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

Good afternoon. Welcome to the final presentation of our 2-day conference, our 16th Annual JPMorgan Homebuilding and Building Products Conference. We have with us Forestar Group CEO, Dan Bartok, and CFO, Jim Allen, in true fireside chat style with the background. Really appreciate that. It gives me a smile at the end of a long 2-day conference. I appreciate you guys joining us, of course. And first off, just I'll say welcome, and again, thanks for your time today.

Thanks for having us. Appreciate it.

So I'd love to jump in just on the market opportunity that you guys still have in front of you. What is your current estimated market share of the lot development market? And what's your goal over the next 2 or 3 years in terms of where you're hoping to take that share?

We look at what's our percentage of lot sales to kind of housing starts. I think we're close to that 2% number today. In other words, 1 out of 50 homes started Americas on a lot that Forestar has developed. Our goal is to get that to 1 out of 20, so basically a 5% market share. Whether we can get there in 3 years or not is a little questionable, but we're going to be on that path, and I think we'll probably be in that 3 to 4 range within 3 years.

And by the way, for those joining, you might see my name at the bottom corner, but my name is Mike Rehaut, and happy to host this presentation. I'm the senior analyst covering the homebuilding and building product names for JPMorgan. And so welcome all those that are joining us towards the end of the second day. And parenthetically, we've had a great conference over the last 2 days with Forestar being our 18th company participating. So put out a bunch of notes in research, I encourage you to take a look. We'll have a takeaways report out, hopefully, Friday morning as well or at least we plan to. So welcome your questions on the conference over the coming days. And by the way, the research is not promised, but in typical fashion, we do typically put a report out after a conference. So sorry about that, Dan and Jim, that's my short little advertisement before I get on the conference.

I thought you're going to say you're saving the best for last anyway, but that's okay.

That goes without saying, but I'm glad you said it. So I appreciate that 3% to 4% range in the next 3 years. Obviously, you guys have always had multiple paths of growth in front of you. And so I was hoping maybe to kind of take us through those different paths of growth, be it deeper penetration with D.R. Horton, your third-party business, non-Horton business geographic expansion, maybe that kind of is an overlap of the 2 prior categories. But how do you think about achieving that share? And more importantly, I think, how does that translate into a growth algorithm over the next couple of years to the extent that the market stabilizes?

Well, I think, number 1 priority for us is to continue to build market share within D.R. Horton. Today, I think we're probably about 18%, 19% of the homes that they're starting on lots that Forestar has developed. I think there's room for us to continue penetrating there pretty easily. The stated goal for, I think, for both companies is to get us up to about 1/3 of the lots that they need or coming from Forestar. There are certain divisions that I'm already at that 1/3 to 40%. So I think it is clearly achievable, but we -- a matter of continuing to expand that throughout their footprint. Second is really build -- selling lots of builders other than D.R. Horton. Over the trailing 12 months, I think, we're at about 15% of our sales, which are builders other than Horton. We're in a pretty good track there. Again, I think our stated goal has been to get that at least up to 30% of our total sales. And I think we are making some pretty significant progress on that. I think that, that trend line will continue for us. So I think from a customer base, I think both of those are achievable, and I think pretty much at hand. Started opening new markets. We already have offices now in 34 different cities, even though we're operating in 50 markets. So in most of the major markets, we can make some incremental additions to markets that we are in. There's a couple of markets that we actually dropped out of here that we'll get ready to get back into. About 2 years ago, we had slowed up some land back, we didn't replace some deals, it was double or a little bit pricey at the time, and now we're seeing opportunities to reenter a couple of those markets. It's really growing depth and growing market share within the markets that we're in is our primary focus.

Right. And just on the third-party sales, I think, I heard you say 30% of your sales is the goal. Just remind us, again, I apologize if I missed it, where you are currently? And I know you've had different partners over time. But if you could kind of remind us of how many other builders you typically do business with on a quarterly basis? And where do you think that can -- I know the goal is 30%, but how do you think about it over the next year or 2?

Yes. I think it's going to be lumpy. I think you're going to have some quarters where we may hit that 30%. But I think on a trailing 12 basis, this will take probably 2 to 3 years from having that more of a steady state. There's a number of builders. Jim, I don't know if you have that off the top of your head? I think it's like a dozen or something like that different builders that we have contracts with in our closing lots. But again, from quarter-to-quarter, that may vary depending on those deliveries.

