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

Good afternoon, everyone. Matt Bouley, Barclays U.S. homebuilding and building products analyst. Very happy to continue the afternoon here with the team from D.R. Horton. We've got Jessica Hansen, VP of IR; and Michael Murray, Co-COO of D.R. Horton. So we're going to begin in a second. But as always, we're going to run through our ARS question first and good stuff. So if you wouldn't mind starting with our first question for the audience, which you can answer on your clickers. Number one, do you currently own DR Horton? Overweight, market weight, underweight, or no? So we've got an audience of new investors. A lot of opportunity. Here we go. Next question please. Anyone blank, yes or no. Team, the question is blank. If this doesn't work, we'll go right into it. General bias towards D.R. Horton right now, positive, negative or neutral? Generally bias positive, although I had that wrong, bias negative. Excuse me. I thought neutral was in the middle. Next question, please. Through cycle EPS growth for D.R. Horton will be above, in line with, or below peers? The audience sees above or in line with. Next question, please. What should D.R. Horton do with excess cash, bolt-ons, larger M&A, share repo, dividends, debt paydown or internal investment? Okay. It's share repo. Okay. Loud and clear. Next question. What multiple of '23 earnings should Horton trade ranging from less than 10 to higher than 21? The question wasn't for homebuilders.

Not homebuilders today. Maybe a few years from now.

20 years ago. Of course. Well, so generally 15 or less. Next question. Most significant headwind facing Horton today, core growth, margins, capital deployment or execution/strategy?

I'd probably take a bet on that one too.

What's your answer? Don't answer. Growth right now.

I would have bet wrong.

I would have thought 2 also. Next question, please. And does ESG play a role in your decision regarding Horton? Yes, positive; yes, negative; no; or no but will in the future.

We did publish our inaugural report if anyone's interested and hasn't seen it. It's out on our investor site.

So we have opportunity for people to use that.

Okay. So Michael, Jessica, thank you both for being here. Much appreciated. So kind of starting with the elephant in the room around demand. I mean, there's clearly been some optimism on the early year for new home construction. You guys kind of kicked that off with your earnings results in late January there. So just kind of curious if you can kind of update us how you're thinking about this -- the way this market is evolving here in light of what we've been seeing with interest rates here today.

Well, so far, we like the way the year is unfolding. We mentioned in January, we like the first few weeks of the year sales trend, and that's continued. We've seen a moderation of the cancellations. So our net sales have been really good, kind of in line or a little better seasonal uptick we normally see from the December quarter in the spring. So by and large, we're positively biased on where spring is. Obviously, all that's occurred part of the past 5 days of interest rate movements. But so there may be a little bit of a headwind with that going forward, but we feel much worse movements in the past.

So I think your prior guide was for -- I mean, well, your normal seasonality for Q2 is a 50% sequential uptick in orders and so effectively tracking in line with or a little better than that. Okay. So I mean, obviously, things have changed in the past week, right? We've repriced monetary policy expectations. Talk about cancellations perhaps getting better at the end of last year. Do you think we're past the peak in cancellations or when you see a kind of a quick move in rates like this with your type of buyer and your type of product, is the expectation that, hey, look, we could see kind of a resurgence or if rates continue at this level?

I think we've been able to compress our build times a little bit on more recent starts, and we're seeing a shorter time window from when we sell a home with the spec inventory we have today to when we close it. So there's less opportunity for fallout. Buyers are much more interested in buying health can lock into an interest rate within the next 60 to 90 days. And so that interest rate volatility really isn't affecting our backlog today.

That's helpful. And so when you talk about this seasonal uptick in demand, it sort of begs the question on what's happening with incentives and home prices and all that, right? I mean some of your peers have spoken about a reduction in incentives year-to-date. So how are you guys thinking about just your own products and pricing and incentives with the CECL uptick?

We're going to continue to meet the market. So we're not in control of how the next few months unfold and what happens in the interest rate environment. So we're going to do what we need to do and our local operators are empowered to on a community-by-community basis and make the best decision to maximize returns on the inventory that they're carrying in that community. So although we'd like to believe that maybe this quarter could be our low point for gross margin. I know another builder or maybe 2 have talked about that as being the case. We generally sell and close intra-quarter 35% to 40% of our homes. So we don't have visibility to do that until we get into the quarter. So we have guided a step down in our gross margin of 20% to 21% for Q2, which would be down from 23.9% that we had in the December quarter. Could that be a low? It could be, but it also may not be depending on how the spring continues to unfold and the interest rate environment we find ourselves in.

