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

Good afternoon. I'm Matt Bouley, Barclays U.S. homebuilding analyst. My pleasure, this afternoon, to have the team from D.R. Horton here at our 38th Annual Barclays Industrial Select Conference. Got Jessica Hansen and Bethany Carle. I'm going to let Jessica kick it off here in a moment with an update of sort of where D.R. Horton stands today. But for everyone listening, please feel free to e-mail me any questions on the side, anything you want asked. You can see my e-mail address up on the left side of the webcast for those of you who don't have it. Also on the right side of the webcast is our annual audience response questions, so please fill those out. It's always appreciated for investors to fill that out every year. So with that, Jessica, thank you for joining us this afternoon. I know some folks were looking for Bill Wheat to join, but hopefully, everything is okay. He is caught up in those difficulties going on in Texas you might have seen in the news today. But we're very lucky to have Jessica and Bethany here. So with that, Jessica, I'll let you go ahead.

Sure. Thank you, Matt, and to the Barclays team for hosting us today. As Matt said, on Bill's regards, send his regrets not being able to join during this crazy winter snowstorm that Texas is currently experiencing. Bethany and I are in good shape right now. But with rolling blackouts currently in place, we're very hopeful it doesn't impact the webcast today. Bill is doing just fine. He's just got very limited Internet and cell service as does most of the state right now, unfortunately. To the good news, after a fantastic first quarter of over $1 billion of consolidated pretax income, a 98% increase in that, a 48% increase in our revenues to $5.9 billion and a 56% increase in our net sales orders to over 20,000 homes, we're very well positioned, even after that strong first quarter for a very strong fiscal 2021. And we continue to be very pleased with our sales pace to date in February. And look forward to discussing DHI and specifically our positioning as it pertains to the rest of the year in future years. We've got 42,100 homes in inventory today, and an ample supply of lots. And as I mentioned, continued strong sales trends. We are being webcast, so we can give here a modest update about where we stand today versus our conference call a few weeks ago. And happy to say that still the early indications for the spring selling season are very strong, and we believe we're very well positioned to capitalize that on fiscal '21 and expect to close between 80,000 and 82,000 homes this year. And with that, Matt, I think I'll turn it over to you for questions.

Perfect. Thank you for that opening, Jessica. So maybe we'll just jump right off on that point, 42,000 homes in inventory, you're talking about January, demand continuing strong. So just curious if you're sort of where you want to be from an inventory perspective? And then just kind of what you meant by strength there in January? Is that to suggest a normal seasonal uptick? Or just any kind of elaboration on that?

Sure. So yes, typically, we see a pretty big step-up from December into January, as you know, from a seasonal perspective. And as we said on our conference call, we did see normal seasonality, and that's coming off and even stronger than normal December quarter. As everyone will call, I'm sure is aware, we didn't really have anything normal seasonality during calendar '21, and it kind of remains to be seen what seasonality looks like in fiscal '21. But right now, all early indications continue through the last day or 2 that sales and the market is still extremely strong going into the traditional spring selling season. I mentioned we have 42,100 homes in inventory at the end of the quarter, so that was at December 31, putting us in a very strong position to deliver on our forward guidance for closings. We started almost 23,000 homes during our first quarter. And that is right in line with the 25,000 or a little bit down from what we started in Q4, which was a little bit of catch-up just because of what we experienced in late March and April last year and then the sharp tick up in demand that I'm not sure anyone was originally anticipating. But our operators in the field have done a fantastic job getting our inventory levels back up to where we'd like for them to be. And we feel very good about our ability to further increase our starts as we move throughout this quarter, positioning us again, once I mentioned, to the 80,000 to 82,000 homes closed for the year.

Got you. Okay. So that's helpful. So just given ending the quarter with, I think, 28,000 homes in backlog, you're talking about doing everything you can to accelerate starts here. My question is just how far out are you willing to extend the backlog? Are you actually willing to run sales pace even stronger than it was in the second half of '20, just into the seasonal spring strength? Or just what else are you doing to kind of manage that supply demand balance?

