Forestar Group Inc. (FOR) Earnings Call Transcript & Summary

Good afternoon. Welcome to the afternoon portion of our second day of our 13th Annual JPMorgan Homebuilding and Building Products Conference. My name is Mike Rehaut. I'm the senior analyst of the homebuilding and building products franchise here at JPMorgan. Thank you for your patience. A couple of minutes late after quarter past 2. A couple of technical difficulties on my end, but we're all set. We're thrilled to have with us Forestar, a kind of an emerging company that we cover, reinvented over the last couple of years through its majority ownership by D.R. Horton, and rapidly emerging as a leader in the finished lot production business. With us, we have Daniel Bartok, CEO; Jim Allen, CFO; and Treasurer, Collin Dawson. As with our prior sessions, this will be about a 35-minute session. Forestar has some slides to walk through, some prepared remarks. I'll have some questions and we can also field questions from our virtual audience. If you click on the Ask A Question feature, I'll see that and relay those questions as well to management. So without any further ado, I'll turn it over to Forestar.

Thank you, Mike, and thanks to everyone who's attending. I believe you all have a copy of the presentation, and we will try to refer to various slides as we discuss them. A copy will be available on Forestar's website after the call. But before we get started, I would like to refer you to Page 2 of the presentation which discusses forward-looking statements. I believe we'll be making a few of those today. Please take a look at this -- these disclaimers and read it at your leisure. Let me turn to Page 3, which provides an overview of Forestar. Forestar is a national residential lot developer. We are active in 50 markets across 21 states, control over 52,000 lots. We have a strategic relationship with D.R. Horton, America's largest builder, and we are well positioned to take advantage of the opportunity that exists in the industry. I'll turn to Slide 4. Economic fundamentals in the housing and residential lot development markets remained solid throughout most of the second quarter. However, during the second half of March, and to date, the COVID-19 pandemic has impacted our business operations and the demand for our residential lots. Our homebuilder customers had informed us of their desire to slow the purchase of lots during the current market uncertainty in order to adjust their inventory levels to the level of home sales orders. In almost all municipalities across the U.S. where social distancing and other restrictions have been issued, residential construction had been designated an essential business. We have continued our lot development operations in those markets where allowed in order to supply homebuilders with finished lots. We're focused on maintaining the health and safety of our employees, customers and trade partners that made appropriate adjustments to comply with social distancing and other health and safety standards. We believe that we are well positioned to operate in this uncertain environment because of our low net leverage, our strong liquidity position, our low overhead model and our relationship with D.R. Horton. We're prepared to quickly respond to demand for residential lots, both during and after this pandemic. Turn to Slide 5, please. Unlike other land developers, we bring a production-oriented returns-focused mindset to the land development process. We are focused on short-duration, fully entitled residential lot development. We typically have a signed lot purchase agreement with a known buyer prior to making any significant new investment. We consider ourselves a lot manufacturer and follow a rigorous process to develop our projects in a phased manner. Our approach to land development is lower risk than other public land developers and will produce more consistent cash flow and returns as we achieve scale. We are in a strong liquidity position with low net leverage. Forestar also has a unique and strategic relationship with D.R. Horton, the nation's largest homebuilder. Our relationship with D.R. Horton derisks the expansion of our operating platform and allows us to have a footprint that is more geographically diverse than most public homebuilders. D.R. Horton has an immense appetite for finished lots that will continue even during a market downturn. During the worst years of the last significant housing downturn, D.R. Horton still closed between 17,000 to 20,000 homes annually, the majority of which were built on finished lots purchased from third parties. We expect to leverage the strategic relationship and our strong capital position to significantly increase our share of the residential lot sales markets both during and after this pandemic. Turning to Page -- Slide 6. We currently have over 150 active projects and are actively evaluating many potential investments. Each project begins with identifying an opportunity. This can be done by Forestar's team, by D.R. Horton's team or by other builders. Once an investment opportunity is placed under the contract, the due diligence process continues, finalizing entitlements and engineering, obtaining a thorough understanding of the market and the development costs as well as obtaining permits to ensure that the project can commence. Once all entitlements are assured, the acquisition of the property takes place and the development of the first phase of lots commences. It typically takes about 1 year from the time of land acquisition to the delivery of the first lots. Subsequent phases are planned and timed to deliver lots in accordance with planned sales pace and are adjusted slower or faster to meet demand. Jim?