Got it. And so when you talk about how this year has started, not to be too short term, but in terms of this uptick in activity, a simple question is, was it as simple as rates coming down that drove that? Or the turning of the calendar? What do you think has kind of led to this bit of...

Any reduction in rates is going to be helpful. I think the best thing was stability in rates that we saw and gave buyers a chance to recalibrate their expectations and have some confidence when they went to the market to determine how they're going to solve their housing need. And certainly, we've seen it in the past few years that over Christmas time, I think people do a lot of online shopping and looking at houses. And then by the time January gets there, they go in the models and they're ready to sign the contract. They've eliminated the choices and they're ready to be sold and they want to get into a house this year.

And so back to my incentive question. Heard you loud and clear on sort of what you've been doing. I mean, what do you think it would take to actually see that reduction in incentives? Is it just -- is it true kind of stabilization in rates? Do you really need to see -- is it as simple as that? Or is it just kind of looking at the rate environment? Or to what degree does it have to do with your own inventory position, right? And just your own kind of need to clear out some of the -- some of what you have under construction?

Well, the great news is we have a lot of inventory ready for delivery right at the time of the year when people are coming into models wanting to buy. And so we're really excited about that. We were very rapid in the fall to try to find the market and understand what it takes to drive interest traffic and qualification for buyers to be able to buy homes as we started rebuilding momentum. And that we're able to pull back a little bit on the incentive levels and try to lock in the buyers with some momentum on pricing as well.

And so you've got some builders, some of your peers that have -- obviously, people have enacted different strategies around pricing in these past few months. And I think with the general expectations/hope that if the demand is there in the spring, we can do this or that with price. But if we take the assumption that some builders may get more aggressive on pricing into the spring, what are you guys seeing, number 1? Are you seeing any of that kind of competition on the ground emerging? And number 2, kind of how do you react to what some peers may be doing?

So I think builders by and large, have been really rational this cycle. And really what we continue to see is there's not an excess supply out there and that we feel like we're the best positioned with our completed spec inventory. Because as Mike was alluding to, the buyer that's in the market today, wants a home and they want a home quickly and they want that certainty of interest rate. And so if there are builders that are out trying to go do things aggressively with price, particularly on the build-to-order side, I don't know that it makes much of a difference because we don't see buyers in the market today that really want to wait 6, 7, 8 months when they don't know what that rate will look like when the home's ultimately completed. So I think we continue to believe we're in a very strong competitive position in that regard. But by and large, we haven't seen anything irrational transpiring. I think builders are in much better shape this cycle for numerous reasons.

Well, there's not excess lot supply anywhere either. Nobody is sitting on a big lot bank anywhere or even entitled while it's not developed yet. Still a constraint on supply to the marketplace.

And so just given the constraints on affordability for your own products I'm curious maybe by brands, legacy Horton, Express, all that. So what are you doing besides just price incentives to kind of manage affordability? Are you finding that people are receptive to smaller square footage offerings and things like that? Or just what might you be doing to actually drive a little bit of demand?

The leverage are going to be to start back houses that are a little bit smaller, maybe a 4-bedroom but a smaller 4-bedroom rather than replacing it with 1,800 square feet. We go with 1,700 and make some improvements on the margin, considering de-specifications in the various homes. But product size is the most immediate lever. Longer term, shifting to smaller lots helps with some of the development costs and reducing the land impact per house and more attached product. People are going to more townhouse as entry-level buyers.

And so thinking about your inventory positioning and what you're doing with spec into the spring and starts, frankly, D.R. Horton big cruise ship, right? You've got to manage down at the local level. So I'm going to ask it across the whole business. But you see potential improvement in demand to begin this year. Are you continuing to match starts with sales? Do you actually hit the gas pedal a little bit more on starts? Kind of what's your thinking generally around where you want to be inventory-wise here?

