this cycle. And we are focused on continuing into -- continuing to increase that percentage over time and owning less land on our balance sheet. That's going to do very good things for our returns going forward. So at 119,000, roughly, lots owned at the end of March, that was about a 2-year land supply. That compares to 3.6 years at the last peak, call it, in 2006. So we've made very good progress on this front, but we're not done, and we would expect to increase the 64% controlled percentage going forward.

And finally on Slide 17. With regard to our outlook, on our last earnings call, we did withdraw our annual guidance due to the uncertainty in the U.S. economy and in our business operations resulting from COVID-19. As you can hear from us, we are starting to gain a bit of visibility. And in the short run, I think we do see a bit better into the level of demand that we're seeing in the marketplace week-to-week. And we're encouraged by that. And honestly, probably a bit surprised by that compared to where our expectations would have been a couple of months ago. However, as we look to the medium-term through the summer and into later 2020 and into 2021, there still is a level of uncertainty in the marketplace. We do not yet know and have visibility to the full impact of the job losses on the economy and to our local markets in which we operate. And ultimately, what that might do to medium and longer-term housing demand. So we expect to remain with no guidance for the short to medium term. And we'll be adjusting our business based on how things develop and how the economies develop in each of our markets. And we believe we're in very well position with our long, tenured, experienced people that have demonstrated the ability to outperform the industry over the longer term. We feel very good with our teams, with our positioning, with our balance sheet, with our business model, focused on returns and focused on having homes available for sale at affordable prices. We believe we're very well positioned to compete in this market and to gain market share. And we're optimistic about the longer-term future while we go through this uncertain time. And so with that, we will turn it back to you, Mike, and be happy to answer any questions you may have.

Great. Thanks very much, Bill and Jessica. Appreciate it very much. Let me ask a few questions. We already gotten a couple of questions from our virtual audience, but I'll kick it off with a few to start, and we'll have time for -- I think, plenty of time to get all these questions answered. Just kind of starting with the new incremental data point of the day, April orders down 1%, obviously, a lot better than down roughly 10%, or 10% or 11% that you were -- had tracked so far through April when you reported. At the time, you actually had expected perhaps even a slightly worse result based on some increased cans towards the end of the month. Obviously, you said you saw those increased cans, but you had better gross sales that more than offset that. So along with the comments that you continue to see improvement, I don't want to misstate, but at least continued good demand each week in May, although variability is it safe to say that your April -- last week of April was a positive order growth week and that you're still seeing that so far in May on a net basis?

Yes. Thanks, Mike. It is safe to say that our final week of April was positive on a net basis. We were -- obviously, a very uncertain time, and we do generally see more cancellations at the end of the month, especially during a time like this when buyers are uncertain about their decision. But we did continue to see good gross sales. So on a net basis, in the final week of April, yes, net sales were positive. We're not commenting on individual weeks in May. We're a bit earlier in may now than we were in April when we reported our April month today. We've seen variability, and we're still seeing good demand. And it's certainly at levels that is stronger than we saw in late March and early April. So very, I'd say, pleased with where sales are and where demand is. But not necessarily commenting on week-to-week comparisons to the prior year. It's an unusual year in terms of seasonality. An ordinary year, we would typically start to see seasonally demand start to drop in mid-May. When you get to Mother's Day and you start to getting into the graduation season and then into summer and vacation season, we typically see housing demand start to tail off seasonally. This has been a highly unusual year in which we took 6 to 8 weeks out of the core of the spring selling season. So we're dealing, I think, right now, with some pent-up demand, and we're certainly seeing that come through. And it's -- I think it remains to be seen how things play out for the remainder of May and into the summer.

Along those lines, in terms of what you're seeing, a question that I've been asking other builder sessions -- during other builder sessions has been their take on what seems to be a pretty stark dynamic or range of results that we've seen in April so far, where you have order trends, I guess, with your updated numbers closer to flat to -- as much as down 50% for the month. And I think one of the key consistent factors in terms of what's been behind that range has been spec-oriented builders versus build to order, have -- those 2 different camps have had significantly different results. And my question earlier, in an earlier session, I asked a more build-to-order oriented builder, what they thought of that what the drivers were and if they would expect that dynamic to persist. So I'll ask the same question to you guys. What do you feel have been the factors driving that better strength in spec? And do you expect those factors to persist to the extent that maybe they're starting to moderate? Could that possibly be one of the reasons that you might be seeing a little bit more variability in May?