Forestar's lot manufacturing business model is differentiated from that of a typical land developer. It is designed to achieve scale and consistency, to minimize risk and to be better positioned to anticipate and adjust to fluctuations in the housing market and economic cycles. Unlike other land developers, Forestar brings a production-oriented, returns-focused mindset to the land development process. At scale, we expect Forestar's operating model to produce financial results and returns that are similar to or better than most mid-cap homebuilders. At the heart of Forestar's unique operating model are certain critical strategies that also represent crucial points of differentiation. We focus on short duration, fully entitled lot development projects as opposed to long-term, complex or unentitled real estate projects. We undertake phased development projects with a known buyer as opposed to speculative land investments with an undefined buyer. We have a returns-focused, lower-risk inventory model that emphasizes velocity, market-level risk diversification and strict underwriting standards. We have a national footprint and in-market depth that allows us to achieve both scalable efficiencies and portfolio diversification compared to smaller, more geographically limited competitors. We have a strong liquidity and access to debt and equity capital to support our growth plans. In summary, we have an understandable growth-oriented business model that is focused on producing consistent operating results at scale. Dan?

Slide 8 summarizes the strong and symbiotic relationship between Forestar and D.R. Horton. Forestar benefits from a strong demand for finished lots, but also from access to the experienced management team, which has enhanced our ability to build a national platform which reduce risk. In addition to improved access to the capital markets, the shared services provide numerous benefits for Forestar to operate efficiently with the benefits of a larger company. Collin?

As the nation's largest homebuilder by volume, D.R. Horton has tremendous demand for finished lots. D.R. Horton is committed to owning no more than a 2- to 3-year supply of owned lots, and therefore, a key operational strategy of the company is to supplement our land pipeline through lot purchase agreements with land developers. Consistent with this long-term strategy, D.R. Horton has developed strong relationships with many land developers across the country and has grown the option portion of our land and lot portfolio to enhance our operational efficiency and returns. The strategic alignment with Forestar provides D.R. Horton a unique platform to accelerate this strategy. Most land developers lack the scale and access to capital to consistently supply D.R. Horton with a meaningful number of lots across our national footprint. Through its strategic alignment with D.R. Horton, Forestar has become a national, well-capitalized and geographically diverse lot developer with the ability to programmatically deliver D.R. Horton's finished lots across the majority of our markets. Turning to Slide 9. This slide shows a chart of D.R. Horton's market share gains since the early 1990s. During this time frame, D.R. Horton has demonstrated consistent market share gains throughout a variety of broader housing market conditions. As we have mentioned, the land development industry is highly fragmented and consists of many local, privately held companies, the majority of which are undercapitalized and lack scale. Given the strategic alignment with D.R. Horton, we believe Forestar has an opportunity to consolidate market share in the lot development industry, much like D.R. Horton has consolidated market share in the homebuilding industry over the last several decades. Jim?

The growth trajectory reflected on Slide 10, showing lot deliveries and revenue from 2018 through the first half of fiscal 2020 reflects the execution of an aggressive plan to scale the business. As illustrated, both lot deliveries and revenues were higher through the first half of fiscal 2020 and for all of fiscal 2019, indicating that prior to COVID-19, Forestar was well on the way to achieving its previously announced guidance for fiscal 2020. However, due to the significant uncertainties related to COVID-19, as previously announced, Forestar has withdrawn its lot delivery and revenue guidance for fiscal 2020 and 2021.

