Hovnanian Enterprises, Inc. (HOV) Earnings Call Transcript & Summary

Good morning, everyone. I'd like to welcome everybody to Deutsche Bank's 31st Annual Leveraged Finance Conference. My name is Andrew Casella. I run the high-yield credit research team in New York. And today, we're excited to have Hovnanian Enterprises join us and present, Brett O'Connor, Chief Accounting Officer and Treasurer; and Jeff O'Keefe, VP, Investor Relations. So with that, I'll turn it over to you, Brad.

Good morning. Thanks, Andrew. I guess, we've got a tough time slot this morning, but thanks for showing up. I'm going to take you through a little information on the housing market, Hovnanian and our recent operating results and then we'll have some time at the end for Q&A. So starting with the housing market, some of these slides, I'm sure if you've talked to other homebuilders this week or recently, you've seen similar slides. But on the single-family housing starts side of things, you could see we have 50 years of single-family housing starts up here. The average over that time frame is around 1 million starts a year, that cash line going horizontally across. You can see leading into the great housing recession, the oversupply/overbuilt that was taking place, obviously, then the great housing recession. And since that time, we've been underproducing the average. We just ticked over it in 2021, 2022 came back down. You could see where we are in 2023. Through August on a year-to-date seasonally adjusted basis, we'll be at -- we're at 907,000, so under 1 million. So there's still an undersupply of single-family housing starts. And then along with that, currently, as many of you have, I'm sure, read about, heard about, maybe are living themselves as I was talking to Andrew about it, but historically, low supply of existing homes for sale. You've got people that are locked in at 33% or less mortgage rates, makes it very challenging to move and accept a much higher rate now in the current environment. And so you can see leading into the great housing recession, there were 3.4 million homes. And that was a peak that were available for sale, existing homes. The average over this time frame is 2.1 million. And you could see, we're under 1 million currently and have been for a while. And I think that's obviously helping the new homebuilders in terms of availability of homes. For those that are willing and able to purchase, there's really only new homes for sale to choose from. Mortgage rates, this shows you on a long-term perspective what mortgage rates have been doing, 30-year fixed rate. You can see going way back how I got almost to 20%. But then very recently, we've been -- had the benefit of very low rates, 3% or less. And then last May, as we all know, rates dramatically jumped to around 6%. The market slowed pretty dramatically for us and all the homebuilders for a period of time as people adjusted to the lower rates and then rates have continued to tick up. And I know they're up even more this week. So it's not helpful when rates go up, certainly for us or others. We have ways to combat that, that existing home sellers don't necessarily have in terms of being able to buy down rates. So we're able to give our customers better rates than what you're seeing here at a cost. But it's challenging as rates tick up, it does cause sellers to pause and take note before they decide to move forward. So similar to the starts side, this is the new home sold slide. And you can see the significant run-up right before the great housing recession and the falloff and then the gradual increase, just like the housing start slide showed and then the jump during COVID and then dropped back down last May with the jump in rates. And then we've been slowly coming back up. As you'll see in a minute, for us, our absorption pace has in sales really improved this calendar year. So around January, the market really started to pick back up for us. So recent operating performance, we are among the top 20 homebuilders in both deliveries and revenues. We market homes across a broad product, right, something that we believe is an advantage for us. Some builders focus on first time only or luxury, like the Toll Brothers. We kind of operate in multiple product areas. On the right-hand side, you can see this, for the year ended 2022, we had 38% first-time buyer product, 33% move up, 13% luxury and 16% active lifestyle. And that varies year-to-year. We're in all those products. It depends on the communities we're opening, et cetera. Probably 5 or 6 years ago, first time was in the low 30s. So that's definitely been increasing for us over the last few years as that market segment has grown. On the bottom left, you can see the markets that we're in by our geographically reported segments. So the orange in the upper right is our Northeast segment. Then you've got a Southeast segment down in Carolinas through Florida. And then our West segment is Texas, Arizona and California. And then lots controlled by region, we have 29,500 lots that we control as of July 31. And it was split almost 50% in the Northeast, 40% in the West and then 14% in the Southeast. And that doesn't necessarily mean that's how we'll deliver going forward. The time to get lots through approval is different in each of our markets. So the Northeast tends to have more lots control. It takes longer to get those lots through to actually get to build homes and construct and deliver. So we end up with more control in the Northeast, doesn't necessarily mean we end up with more deliveries in a particular year. So for the quarter ended July for us, on the left-hand side of this, you can see how -- and you'll see a few slides on this, how