Sure. Well, the great thing is it starts with our lot position, and I think we have the most robust finished lot position in the industry, which puts us in a very good position to continue to replace and bring new communities online and keep those absorptions up. While our homes and backlog are younger than usual today, we were selling homes later in our build cycle than we are today because of the strength in demand. We still don't have a lengthy build cycle, and we haven't generally seen our build cycle elongate, at least not to any noticeable extent. So we believe our backlog is very manageable. We're not shifting our business model. We're still heavily predominantly a spec builder. So when I think of what we're selling today, if we're selling into lots that we haven't actually started the home construction on, it's really just a preplanned construction start. So it was a home that we were already planning to start, have a very good handle on the costs associated with that home. And then based on current market conditions, what we think we can sell it for, and so we feel very good about our ability to continue to manage that backlog as we move throughout '21. It really comes down to the individual community though. If it's not an easily replaceable community, if we don't have the finished lots ready to go in the next phase, we're going to push price and get more margin in those communities. But in most cases, we have the lots and next phase of lots for next community ready to go. And in that regard, it makes the most sense from a return perspective to keep our absorptions up and keep turning that inventory.

Got it. Okay. So thinking about the start position as you kind of go through or head into the spring here, I guess, it's a question on labor. I mean, do you feel like the labor is where it needs to be for D.R. Horton in order to get the starts in the ground? Well, I'll stop there. That's the question.

Yes. We're still seeing great labor availability. Particularly for us, the industry may have something else to say, but our local scale really does play an impact. And our spec business model also does as well. We're able to give our trade a schedule and say here's the work that's coming down the pipeline and that plays very well to our advantage.

Got it. Okay. Yes. And then where I cut myself off, the second part of that question was on the lot position. I mean, 442,000 lots under control that you disclosed at the end of the last quarter. And it seems based on the percentage that's optioned up to 72% would seem that the vast majority of what you're adding is options lot. So I guess, number one, what's kind of the longer-term signal there around your view of housing? And then just number two, of those lots that were added in the quarter, what's kind of the duration of when we might see that come into the fold?

Sure. So with our lot position, as you mentioned and I think I mentioned in my intro comments, very robust, puts us in a very strong competitive position. We own about 122,000 lots today, but we control several hundred thousand behind that to get us over 400,000 lots owned and controlled, which really means that we've already got our lots that we need for '21. And by and large, the lots we need for fiscal 2022 are already identified, either finished, under development or going to be put in development very quickly to be available to us for home construction in '22. So really, what we're looking at today is for fiscal '23 and beyond with maybe some small finished lot deals that could provide upside in fiscal '22 if we find those here in the coming months. But we feel very good about our ability to continue replenishing that and put us in a very strong position for not only the growth we're experiencing this year, but for growth and continued consolidation and market share going forward. The 72% you optioned -- you mentioned from an option percentage, we're very pleased with how well our teams did this quarter because we significantly saw an uptick in both the absolute number of lots we had under contract and what that percentage looks like in terms of 72% versus 28% owned. And it's doing great things for our returns. You saw our ROE on a trailing 12 months is over 24% today, and our return on inventory, ROI is at 28%.

Got you. So when we think about bringing lots under control for 2023, are you guys doing anything, I guess, different sort of post-COVID as you're taking on all of these lots? Is it larger parcels? Is it -- are you actually looking at new markets at this point? Anything along those lines that might be sort of different around the future lot portfolio versus what you've got coming in the near term.

Yes. So generally speaking, our community sizes are trending upward just ever so slightly, but no major changes in how we're looking at land. Our underwriting criteria have not changed. We underwrite to current market conditions, and we're still underwriting to a minimum 20% pretax return on inventory and a return of our initial cash investment in 2 years. So those criteria have not changed and no significant changes in what we're looking at from a parcel standpoint.

Got you. Okay. That's helpful. So maybe zooming into 2021, the closings guide, give or take, it implies, I guess, some level of deceleration as you move through the year. If you think about what you're doing with starts and attempting to at least continue that pace, is there any reason why you would expect to see deceleration as you move through the year? Or I guess the other way to put that would be if demand continues at this pace, would that drive upside to the guide?