Right. Right. And just thinking about growth more broadly over the next year or 2, prior to the market volatility I know the company has talked about growing at least 15% to 20% a year in terms of volume. Is there still a reasonable goal for Forestar as the market volatility kind of smooths out or the market hopefully continues to normalize here? Or how should we think about those growth goals over the next couple of years?

I believe that is a reasonable goal for us within our current capital stack today. If you look back over the last 5 years, we went from 1,500 lots a year to almost 18,000 lots. So our growth has actually been much more rapid than 20% a year on an annualized basis. But we believe that we can achieve that from where we're at today, that's if we didn't raise any additional capital just kind of within our current capital set.

Right. right. And it's interesting because we spoke with D.R. Horton yesterday, you might have seen that, and we asked them about Forestar and their plans to ultimately still -- are still there in terms of eventually deconsolidating your statements from theirs and that would require getting below 35%. Initially, it was thought that might be done through a combination of they're selling their shares, but also you issuing primary shares. Your cash flow has been a lot stronger. Your balance sheet has been reasonable levels of leverage -- and so you haven't had to necessarily raise additional funds. I mean, your comments around potentially raising money to accelerate growth. I mean -- how do you see -- and maybe this is more of a question for Jim, but how do you think about the balance between perhaps accelerating growth, which might require more capital? Or kind of get us continuing on the path you are or have been for the last couple of years, which is kind of growing within your means, within your balance sheet, within your cash flow generation that would not necessitate any additional capital raises?

Well, our financing plan has always been to have a balanced sort of blend between equity and debt and to maintain a net debt to capital ratio of 40% or less. So today, we're about 25%. Our liquidity -- total liquidity is about $650 million. So we're in good shape. We can continue to grow at 15% to 20% with our current capital structure. Equity would allow us to accelerate that, but that's really opportunistic depending on our stock price. And as it's been trading at a discount to book value is probably not the right time for us to issue equity at this point.

Right. Right. Okay. So maybe shifting a little bit to -- going back to the industry backdrop again. The regional banking crisis has obviously been a big topic. I think it was one of the questions on your recent earnings call. How have, to the extent that you've seen things change at this point, how have lending standards and credit availability changed so far this year for land developers? And does this create or has this begun to create any opportunities for Forestar in terms of opportunistic acquisitions of either certain land parcels or even other lot developers?

Sure. We've added actually a new slide to our investor deck, which I'm sure you probably noticed, but if not, it actually shows a recent survey from NAHB that says the majority of respondents or the highest level of respondents like in the last decade, had said financing development -- land development financing is harder to get. So that and coupled with the fact that cost of capital has increased, effective interest rates of 10% or higher. And compare that with our weighted average debt of 4.6%. We do have an advantage on the cost of capital but -- so I think that will present opportunities. We have built our liquidity in anticipation of seeing those opportunities. We haven't seen the level of distress yet that we thought we might. But we are seeing opportunities. We're beginning to see opportunities.

I think the other interesting part of that, Mike, is having no project level debt and not relying on the banks to approve with any given acquisition or approve [indiscernible] also gives us a leg up when we're acquiring land. Being the credible counterparty where the seller knows that we can just write a check basically with our own approval and not have to give an appraisal and go through the process of getting a bank loan approved gives a little bit of a leg up on tying up land for acquisitions for local development as well.

Right. Right. No. I mean I think it would be very interesting for you guys over the next couple of years potentially. And obviously, it's very dependent on how quickly things might stabilize that might then limit opportunities, let's say. But still, I mean, even in normal times, I would think the ability to acquire and aggregate assets is going to be a competitive advantage over time. Let's shift to some of the income statement lines of profitability. I would love to start with gross margins. Your gross margins have ranged a decent amount over the last few years from high teens to low 20s. How should we think about this metric over the next 2 or 3 years as the market normalizes?