we performed versus the prior year and then how we did against our guidance on the right-hand side of the slide. As a reminder, for the third quarter last year, we still had a big backlog that had been built up during the really strong market during COVID. So we were still delivering quite a few homes as a result of that backlog. So it was a tough comparison from a revenue perspective. So we were down versus the prior year, but we were within our guidance range, as you can see on the right-hand side of the slide, at $650 million of revenue. SG&A ratio, obviously, as a result of the revenue being down, our SG&A was up, but again right within our guidance that we had provided. And then from an adjusted homebuilding gross margin perspective, margins in the third quarter of '22, again really strong because of the very strong sales we had during COVID. Margins have continued to grow. I think this may have been our peak at 26.3% or right around it. You can see for the third quarter of this year, we were 23.2%, still very healthy margins and up sequentially. On the upper right-hand side, we are showing sequential just so you can see the improvement sequentially in our margins. So we -- in a minute, you'll see, we've been raising prices during this calendar year as the sales improved. We were able to raise prices in many of our markets and the margin showed that improvement sequentially. And you could see we actually beat our guidance by a little bit there. Adjusted EBITDA, again down from the prior year as a result of the lower volume, lower margin but up sequentially from the prior quarter. And we did beat our guidance. And again, that helped the margins. The higher margins really helped us in that respect. And we're selling more, what we call, quick move-in or QMI homes or spec homes, which makes known exactly what the margins will be for the quarter a little hard as we're getting into the beginning of the quarter. We're selling homes and delivering them in the quarter now with our existing QMI inventory. And then pretax, very similar to what we just saw in EBITDA, down from the prior year but certainly up sequentially and exceeded guidance. So overall, really good quarter, I'm going to go into the sales in a minute. So we're very happy with our operating results compared to our guidance. And you'll see, we're also very happy with sales for the quarter as well. So on the sales absorption side, you can see that for the third quarter contracts per community were at 14.2%. And on this slide, we're just showing you the third quarter specifically all the way back to 2017. And you can see that, that was the second highest over that time frame. The only other time it was higher was in Q3 of 2020, which was the peak of the really strong COVID market. In fact, our 2023 actually exceeded Q3 2021, which was still COVID, markets feel pretty good. And on the far left, we often used the '97 to 2002 time frame as kind of a normal market. It was not a boom or bust at that time. So we reference that as well just to see how we compare whenever -- where we are back to that kind of normal market time frame. And you can see, again, Q3 of '23 was better than that as well, so very strong third quarter sales for us. This slide shows the same thing but by month. And it's a seasonally adjusted and annualized number for each month. So it assumes what that month sales would have been on a full year basis if you seasonally adjust it and extrapolate it over the 12 months. And you can see, as I mentioned in May last year, the market really slowed down, a trough for us in the month of November. Let me take a step back. There's two sets of -- each bar has two colors to it. We've isolated on this slide, build for rent sales just to -- because we did have, especially in the month of June, some significant build for rent. So we wanted to show what it was without it. For us, build for rent, it just means we're building houses and delivering them to a third party, who's going to rent them out. We do not keep or own and rent the building -- rent the homes out ourselves. It's really like any other single-family home for us that we deliver. We're just delivering a significant number to one individual party. So you can get some lumpy contracts in those situations. So anyway, so if you focus just on the excluding build for rent, you can see we troughed in November. December picked up. And then as I mentioned, the calendar year came and the lights came back on basically and sales continued to grow on an absorption pace basis every month all the way through June. And then it dropped a little in July but still quite good. Anything in the 40s is really good on an annualized basis. And August, as we said at the time, it was -- August wasn't over when we gave our release, but August was trending similar to July. So really, really happy with the sales pace we saw in the third quarter. Our quick move-in homes per community, or other builders call them specs. During COVID, you can see historically, we've been running around 4.4 QMIs per community. We typically are more of a to-be-built builder than a QMI builder. Our sales are typically 60-40 out to the to-be-built side. During COVID, we couldn't even start enough homes to have any QMI. You can see it got very low at about 1.5. And then last year, as the market slowed down and the rates ticked up, it became apparent that it was better for customers and more customers were interested in having QMIs to buy rather than to-be-builts because they're able to have the certainty of what their monthly payments were going to be, what their rate was going to be. It also allows us to buy down their rate. If you're within 60 days of closing, you