Slide 11 illustrates the land and development investments we've made over the past 5 quarters. Our focus on liquidity and maintaining a strong balance sheet is easily seen when you look at the significant reduction in land investment in March. At the first sign of market uncertainty, we immediately restricted land purchases and have been scrutinizing all development projects, looking for opportunities to subphase projects and negotiate reductions in development costs. Slide 12 illustrates our diversified footprint. We own and control over 52,000 lots and a number within each state as shown on the map, along with our current markets and our division office locations. We target owning a 3- to 4-year supply of lots. Turning to Page 13. We are focused on the entry-level segment of the housing industry. Our average lot price for the trailing 12 months ended March 31 was $85,500. And which equates roughly to a $300,000 home. There's compelling demand for entry-level housing and a lack of adequate supply at the affordable price points. Collin?

Forestar's focus on the entry-level segment aligns with D.R. Horton's product positioning. While we offer homes at price -- at all price points, entry-level and first-time buyers represent the majority of our home closings. On a trailing 12-month basis, 2/3 of our homes closed at an average selling price of less than $300,000. Jim (sic) [ Dan ]?

Slide 14. The homebuilding industry and D.R. Horton, in particular, has been shifting their strategy to purchase more developed lots and develop less lots themselves. Slide 14 illustrates this trend in this strategy. We believe the current market uncertainty will increase the appetite of builders to purchase more of lots finished, and we believe that Forestar is uniquely positioned to benefit from this and build market share. Slide 15 summarizes the executive team of Forestar, with the significant experience we all have had in navigating market cycles. Jim?

As of March 31, 2020, Forestar had approximately $790 million of total liquidity, comprised of a $380 million unsecured revolving credit facility and $438 million of unrestricted cash. The $438 million of unrestricted cash reflects the well-timed issuance in February 2020 of $300 million 5% senior notes due in 2028. There are no current debt maturities. $350 million of 8% senior notes are due in 2024 and $300 million of 5% senior notes are due in 2028. At March 31, 2020, stockholders' equity was $836 million, and net debt to total capital was 19.5%. Forestar's disciplined financial policies are core to its lot manufacturing business model and begin with strict investment underwriting. Fundamental underwriting requirements include at least 15% return on inventory and a minimum 36-month cash recovery of Phase I investment. Broader elements of Forestar's financial policy include maximum net debt-to-capital of 40%, strong liquidity and a balanced capital financing plan that includes both debt and equity.

Turning to Slide 17. I would like to summarize Forestar's strong position. We have a unique lot manufacturing business model, very different from a typical developer. We have a strategic relationship with D.R. Horton, the nation's largest builder. We benefit from industry tailwinds, emphasizing a land light model by builders. We are geographically diversified with a significant control of land and lot. We are focused on the entry-level segment. We have an experienced management team that can navigate market cycles. We have a strong balance sheet and liquidity position, and we are profitable at our current operating levels. In closing, Forestar is extremely well-positioned and prepared to operate through this uncertain environment as we look for opportunities to build market share. Mike, I'll turn it back to you.

Great. Thanks, Dan, and thanks as well, Jim and Collin. As I said, I'll ask a few questions to the group. We have about 15 minutes remaining on the session. And again, for those listening, happy to field questions virtually and pass them along to the management team as well. So first off, we've been fortunate enough yesterday and today to get some updates from builders as kind of trends so far in May. Many of them have kind of talked to continued improvement in order trends that the builders have seen, not only back half of April versus first half, but even continuing into May. So my question is, how has that trend affected your conversations with your customers? And obviously, your primary customer being D.R. Horton, how have these trends impacted your own views around the second quarter? And if you could give us any sense or any statistics relating to how your quarter is progressing from a lot delivery or other types of transactions that you track to give us a sense of demand.