Generally, we're going to look at every community differently. And every one of our division operators, as you said, it's decentralized. It's going to make a decision based upon their lot supply in a given project or submarket, the production capacity of that area and then what they believe the demand makes the most sense of that. And whatever the limiter is, is going to determine what the start space is. So right now, if over the fall, we saw a lot of cancellations, sales may have been a broad limiter. As that's changed a bit, and we've seen stronger sales demands, that limiter may back off a little bit and we'll be pressing into what production capacity is. And then where the lot supply is so we don't cap ourselves. So it's kind of a week-to-week process that's managed locally, but everybody has a plan and they're working to execute it every day.

And so as you mentioned, what's going on with lots and lack of finished lots out there. As builder orders have come down, and typically, you might see some reaction in the land market, how are you guys seeing that land market evolve here and what's happening with both kind of finished and unfinished lot prices?

The land prices continue to be very sticky. That's generally always the case. They tend to follow home prices up very quickly. But then as home prices adjust, it takes a little bit longer for the land market to truly adjust. And I think it goes back to what Mike was saying earlier. There's just not an excess supply of finished lots out there. So right now, there's really not a need for broad-based reductions in finished lot cost. We are being very selective, particularly on the raw land front right now as we go through this market transition. So we've cut back on our raw land purchases significantly from where they've been over the last couple of years. But we're going to continue to buy finished lots where we always get the ability to re-underwrite. Once we have something under control before we bring it on our balance sheet, we're going to look at it again in today's market conditions. What do we think we can sell the house for? What's it going to cost us to build? And does this still make sense? If it doesn't, we go back to the land developer and have a conversation about either changing the takedown schedule or doing something from a cost perspective. I would say the easiest adjustment to get is just on the takedowns. If we don't need as many lots as quickly as we ultimately did. Generally, that's a pretty easy concession to get from the developer. If D.R. Horton is not going to be able to follow through on a transaction and make it pencil, there's generally not that many other builders standing in line behind us that can. So that does put us in a strong position. And we look at our lot developers as partners and people that we need to run a capital-efficient long-term business. So we'll continue to adjust our pipeline as necessary, and we have walk deals that haven't made sense. But by and large, we've kept most of our portfolio intact.

And then so back to the gross margin side, I know you guys don't quantify incentives the way others do. But curious if you can kind of just ballpark between what we've seen with order ASPs and kind of what type of pressure might you be seeing on the gross margin side at this point relative to where might you be seeing some relief on lumber and other construction costs?

We're certainly seeing pressure on margins through the incentives. Both the biggest incentive we've gone with is generally been interest rate buydowns, trying to hit the affordability on the payment side. We've also adjusted price in some markets where we needed to bring it back in line and drive traffic to get people to focus on the communities. Where we're seeing cost relief, certainly lumber is cost relief. It just takes a while for those reliefs to come through inventory, especially with our elongated build type that we experienced last year. So those lower lumber prices have yet to really materialize in a meaningful way in our deliveries.

And so on that incentive side in terms of elasticity between rate buydowns and drawing that to base price reduction. What do you find with your buyer is actually driving elasticity? Where are you actually seeing results?

Probably more the rate buydown more than anything else. It's driving into that payment that makes sense for somebody. They're not able to conceptualize what the home price really is. How do you make it tangible to them? And that's in the form of the payment. And that's what they qualify for. That's part of their budget every month. That's what they're paying in rent today. How do they work around that number. And so that's been the biggest incentive we've utilized.

And then so what are you seeing on the cycle time side year-to-date? And starting to see any improvement yet or is it still sticky?

We're seeing some improvement on more recent starts, but things that -- the homes that we're delivering today were started 8, 9 months ago. And so we're still seeing long average time from start to close. We need to get that back to 180 days and we need to turn our housing inventory twice a year. And that's the focus this year, pulling back starts, trying to get the production machine unsnarled and then moving through in a more consistent fashion.

So if cycle times do come down, what's kind of the implication to your sales pace strategy? Is it the kind of thing where you kind of let pace run a little hot for a period? Or is it the type of thing where you still want to really manage your sales?