can buy down the rate on a to-be-built house that's 6 or 7 months out. That's cost-prohibitive to buy down a rate and lock in a rate at that time. So we have intentionally been increasing our QMIs per community. We had stated a goal of about 7. And we've gotten close to that, at the end of July, we're at 6.7. And we do think that's helping our sales to have QMIs available in our communities that are getting close to delivery. The good news is that you don't want to have finished QMIs. And we only had 100 across our 122 communities as of July 31. And that was down from 150-ish or whatever at the end of the second quarter, so been able to manage our QMIs quite well, have them available but not have too many that are sitting around finished. As I -- so as the market improves during this fiscal year for us, so Q1 for us ends in January and then Q2 is April, Q3 is July, you can see in the first quarter, no surprise when we looked at the absorption paces, we weren't raising prices in too many communities, or in certain communities that were performing, we were able to raise prices in 30% of our communities. But as the sales pace really picked up in the second and third quarter of this year, we've been able to raise prices in 69% of our communities in Q2 and 71% of them in Q3. And many of those are repeat, obviously, that got raised into Q2 and in Q3. We raised prices -- we focus on it at a community-level basis and can raise prices every week. If we raise prices and we continue to sell, we raise them again. So small, consistent price increases is what we try to do, so been very happy with that. And you saw the improvement in our sequential gross margin on the earlier slide. And that's partly to do with the fact that we've been able to raise prices. Our community count over the last 3 years. This just shows you Q3 of each of the last 3 years, basically flat, 120 to 124, now 122. We are expecting to have our community count grow in the fourth quarter of '23 and then grow even further in '24, definitely something we want to focus on and have growth in our community count to build and have higher revenues and set deliveries going forward. We need to leverage the SG&A that we have, the debt that we have, et cetera. So there's a lot of benefit that we can grow our community count. And we have the capital to do so, which you'll see in a minute. Our lots controlled from Q3 of '22 by quarter end all the way through the end of Q3 '23. It was coming down since Q3 of '22. No surprise really, we stopped, like many homebuilders, kind of paused as what we were doing on the land side as the market really slowed last summer. So we had less -- and we're delivering homes, obviously, but we're not replacing them with new lots controlled, new contracts with land sellers. So we had some declines. We've troughed at Q2 of '23. And now we're going back up the market. We're back in buying land, optioning lands, controlling land for future deliveries. The other good thing about this slide is you can see that while the total went up, the owned lots has actually come down and optioned increased. And that's important that the more we can control the lots through option and not have to own them generates a higher return on inventory, higher return on invested capital for us. It's something that many of the builders are talking about. Asset-light or land-light is something we've been doing for a long time. But we're pushing even harder to continue to expand and have more lots controlled through option. So you can see the progress we've made on that basis all the way back to 2015. We started at 46%. And there's just been gradual improvement and now at a peak of 73% at the end of the most recent quarter, and something we continue to focus on. We'd love to be 99%, 100% optioned and only own lots when we're constructing homes because where NVR, for those who are familiar, operates. So that translates -- this now shows you where our 73% stacks up on the top versus other builders. You can see NVR to the far right, Dream Finders and D.R. Horton and then so we're fourth highest in terms of asset-light lots controlled by option. And that translates importantly to the bottom, where our inventory turn is third highest. And that's something that's always, always been a focus of ours. It helps us generate the highest returns on our invested capital and frankly higher than most in the industry. This is an EBIT return on investment slide, which we think is the purest form of operating performance, takes out leverage and interest and just focuses on how each of the builders is operating and getting a return. You can see NVR's strategy in having very few lots owned. Their inventory turn is very high, very high ROI. But we're the fourth highest, similar to the land-light slide. You can see it translates right to return on investment here. We also have our own financial services business, both the mortgage origination business and a title company. The mortgage origination business operates in all of the states that we're in. It's complementary to our homebuilding operations, always has been. It's even more so now. The ability to do rate buydowns is simplified by having our own mortgage origination company to help us do that. And in addition to being complementary from a service provider perspective, helping our customer make sure we close on time, which is critical for us in closing our homes, and we're much better at closing on time if it's our own mortgage company versus a third-party mortgage provider. But you can see it also generates profit, trailing 12 months, $19 million of income. So it's been a very successful and important part of our business. On the liquidity and balance sheet