We've seen our spec strategy work well in all cycles through the worst days of the financial crisis. And the ability to sell completed homes was there. It's always allowed us to compete against the existing home market. But I think in a time like this, I think it's been especially strong. And I think it'll still continue to be strong demand for specs. But definitely, during this time when there's a level of urgency and buyers that are looking to find a home to move into very quickly. I think the largest part of the demand that we're seeing are those buyers today. So it's certainly helped right now. And at some point, as we move further into whatever the new normal is going to be in the market, yes, I would expect to see some moderation of it. But I -- from our experience, always having a good balance of spec inventory, homes available that are completed, homes that are nearing completion and available for move-in very quickly, has always been a very good competitive advantage versus new homebuilders and the existing home markets. And our comments around May are just simply that each week is different. Mother's Day was a week ago. Well, it's always a little bit lighter traffic on Mother's Day versus a week prior and the week after. So one week doesn't really tell a story. So we basically don't want to comment on our full month or our month-to-date comparison yet because each week will be a different story. Memorial Day is coming up in over this next weekend, and that can be a strong weekend. Sometimes, we'll see what it is this year.

Okay. Fair enough. Fair enough. You mentioned also in your comments that your mortgage company amid some of the volatility that you've seen in the mortgage market beginning to retain some of the servicing on some of the mortgages you're originating. We've had another builder in the sector do something similar to that. At the same time, we have heard that off of some initial tightening in the mortgage market, there might have been some loosening and some stabilization or reversal in the last 2 or 3 weeks. So I'm curious if you've seen that be the case, how it's impacted your customer, and it doesn't seem like, obviously, with the results, it seemed to big negative factor in ability to write orders. But wanted your thoughts on that, and also, how large this component of retaining servicing could be on your balance sheet?

We have started to see some level of stabilization in the mortgage market. There still are some credit overlays at lower FICO scores that are still impacting some investors in what they're willing to buy. The servicing aspect of the mortgage market has been the most impacted just due to the uncertainty around the forbearance provisions. Of the CARES Act. And so a number of the third-party servicers, the nonbank services are still very limited in terms of their operations and how much servicing they're taking on. And pricing is still lower than it was normally, prior to the crisis. But we have seen in the last week or 2 some improvement there and some pricing start to improve in terms of offers for servicing. And so to clarify what we are doing, we are still selling our loans. Our mortgage company is still selling the loan. So there's no loans on our balance sheet going forward. However, primarily in the government loan sector, so for the FHA and VA loans, those are the ones that servicing has been impacted the most. We are starting to service some of our government loans. That are being originated by our mortgage company, and we're using a subservicer to assist with that. So not a big impact on our balance sheet. The loan is sold. We're just retaining the servicing. And so rather than selling it at an abnormally low price, we're retaining the servicing, and we have a servicing right on our balance sheet. And then we'll manage that portfolio over time. If pricing improves, our base case would be that we would still continue to sell a certain amount of our servicing. But during a period of dislocation when pricing is extremely low, and an unwarranted low from our perspective, we've got the flexibility and believe that we're able to service some portion of our loans for some period of time.

Right, right. No, I appreciate that. So we have a few questions from the audience. One is I'm going to kind of combine a couple. So there are some easy questions to answer. One was -- a couple was around -- this is a little bit 2 different topics, but I'll throw them in here, just easy to answer quickly, we'll get these through. One is just around April closings and orders. Would you expect to continue to report orders and closings on a monthly basis? I know, obviously, this isn't your normal practice. I remember back in the '90s, that was the industry standard. I go back quite a ways. Makes all of our lives easier, that the industry has moved away from that since then. But in the near term, would that -- is that something we should expect for at least May or June? Well, let me -- I'll let you answer that real quick, and then I have a couple of others.

We expect -- based on where we are today, we expect to return to our quarterly reporting. Obviously, the end of March and April were highly unusual period of periods of time with extreme volatility. We have seen some level of stability start to return back to the market, and so our base plan right now is that we would wait to report our full quarter when we report our June quarter in the month of July.

Right. Another quick question for you, Bill, the -- what is your average interest on your long-term debt? And are there any plans to refinance given the low rates today?

No immediate plans to refinance. Our average rate, I don't have it right here in front of me, but we're in the 3.5% range right now. Our most recent issues have been in the mid-2% range. And we don't have any immediate plans for refinance, but that's something we'll continue to evaluate.

Okay. Another question, I think, is actually one of the questions that we have as well. The drivers of cancellation. Historically, when you think about just in a normal market, the top reason is not able to get mortgage financing, you're not qualifying or putting a small deposit down that can be refundable and -- but in today's environment, you have fear, you have job loss, you have a lot of changing circumstances. So since the end of March, through today, it's a 6 to 8 week period. How has that cancel -- the reason for cancellation changed over time? If you can kind of give us what the primary -- the top 1 or 2 reasons for cancellation as this pandemic has progressed.