Sure. We did move our guidance pretty significantly from November to our call in January. A pretty sizable move in terms of we're in the high 70s and now the low end of our guide is 80,000 to 82,000. That generally is around a 2.1 to 2.2x turn of our houses from the outset of the year until the end of this year. We generally turn our housing inventory at least 2 times a year, but generally, not a whole lot more than the 2.1 to 2.2x that we're already guiding to. That being said, if the market conditions remain this robust and demand is this strong. Could there be a little bit of upside from here? Yes, that's definitely the case. We saw outsized turns in fiscal 2020, which I think we turned our housing inventory about 2.3x. The bigger difference this year as compared to last year is that we had a lot more completed specs in fiscal 2020, going into really when the pandemic first hit, we had almost 5,000 completed specs. Today, that number is well under 2,000. And so as I mentioned earlier, our homes are in much earlier stages of construction. So for us to accelerate that and turn those houses more quickly, isn't as easy as when it's completed specs already sitting there ready to go on the ground. The other thing I would point to, Matt, is we do plan to grow, although we haven't given guidance specifically for fiscal '22, we would plan to grow in fiscal '22 as well. And so a lot of the starts that we'll be doing in the back half of this year are not necessarily for closings in fiscal '21, they're to position us to be in a good position for that further growth in fiscal '22.

Got you. Okay. Very helpful. If we talk about pricing power a little bit, obviously, you're seeing resale prices up mid-teens on a year-over-year basis. Can you speak a little bit about the level of pricing you're seeing at your different price bands and then just sort of how far you're willing to push that while keeping homes affordable?

Sure. So we are very cognizant of maintaining affordability. And as we've talked about multiple times that, that's kind of -- that part of the market is our bread and butter. But that said, it is a very robust housing market right now. So we are taking price. We've got 4% on a per square foot basis price increased this last quarter. But you've also seen our -- size of our homes come down a little bit. That was down 2% this last year to help us maintain that affordability. It's a little easier to push price at the higher price point communities and at our higher-end brands. We might move the needle a little slower at the express or entry-level price points. So we're probably not taking the headline price increases you're seeing, but we are taking price.

And as you hear us say, on repeat, focused on maximizing returns. And so it's always trying to strike that balance of the individual community level of pace versus price.

Okay. Got you. And then just one follow-up to that since it's come up. FHA is about 1/3 of your business, I believe, at least what you disclosed on the mortgage side. Are you coming up against FHA limits in any market? Or is that not really a concern for this year?

I haven't heard much about that yet, and they did recently raise them at the outset of the year, kind of in line with, I guess, at least inflation. So we got a little bit more room on that front if we were starting to approach any of those. But that's not something, by and large, I'm hearing any issues with yet today. The further prices move, the closer we'd be getting to those bands, but they do get reset annually at least.

Got you. Okay. So maybe shifting to the gross margin. You've guided basically similar gross margins in your fiscal 2Q, what's that assume price versus cost?

Sure. It really just assumes more of the same. We've been experiencing relatively low single-digit price per square foot inflation from a revenue or average sales price perspective. And then a little bit more modest cost inflation, but still a low single digit. What we talked to on our conference call in January was, we really have a lot of cost pressures coming at us that we expected to see in the December quarter, and they didn't quite flow through yet, but we do know that they're coming, more so on the material cost side than really anywhere. And that's why we've guided to an essentially flat gross margin in Q2, around 24%, consistent with our first quarter ended December. And it's really hard for us to project a gross margin further out than that because gross margins are so dependent on market conditions. But if the early signs for the spring are right and the market stays this robust, we'd be hopeful that we can maintain a relatively flat, give it slightly up, slightly down gross margin from here. The great thing is at 24%, we've got some room, and we can still generate very strong returns at these levels or even slightly lower than here.

Got you. Okay. And then -- so when you talk about some of the material inflation, presumably, lumber is a big piece of it. Any other materials that would actually sort of move the needle, whether it's cost inflation itself or actually supply issues?

It's more on the cost inflation side. We're not having to pay more because of supply issues, whereas that's usually the case on the labor side, definitely. And we do have to pay more for labor when that's in short demand. On the supply side, it's really just a function -- yes, it's a function of us not being able to keep our costs flat like we have really almost this entire cycle. I mean if you think about it, Matt, you haven't heard us talk about material cost inflation outside of commodities and lumber really for quite some time. Our national accounts team and our purchasing teams across the country have done a great job keeping those costs in check as we've leveraged our volume and continue to grow. But the market has inflated. Home prices have risen. And so our building products partners are pushing through price increases this year. We're not as normal because of our size and our scale, taking the headline price you'd see being talked about from those other public building product companies. But we are taking some level of price increase. So when we talk about knowing there's cost pressures coming, it's really as a result of accepting some of those price increases.