It's going to be that balance I talked about before. The 3 limiters. Driving for the best return, as Jessica mentioned, in a given community. So if we can take more pace without sacrificing margin and we can drive a better return, we'll certainly try to do that. If it becomes a production issue, that becomes a gating factor. We're going to adjust to make sure that that's not going to become another rat in a snake. We don't want to live through that. It's frustrating for us, frustrating for our customers and our trades for sure.

But if our build time has improved and we have certainty of that and believe that it's sustainable, I think the answer is somewhere in the middle, that yes, we'd feel more comfortable releasing more homes for sale. Whereas if you go back over the last year, 1.5 years, we had a lot of restrictions in place because we didn't have that certainty of our construction cycle.

And so as you mentioned, we don't want to get too far ahead of ourselves, talking about gross margins and you guys purposely speak to what your visibility is, right? So think about just historically and structurally, margins kind of ran around that 20% level, and you guys were -- the strategy, at least from my perspective, was a lot of volume through -- running it through a 20% gross margin. And so how do you think about where the margin may settle? Where do you feel like the structural profitability of this business may be coming out of this housing.

Historically, that 20% margin, 10% overhead, 10% pretax margin. I think we have an opportunity to demonstrate a higher pretax margin than the 10% going forward. As we see our various operations in different markets where we've retained adequate market scale or even significant share, we're able to drive a higher efficiency, a better op margin in each one of those. So as we continue to aggregate market share across the platform, I expect that we'll see a sustained higher operating margin than the 10%. I mean we just did 20% at 1 quarter last year. We're probably not going to do that going forward on a regular basis, but I do think higher [indiscernible] should be where we start thinking about the operating margin.

So I'm not going to try to lead too much with this question. But your starting point was a 30% gross margin. Rates moved very quickly. You had a lot of inventory under production. You can imagine why pricing and incentives needs to move quickly in that type of scenario. So here we are today. You're getting closer to the 20%. At what point do you feel like you kind of -- you want to limit that margin decline, right? Is there a point where high teens, something like that? Is there kind of a bar where you say, okay, that's it. We're not going to continue to just press hard on pricing and incentives. How do you think about that?

It's still going to be dependent community by community. Because if it's a high-velocity community with low overhead, we might be very comfortable running at a mid- to high teens gross margin versus 20%. If it's a slower absorption community, that's where to generate an acceptable return, we need to garner a little bit better gross margin. So we don't ever sit in Texas at our corporate office and say we're going to stop selling houses because our average gross margin has gone to x. We continue to maximize returns. And the way we do that is compensating our division presidents and our region presidents based on the pretax profits they generate and the return on inventory for whatever inventory investment we've allocated to them. And then really, the gross margin falls out to whatever it falls out to based on their cumulative activity at the local level to maximize returns.

That's helpful. So if I zoom into the very near term, and I think your Q2 would guide something like a 300 basis point sequential decline in gross margins, I mean, what are the puts and takes on that? Is that just entirely price incentives or lands?

It's primarily driven on price incentives. And what we felt we had visibility to in December. But as Jessica mentioned, 35% to 40% of our deliveries in a given quarter are sold in that quarter. So we only know roughly 60% of our deliveries, what price and incentive structures in those. But based on where sales trends have been, that's been an encouraging sign. And that does translate through ultimately to margin and pricing and incentive levels.

Understood. And so as we get to your next quarter at the end of April when you report, obviously, you guys have kind of given a soft guide, in my words, in terms of the full year. As you kind of have that visibility to the spring selling season, what do you think it will take for you guys to feel more comfortable about providing that full set of guidance you typically would?

Yes. That's a hard one. Bill and I have lengthy conversations every quarter on what we need to say from a guidance perspective. And I'd tell you visibility and our confidence in the visibility because it's one thing to miss Street consensus. It's another thing for us to miss our own internal guidance that we've chosen to provide publicly. So we'll just have to be more confident in the range of our outcomes. And really, I think the reason we haven't given much in the way of the annual guidance to date is there's such a wide range. At some point, a wide range isn't worth anything and it may cause more confusion versus less. So we'll [indiscernible] get to April [indiscernible] bracketing maybe revenues and closings. But I wouldn't say we're sitting here today saying we can for sure do that yet.

Next 3 months are pretty important.