Well, as you know, we underwrite to a return, so not necessarily to margins. So in our portfolio, we have a mix of slower turning projects with higher margins and faster turning projects with lower margins. So our margin is always kind of a blend between those 2 things, and it's really dependent on what -- which projects have deliveries in the quarter. So we have seen margins increase. Part of that is just the increase in Forestar-sourced projects, Forestar-sourced land. So today, about 60% of our owned lots are Forestar sourced but about 25% to 30% of our sales are from Forestar-sourced lots. So we have seen a correlation, an increase in margin due to that. But otherwise, it's really just a blend between projects. We'll continue to price our lots at market and give -- take whatever margin the market gives us.

Right. And where could that -- so currently, you're at 25% to 30% Forestar sourced. Is there a number that you hope to achieve over the next year or 2 or even longer term that would ostensibly drive that high -- the margin higher?

There's no particular target. I mean, it will likely trend higher given the percentage of lots owned that are Forestar sourced, but we have no particular target there.

We really look at each deal individually and whether it's sourced by a builder or by us. We're looking for the best real estate opportunities. And again, it's a blend of pricing as well as velocity. And we're really looking for the best return versus, as Jim said, the underwriting of the return and how fast we can turn our capital more so than we are -- the actual margin on a given project.

Right. Right. I guess, similarly on SG&A, in fiscal 2021, it was around 5% and kind of crept up to 6% in '22, it's going to be a little higher this year, at least it's trending that way. How should we think about this metric going forward as well as you maybe return to a growth mode?

Yes. Well, as you know, we went through a lot of growth. When you think about 2020, 2021, '22 and are rapidly increasing revenue base, but we're also building out our team and our infrastructure. So I think you saw -- we really kind of hit that mid the upper single-digit SG&A. Frankly, sales over the last couple of quarters were a level than half of the revenue of a year ago even though we stated profitability and our profitability percentage are the same, we didn't get that leverage of our SG&A and our SG&A percentage went up. I think as we return to growth and our revenues we gain that kind of pace where we were at, you'll see our SG&A go back to that mid- to high single digits.

Right. Right. Maybe also just talking a little bit about lot ASPs. It's been interesting that despite the rising home prices, your lot ASPs have been pretty steady. Maybe only going from the mid-80s in fiscal '21 to the high 80s over the last couple of years. So how should we think about this number going forward, either through geographic mix or just broad housing appreciation in the markets. How should we think about the lot ASPs for you guys?

Well, that one is always tough to predict because it is a mix based on geography and to a lesser extent, lot size. So over time, I mean, we have -- we've tended to do less in the Western states, some of the more expensive lot -- regions with more expensive lot prices. So we've had that mix shift. To Dan's point, we may go back into some of those markets. We'll look at that. So it really is dependent on that mix and really hard to predict.

Yes. I think if you think about -- I have markets where the average lot sale price is $250,000 and markets where the average lot sale price is $50,000. So that really can influence quite a bit that ASP based on which projects your total lots are in a given quarter.

And I mean, on that point, obviously, it does seem like your business is predominantly still perhaps Texas and Southeast driven. Any plans to maybe increase the exposure on the West Coast or Pacific Northwest or those areas that you would not only drive a higher lot ASP mix, but also higher revenues and profits [indiscernible]?

Yes. Obviously, Pacific Northwest is one of the markets that we were in. We've been pretty heavy. And as projects rolled off, we weren't able to find projects that underwrote to our standards. So we ended up with nothing up there. And now we are looking at opportunities to reenter that market. So I think that's one place you you'll probably see us reenter with a higher pricing. California, kind of same thing. When you look at some of our exposure early on, it was higher than it was and for the right opportunity, will we reenter those markets. But your point about Texas and Florida, we still allocate our capital based on housing permits and starts more than we do on dollars. So there will always be kind of a heavier emphasis in Texas and Florida when you -- so that's [indiscernible] over 55%, I think, of our owned and controlled lots are in those 2 states. And I don't see that changing too much because, again, when you look at how we map out all the MSAs and we track a little over 100 different MSAs today. And that's predominantly were -- the busiest of markets.

Right. Maybe talking a little bit about cycle times. And for those listening, I have a couple more questions but would kind of push me towards the end of my list. So if people have questions, I would like to -- for me to ask, again, hit the Ask a Question icon on your dashboard, and I'd be or even -- or even ping me on Bloomberg and I'd be happy to pass those along to the company. Wanted to hit on cycle times actually for a moment. And maybe just take us through where cycle times are currently? Where they were at its worst and where could they be on a more normalized basis?