So it's still pretty early to give any real thoughts on how the quarter is going to turn out. But what I can say is, in March, everybody pretty much had that knee-jerk reaction, and they immediately wanted to stop buying lots and understand what the inventory position was in each project. And we really dove into every project, trying to understand what continued sales pace there was, how many spec homes were in that market, how many finished lots the builder already own versus our position, to really understand what we thought might be reasonable projections for future lot deliveries. And then we started really dialing into the projects that had what we thought was sufficient inventory to see where we might be able to slow up development or even sub phase development that delivered less lots than was originally anticipated. So as we work through that process, we continue to very regularly monitor the sales in each of the subdivisions. And you're right. I mean I think sales have been performing better than what was anticipated 4, 5 weeks ago. And our focus has now been on really making sure that there are lots in front of the builder. I'd say we haven't -- although we plan for a lot of slow up in development, we didn't execute a lot of that, but we're able to obtain some pricing reductions. At least at this point, it still kind of changes from week to week. As far as our lot deliveries, they're improving, but I think it was still a matter of the builders wanting to rightsize their lot inventories as the sales pace. So I think there was a little bit of a -- there's going to be a little bit of a lag of their improved sales as to ours, and -- but we're pretty optimistic with how things are looking.

Okay. That's good to hear. Along those lines with the -- it's kind of worked itself through the chain in terms of the homebuilders kind of pausing, or first consumers causing along with homebuilders, homebuilders pausing their activities and you've halted some of your activities as well in terms of what you're putting through your own channel and in terms of also perhaps what you're doing outside in the broader land market. From a pricing perspective, I was curious if you could kind of give us sense, has there been any movement in terms of the average selling price of lots relative to your selling out to D.R. Horton and perhaps other customers as well? Has there been any renegotiation on those strike prices for those lots? And similarly, on the back end of your business, has there been any renegotiation or price movement as it relates to your own acquisition of lots, be it option exercises or outright purchases?

Okay. First, I'll chat a little bit about what's happened at the builder level. As everybody wanted to slow up their takes or at least their take commitments, we did enter into some negotiations, which changed some terms, primarily on the speed or the velocity of delivery. But I could say that we -- not in any circumstance had we negotiated any reduction in the agreed upon prices of lots. I think pricing held, although there was an expectation that deliveries would slow. So we felt really good about that piece of the equation. As it relates to land acquisition, we slowed our acquisition considerably over what was planned for the rest of March and into April, but none of that was -- did require us walking away from contracts. And almost, I'd say, in every case, the sellers were willing to give us time, add time to the due diligence period, add time to the closing time frames that was set out originally and really allowed the market to kind of settle out. So we -- although we had a lot in our inventory and we slowed up our acquisition, there was still -- our pipeline is still intact. So we feel really good about that. As far as price reductions, I can't say that we really obtained any price reductions on existing contracts. We did get price cost reductions from our underlying contractors developing lots. They wanted to keep their crews busy. I think many other developers or those developing lots kind of stopped and created total uncertainty as to the ability for these guys to go to work and continue to keep their crews busy. And we were able to get some price concessions for continuing the development process. So that -- I thought that was good news.

Right. Most certainly. Maybe shifting gears a little bit. I think, from my perspective, that's a pretty good update around current trends and pricing. Maybe shifting to the Forestar business itself and the management team, Jim, welcome aboard. I think it's the first time we've been able to talk. And this concludes a search that you've had for the CFO role, I guess, for a few months now. Maybe I want to say 4, 5, 6 months, something in that time frame. Jim, maybe you could introduce yourself and give us a sense of your background. I saw your -- the press release and some of the highlights. But can you just give us a sense of where you come from and how you're thinking about the Forestar business and kind of your primary charges that you see yourself really focused on over the next 6, 12 months?