Got you. Okay. And then you look at the market today. And over these past few weeks, you've seen tenure start to creep higher. Perhaps mortgage rates have not really moved to that degree. But clearly, there's a bit of a narrative or a worry that interest rates could continue to move in one direction at this point. And so with that in mind, are you guys actually thinking about, hey, what happens if interest rates do move higher quicker here? And is that kind of manifesting into how your own pricing? Or just what are your thoughts on kind of your positioning if interest rates were to rise?

Yes. To second Bethany's earlier comments, we're very focused on affordability. And so interest rates clearly play a huge role in that. And so we'll keep an eye on them. We don't necessarily have a company-wide outlook on what we think rates are going to do. But I'd say late calendar '18 was a very good reminder of how quickly the market can change based on changes in interest rates. And so we did see a lull in demand when rates went up essentially 100 basis points over a 30-day period. What we did then was put some incentives into the market to keep our absorptions up, but we also started adjusting the features that were on our home and working on our cost structure. And we can do that relatively quickly, along with adjusting our starts to smaller homes, as I believe, Bethany already touched on in terms of our average square footage coming down. Because typically, an entry level, first-time buyer, they're not buying because of an absolute interest rate. They're not trying to time the market based on an interest rate. They're looking at what's my monthly rent payment and what's a monthly house payment, which clearly the interest rate factors into. And so if there's a sharp move in that, then they have to reset their expectations on how much house they can afford. But ultimately, they typically still buy a house, they just end up buying a little less house. So I'd say, generally speaking, it's a combination of us building smaller floor plans and working to adjust our cost structure in terms of what goes into the house to maintain affordability regardless of what happens with interest rates. We still prefer our focus on the entry level first 10% move-up buyers. It's the largest pool of the U.S. housing market, generally always. And they're not buying out of discretion. They're typically buying out of need, a life event. They're getting married, having a child, or having a second child and now need that first move-up home. So that is why we prefer that positioning and really think it's less interest-rate-sensitive than the move-up buyer who's a much more discretionary buyer.

Got you. Okay. And then -- so typically, in those environments, you also have incentives as a tool. My question is, and it's certainly not a topic that's -- incentive that is being top of mind today. But where are you guys on incentives today? How much have you been able to actually take out? Or is there still sort of an underlying level of incentives there that if rates do stay low, could actually continue to come down? So just kind of where are you guys on the incentive side today?

Sure. We're at a pretty base level of incentives now. Anything we might have rolled out back in late calendar '18 when rates did rise sharply, we've been able to pull back on most of that. And we do have a couple of incentives in the marketplace that we typically always have, paying a level of closing costs if a buyer utilizes our mortgage company. We've also had some builder forward commitments for buying down interest rates in the marketplace. But generally, they're at a pretty low level right now.

Okay. Understood. So talk about the entry-level business because it's now, I guess, sort of mid- to high 50s just -- of your portfolio, which is not unique to see it increasing as it is with many other builders who've also leaned into it. But that's sort of the question. I guess it's not completely new. You guys were among the first to push harder into this, but now you've seen many others do the same. Now we've got land and labor getting tighter, post-COVID. Has the competitive dynamic finally changed at all on the entry-level side from your perspective on acquiring land and then certainly with the customer side as well?

To some degree, yes, but I would tell you that scale is still our biggest advantage and particularly local scale, especially when it comes to land and seeing land deals and labor and controlling the trade base. So with our scale and our absorptions, our communities are often a little bit larger than some of our competitors. So we might be able to make a different sized land deal pencil. And on top of that, while many builders have come down the price curve, a lot of them are still not quite going head-to-head with our express price points. So you might see a little bit more competition at some of the D.R. Horton-branded product that's a little bit on the higher price, but still more of an entry-level first time buyer, but not necessarily at the express price points.

Yes. And then, Matt, I think the other thing that still doesn't necessarily get -- I think it gets more attention today than it had, but still not -- full-blown attention is on just our cost structure as it pertains to the debt load we carry and our capitalization, what we've done in terms of deleveraging. So the amount of interest we have to cover on a home we start is a huge competitive advantage when you compare us to essentially any other builder out there in terms of what we've done with our balance sheet on that front.