Yes. So we used to look at an average first delivery on a first phase and being about 12 months, even though it may vary from market to market. But from the day I put a shovel on the ground that actually turning that first revenue then was about a 12-month period on average. I'd say at the worst, that elongated by about 90 days, those 12 months extending to about 15 months back down to about a 60-day elongation. We're starting to finally see maybe a little relief in transformers in some markets, which will help quite a bit. Also contractor availability seemed to loosen up. I think we'll be back to that 1 year. So I still see us contracting back to normal -- at normal periods. Would that happen in '23 or '24? And again, it will depend on market by market and where activity is. But I think we did a really good job over the last year of staging development. As we saw the market slowing rather than just mothballing a project we might take it to a natural stopping point. So we had a lot of lots that were greater than we didn't put pipe in the ground. We've got lots that had pipe underground when we decided not to put streets in yet. So that we should be able to turn those lots on a lot faster than starting from scratch.

Great. Great. And my last question is just more revolves around, I think, Part of the reason that your stock is where it is from a price to book standpoint is concerns around impairments. And I'm sure you get this question a lot, so it's important for me to kind of at least hit on it during the forum -- during this forum. In the second quarter, in your March quarter, you took a $19 million of impairments on 2 projects. So how should we think about impairment risk going forward? And with the recent more recent price stability or home price stability in the market over the last few months, does this get you a little further in the clear or should we expect that there might be still a project here and there where there might be an impairment going forward?

Right. Well, as we've said before, we don't expect to see widespread impairments due to the market. Both of the impairments that we took last quarter were due to cost. Each of the projects had its own unique set of circumstances that caused those impairments, but neither was really based on the market or a deterioration in the market. So again, we don't expect to see widespread impairments due to the market going forward. There could be isolated impairments due to cost. That's always -- there's a potential for that. But otherwise, we don't see it.

Another way to think about it, there's kind of unique situations in both of them. And in one case, we had a project where the city had kind of given us approval of building an access road situation of being able to build that road. And when it came -- time to pull the permit, they decided they wanted to redesign the road. And even though we only kind of had a piece of paper that said go forward, they decided that they wanted to change the rules and it ended up being a very elongated process as well as a significant increase in the cost to access the property. And when you roll all that back in, we didn't really have a ton of choice, we needed to get the project approved. And the cost -- the cost run up was something that the project just couldn't absorb. The other one was a similar situation in that it wasn't necessarily the city promised to do something. The city had approved some plans that we thought we could convince the city to go with a much less expensive route because it made sense. Do the logical thing, but actually reduce the city's maintenance of those improvements over time. It's really about deep sewer in Florida, which you might imagine has a very high water table. We're trying to convince them that there was a much faster, easier way to put the sewer in the ground, but it came down to it, we guessed wrong. We thought we could convince them to go with what seemed to us to be a more logical system, and they held their guns and said, here's the way it's designed. This is the way you got to build it. And the project really couldn't absorb that additional cost, basically build a sewer in water below ground, it just didn't make a lot of sense. So it could be done and which is very costly. Again, in each situation, neither of which were market related. They were really, to Jim's point, it's really more about the cost of the project and maybe we learned a lesson there along the way.

Right. Understood. It's you never fully appreciate some of the dynamics of land development until you work through, you hear some of these issues and problems. And each municipality is its own animal, I guess. So well, that does it for me. And I'm just checking on the question bank. We don't have any inbound questions. So I'll just, again, say that if you do have a question, again, feel free to email me outside of the conference and I can certainly pass those along. But we'll conclude here. And again, Dan and Jim, thanks again for spending some time with us today. I always learn a lot when we're able to sit down and again, appreciate the fireplace backdrop and you get extra stars for that, it really put a smile to my face at least. So I want to say thanks and enjoy the rest of the day. Now for those that are still on, thanks for joining us over these last 2 days. Happy to connect over the next few days and next week. If you'd like to review takeaways from the conference. Either way, have a great rest of the day, and we'll see you soon.

Thanks, Mike. It's my pleasure.

Thanks.