Sure, Michael. And by the way, it's very nice to meet you finally. I'm about 6 weeks in now. And it's been kind of a strange start, meeting a lot of people virtually. And hopefully, that will change soon. My background is I started off as a CPA. I was with Pricewaterhouse, and then left public accounting, worked in a number of companies, a company called Tandycrafts, Mattress Firm, when it was owned by Bain Capital. And that kind of took me into private equity. I was with Sun Capital Partners for about 11 years, about 7 of those years in London, working with various portfolio companies all over Europe, and came back. Most recently, I was with a company called Palm Beach Capital, a small private equity firm based in Palm Beach, Florida. So I've had a variety of different roles, different types of companies, businesses. Parts that seem to fit very well with Forestar are the manufacturing background that I've had and some retail. But what attracted me to Forestar was the opportunity for growth to scale and build a great business. It's really the only public company of its kind in a very fragmented industry. There's a lot of opportunity, I believe, to grow and to scale this business. My immediate focus, really, is continuing to build out the team, looking at different processes at some of the tools and information that's available. And with the goal of, over time, of transferring much of what is still done by D.R. Horton under a shared services agreement to Forestar.

Great. Great. Thank you. Dan, also kind of curious, I mean, one of your longer-term goals of the company is to not only kind of deepen your relationship or gain greater share within D.R. Horton's book of business in terms of lot optioning, as you probably -- that's probably your first or biggest near- to medium-term opportunity in terms of the ability to grow and broaden out your own footprint, but also over the medium- to maybe longer-term, to increase your business with other homebuilders in the industry, other publicly traded builders in particular. Has the last couple of months done anything to accelerate those ambitions, those growth plans? And I'm specifically referring to just, obviously, there's been a certain amount of dislocation. Things are changing very, very quickly. But I'm just curious, I mean, certainly, many builders, it's one of their top objectives is to increase their percentage of lots that they option. So just kind of curious, over the last month or 2, obviously, a lot of pandemonium and aggressive actions that these companies have to take for their own, looking internally. But I'm just curious if it's also created any types of new opportunities for you as we reach out to the broader industry.

We've been having discussions with other builders of -- starting some relationships where other than just Forestar sourcing transactions and offering lots to public -- to the builders, where they would bring us transactions as well. So those conversations have been taking place. I will say that over the last several weeks, those conversations have probably accelerated and we're having more of them and maybe getting a little bit more serious note. So yes, I anticipate that we will be expanding on our customer base as a result of this.

That's helpful. We do have a question from the field. Any detail or breakout of the value or breakdown of the real estate assets reported at quarter end? The $1.2 billion inventory line on your books, how that might break down between completed lots versus WIP versus raw land. Any sense of a breakdown there?

Jim, do you want to cover that, or you want me to do that?

Sure. Sure. It's about 9,100 lots under development, 4,400 finished lots, 22,300 unimproved lots. In addition, there's 16,500 lots that are controlled. So that gives us a total of 52,300 lots at the end of March.

And on a dollar basis, that $1.2 billion of assets, I think that was -- the lot -- the number of lots can differ sometimes widely from the underlying dollar values. So there's -- I don't know if that's something you have readily available or that you typically disclose.

Yes. We don't have that readily available, but we can pull that. If you think of our finished lots, they're generally probably going to be significantly higher per lot value than a raw lot. And then I think our average, overall, was roughly $30,000, $32,000 per lot on average. You're probably looking at our raw lots probably in that $12,000 to $15,000 range, and our finished lots, closer to that $60,000 to $70,000 if you kind of apply that math, you could probably come pretty close.

Right. Right. I think that's right. Okay. All right. Well, we're actually closing in on the last minute or 2 of the presentation, and I'm out of questions. So I think we're basically within 60, 90 seconds of the end of the session. So appreciate your time, gentlemen. Dan, Jim and Collin, thanks so much for participating. Great to have you. For the people dialing into the conference, we have our final presentation at 3:00 p.m. Eastern, JELD-WEN, a leading door and window manufacturer on the building products side of our universe. So we'll see you then. Again, Forestar, Dan, Jim, Collin, thanks for joining. We'll see you soon.

Great. Thank you, Mike. Thanks for having us.

Thank you.