Got it. Okay. That makes sense. We talk about the single-family rental side a little bit. And you've had some tangible results, early results, I guess, from it now. So I guess the longer-term question is, just how do you think about the return profile of that business versus the traditional business? And maybe if you kind of outline the roadmap of going from this merchant build strategy to where you guys eventually see that business getting to.

Sure. I'll start and then see if Jessica wants to add anything at the end. But yes, for single-family rental, we're still kind of in the early start-up phase for that business. And right now, it's fully funded from the DHI balance sheet. But eventually, we will be looking to separately capitalize that business potentially as early as this year, looking at maybe adding debt to it. But we do think there's a large class of Americans that likely may never own a home. And so this is kind of a new asset class all on its own. People still looking for that single-family lifestyle, but maybe can't quite get into their own home. And we have talked about single-family rental and multi-family rental combined. We plan to double our investment in those businesses this year. So in total, we had about $330 million invested in the 2 businesses at our fiscal year-end, so we expect to double that.

Got you. No, that's helpful. It will be interesting to watch how that all evolves. So you guys talk a lot about the balance sheet. Right now, I think you're maintaining close to a $2 billion cash balance. I think Bill has talked about wanting to maintain a sort of higher level of ongoing cash on the balance sheet. Is there any reason why you might not get a little more aggressive with share repurchase here or just some other type of deployment?

Sure. Well, with our expanded size and scale, it does take more cash to run our business day-to-day. So really, it's just along with our conservative nature of what we've done with our balance sheet as a whole to kind of rightsize those cash balances to where we are as a company today in terms of our higher cash spend on home construction, payroll, land and lots, taxes, everything that goes out the door. Shortly after quarter-end, we'll have cycled through a lot of that cash you see. So you're correct. Generally, we have talked about $1 billion. That's still our base case minimum, at least $1 billion of homebuilding cash on the balance sheet at quarter-end. But we have stated that's likely going to be closer to the $1.50 billion to $2 billion range just because of our size and scale today and wanting to be prudent on that front. As it pertains to share repurchase, we did say at the outset of the year after reducing our share count each of the last 2 years by 2% in fiscal '19 and by 1% in fiscal '20, even with the halt in share repurchase at the early stages of COVID last year that we've now started buying shares back again. We're going to keep our outstanding share count flat or we've committed to at least flat in fiscal 2021. And it's really as a result of the very attractive returns that we see in our core homebuilding business right now. And just like our cash balances, we need to build our housing inventory and our land and lot inventory up to this new level of scale, so we can continue to deliver on our growth targets and grow beyond fiscal 2021. That being said, the keeping our outstanding share count flat, as you know, we definitely want to do what we say we're going to do from a guidance perspective. And so I would tell you that was our base case at the outset of the year because we wanted to have the flexibility to reinvest in the business as necessary. But that doesn't preclude us from potentially doing more than that, and we clearly take into account our stock valuation and what's happening in our share price as we move throughout the year as well.

Got you. And then with a minute to go here, I wanted to touch on communities because one of the many things that differentiate Horton is sort of having this large pipeline. And I think one of the few things that investors have been able to bifurcate in homebuilders today in such a strong housing environment is kind of who has the communities and who's got a little bit more of a gap. And it seems to be manifesting in how investors are valuing businesses today. So without looking for 2022 guidance, is there any reason to suspect that you wouldn't be able to maintain this very consistent level of communities that you guys have had for a couple of years and you're talking to in 2021?

Yes. I think with our lot position, that's where it all starts. So I think that's very reasonable. We should be able to continue to drive further absorptions as our communities have gotten a little bit larger, but a little bit of community count on the lot or on the communities count that you're talking about that we're starting from goes a long way in terms of helping us grow. So it's nearly impossible to predict quarter-to-quarter because there are so many moving pieces in terms of when you sellout of a community versus when you're able to bring a new community online. But I think our base case would be with how our lot position has grown, is that our community count would continue to grow on an annual basis, at least at low single-digit percentage. There could be some choppiness to that quarter-to-quarter.

Got it. Okay. Well, that math makes sense. So I think with that, we're right at time. Jessica, Bethany, much appreciated, as always. And all my best to Bill, hope he's okay. And we'll wrap it up there.

Great. Thank you very much.

Thanks.

Thanks, everyone, for your time.