Absolutely. Understood, yes. But slight positives to down mid-teens, yes. Understood. With a few minutes to go, I want to check with our large audience to see if anyone has a question from Michael or Jessica. Okay. I will continue. So the rental business, you continue to scale that up pretty meaningfully. I ask this question every year, and it gets bigger every year. So what's your kind of take today on -- as you've now spent a lot of time doing a lot of work on understanding this market and where you guys want to be positioned in that? How meaningful of a business can both the multifamily and single-family rental businesses be?

Right now, it's grown well. We really like the positioning we have. We have a little over 8,000 homes in various stages of construction through completion and purpose-built rental only communities. And we're seeing really good demand on the investor group and the capital pools that are looking for the exposure to U.S. residential real estate that can be managed in a way that's as efficient as an apartment complex from a management perspective. So we really like the way we see that. We're now working our way through the capitalization of that business. The team did a great job putting a $1 billion revolving credit facility in place, unlike anything in the rental development business out there. And so we feel like that's a first step in the process, and now we're going to continue to look at how that business is capitalized and where it grows to. Ultimately, I don't know where it's going to top out at. I do think the rate of growth is going to be decelerating as we've gotten to more of a critical scale and projects working in almost all of our markets. So that we're not looking to expand the footprint as much. It's just going to be replacing it. And so the need for additional capital will be decelerating.

And we've been working towards getting incremental disclosures towards that business. The Street can start to model it more on a unit basis like our for sale side of the business because we're not quite there yet from a scale perspective, but we do expect our rental platform to be a very consistent and strong generator in both revenues and profit. Eventually on a pretty consistent quarter-to-quarter-to-quarter basis, so you can actually give us credit for that earnings stream. I think you could argue that nobody in the industry has maybe gotten paid for to date, what they've done on the single-family for rent side of the platform. So we want to make sure we keep giving the disclosure and as much guidance as we can on that front, so you can see that consistent earnings stream that's coming.

So just given what we've seen on the home buyer side in the first 6 or 7 weeks of the year, have you seen any trends in terms of that institutional demand changing? Or is that just a much more of a kind of a slower moving ship of demand?

January, February is a better time than December. Nobody is focused on the institutional side in December doing anything. Seeing some good interest right now, very encouraged by that.

So I think on the share repurchase side, the guide is for a similar dollar volume, if I'm wrong. Your net debt to cap is at all-time lows. Cycle [indiscernible] come down a little, maybe you get a little whiff off the balance sheet. I don't think you gave a guide on land spend for the year, but presumably, it's lower. Net income is lower too. So before I talk myself into circles here. Where do you want to be from a net debt to capital perspective? And in light of that, what type of share repurchase do you think you can do?

Very low leverage is something that we've been focused on for a while. We are attaining that. We had $700 million maturing this year. We paid off, was it $300 million last week, with $400 million to go in the summer time. And what's left in our debt stack. We have nothing next year. But everything has got a one handle on the coupon rate. So it's really hard to think about refinancing any of that $700 million with where the rates would be today. So at some point, I would expect that we would not be opposed to putting a little more debt back on. But by and large, we like the low leverage ratio. We like the flexibility it affords. And in terms of committing to a share repurchase number, if we are able to do some other things, then perhaps that would be the best use of that additional cash. But we're going to commit to what we feel like we can really do within our control of the business before we go any further.

Got it. And so kind of higher level on the customer segment side. You guys have a pretty diverse exposure between entry level and sort of the first move up. What are you seeing either through the second half of last year or even into sort of year-to-date in terms of just buyer segments? And where do you think the sort of greatest depth of demand is amongst your exposures?

Yes. I think we've been really pleased with our commentary about January and now updating through today has really been that it has been broad-based improvement across our product portfolio and really across our geographies. So that's a really big positive. But if you look at and slice and dice however you want the price points out there in new existing homes month supply, it's still generally the lowest at the most affordable price point. And so I think over the long term, we still very much believe in having the lion's share of our business be for that entry-level first-time move-up buyer because the lower the price point we can deliver houses at, the bigger the piece of the overall market that we can continue to aggregate and consolidate. And so that's going to continue to be our focus.

I think with that we ran through our 30 minutes very quickly. So Jessica Hansen, Michael Murray, thank you for being here.

Thank you.

Thank you.