Sure, Mike. We continue to see the main reason people cancel as they can't qualify for the mortgage. Now a bigger portion of the reason people can't qualify for the mortgage is likely that they've had a change in their job situation. So they've either lost their job or they have less income coming in than they originally anticipated. We do have people that are choosing to cancel just because of the uncertainty in the market. Right behind jobs, the next biggest driver of our business really is consumer confidence, and clearly, the headlines haven't been that supportive of confidence in people going out and making that big long-term decision and a very large asset purchase. That being said, I think we feel like after we got through March and April, that hopefully, our cancellations will settle out somewhat because if a buyer is in the market today, clearly, the headlines have been what they've been for quite some time, and that buyer likely has more certainty of the job situation if they feel comfortable coming out and shopping for that really large home purchase. We have adjusted in terms of -- prior to closing, typically, we would have reached that employment our verified employment 10 days in advance of closing. That window has tightened in 3 days because of the current environment. And I think that also supports the -- still not being able to qualify being the largest reason people are canceling, but more and more a portion of that is because of job losses.

Okay. That's great. Very helpful. Another question we wanted to throw out there was some of the regional differences across the country. There have been different -- obviously, across the country, you've had different shelter and place orders that have caused some different levels of performance. I just wanted to get a sense from you as you've -- particularly over the last 2, 3, 4 weeks, things changed so quickly. Which markets kind of stand out to you as being stronger versus weaker, and if any markets started to come back at all, may be better than expected?

Yes. Thanks, Mike. Throughout this time, the states of Texas and Florida have stood out as being very strong. We've seen good sales in the Carolinas as well. The Texas and Florida have definitely stood out throughout. Really, the only places we've seen are significantly negative impact is in those areas that have been shut down or where activities have been closed. It's been fairly limited for us. The state of Washington was closed for a while. They've started to incrementally reopen and allow construction on projects that had already been permitted. But new projects and new construction is still limited there. So I think we're going to still see some constraints there. And really, outside of that, a few counties in California were restrained for a while and then some counties in the Pennsylvania area. We have a few communities that are still closed there. But for the most part, most of our operations have been able to continue. And I think those markets that were strongest going into this, have continued to remain strong.

Great. One last one that I think is important. You had mentioned that your order is down 1% in April, but your average -- your dollar value is down 6%, so kind of, pointing to some change in mix. Do you see that continuing into May? And also going back to the earlier question around geography, if some of the shelter in place -- and we heard about Washington and Northern California being higher ASP areas that we're kind of off-line for longer, if that also contributed to the change in mix or if it was just more of a broader market dynamic due to the more challenged economic backdrop?

Sure. No, very much to what you outlined, Mike, we've seen the western part of the country, by and large, have stricter and longer shutdowns. Than other parts of the country and also maybe had more severe impact from actual virus itself, if you think about Seattle versus our comments on Texas and Florida holding up relatively better than other parts of the country. Our western states, by and large, are our highest ASP markets, coupled with our small presence in the Northeast, which is also a higher ASP market. So as Texas and Florida and some of those other southeastern type markets take a bigger piece of the share. That is what's driving our change in ASP. We have not seen any broad-based home price declines on a like-for-like basis. Any continued decline in our ASP that we would expect would be from geographic mix.

Okay. So product mix within Florida or Texas or the Southeast, not playing as much of a role in and of itself then?

Generally affordable price points are holding up better than the higher end part of the market. I do think, though, there are some buyers coming in the market today. Really hard to ascertain so early on how many and how deep this demand is. But if people are choosing to move out of an urban infill environment in a Dallas or Houston, where they had a high rent, they're probably not an Express hire. They're probably coming and buying a higher end deal important home. But that's more anecdotal today. That's starting to happen in certain cases, and it kind of remains to be seen how deep that demand ultimately is.

All right. So it's fair to say then, primarily, this negative ASP trend is more geographic driven, more than anything else?

Yes.

Okay. Perfect. All right. Well, that actually does it for time. We're right around 12:20. So we're at the end of our 35 minutes. Thanks so much. I appreciate the participation, as always. It's always great to have D.R. Horton a cornerstone of our conference year in, year out, and we don't take it for granted. So it's great to see you. We will be resuming the conference with our afternoon session, kicked off with -- kicking off at 1:30 in the afternoon Eastern time with Century Communities, followed by Forestar, and closing out the conference will be JELD-WEN. So appreciate -- again, great job, Bill and Jessica. Appreciate it, as always, and we'll see you soon.

Thanks, Mike.

Thank you, Mike. Thank you all.