side, we have been over-levered for a long time, still are relative to our peers, been a challenge of ours since the great housing recession. We've been fighting that battle. We've made a lot of progress, you'll see in a minute. But during that time frame, we've always had a target -- liquidity target at quarter end to be between $170 million and $245 million. We think that's a safe place to operate from a cash perspective. You can see that going back to July of 2020, we've been in excess of that targeted range over this whole time frame. And you'll see in a minute, we've been paying down quite a bit of debt over that time as well. So our liquidity position is strong. We have the capital and liquidity to invest in new communities. And that's where we want to get that growth I was talking about earlier to come from. On the debt maturity ladder, we've got a lot going on here. So I'll start at the top. The top half of this chart is what our debt was outstanding as of the end of July adjusted for one additional debt paydown we did in August. We paid another $100 million of debt off in August of '23. We paid off $100 million in May of '23. And we've reduced our total debt by $668 million since the beginning of fiscal '20. So we've been making a lot of progress on reducing our debt, improving our leverage. And that's been critical. So with all of that, we then announced last week a debt refinancing that took the revolver, which was the first thing maturing, the $125 million revolver that was coming due in Q3 of '24. And we pushed that out to Q3 of '26. That's very helpful for us. And then the stack of secured notes that was coming due for us in fiscal '26 in Q1 and Q2 of '26, we refinanced that out to 2028 and to 2029. And so we now have much more runway and safety to operate, grow our business. We did intentionally leave the amounts that you see there is $91 million in Q2 of '26, the $40 million in '27, et cetera. In advance of that, didn't bother refinancing those, we want to continue to pay down debt. So that allows us to either pay those down early or as they mature but continue to pay down debt and improve our financial leverage position. And that's definitely something that's very important for us. That refinancing kept the debt outstanding basically flat, $2 million extra, and the annual interest incurred about $900,000 more a year. So we were able to basically do debt refinancing at the same rates that we are at today, which we thought was a success, given the current rate environment. Our credit metrics have improved dramatically from 2019 to today. Total debt-to-adjusted EBITDA and net-debt-to-adjusted EBITDA on the top, you can see the dramatic improvement as we paid down that debt but also grown our earnings over that time frame. And then the fixed charge -- basically, fixed charge coverage of EBITDA to interest incurred is on the bottom. So great improvement there since 2019 as we continue to improve our balance sheet position. And then you can see in 2021, we finally flipped to positive equity. We had negative equity. We wrote off $2 billion worth of assets in the great housing recession. And we're fighting against that over this whole time. We finally got back to positive equity in 2021. And we've grown that pretty quickly. And you can see where we project to be at the end '23 in October, so at the end of this month, frankly. And then what happens on the net debt side, down to $749 million by the end of the year and net debt-to-net cap of under 60%. So significant, significant improvements from about 150% to get down to 57%, 58%, really good improvement. And we want to keep that happening. And we're targeting ultimately a mid-30s debt-to-cap is where we want to be. The last slide I'll show you here is our guidance for the full year. The left-hand column is the guidance we gave at the end of the second quarter for the full year and then the new guidance, which is what we just provided when we did the third quarter earnings release. And all of the metrics improved as we continued to sell, margins were getting better, et cetera. So we expect for the -- now for the year to be between $2.6 billion and $2.7 billion of revenue; our margin to be between 22% and 23%; SG&A to be in the 11% to 12% of revenue range; adjusted EBITDA at $350 million to $370 million; and pretax of $215 million to $235 million, which translates to diluted EPS of $21 to $24 and a book value per share of $66 to $68 per share. So we're frankly very, very happy with the way the year shaped up. I think if you had asked us at the beginning of this fiscal year or late last summer, we would not have thought that this was possible. So we were happy with the improvement in the market, sales picked up and continue to see that. I think we definitely have the benefit, as we talked about, of there being no existing home supply. The demographics still show household formation, so people need homes. And we're the only -- we and the other new homebuilders are the only game in town. With rates ticking up and continuing to tick up, that isn't good for us. So we'll see how that translates. But so far, we've been able to manage through rate increases with the benefit of the rate buydowns that we're using to help our customers out. And that's it. I'll take questions.

So obviously, the [indiscernible]. So what's the response from customers or [indiscernible] I guess, that's the only tool in the toolkit as far as the [indiscernible]

Yes. I mean, there's multiple tools in the toolkit. It's a good question. The rate buydown, the way that, that's kind of unfolded over the last 12 months, if you went back and looked at what us and other builders provided as the rate buydown, it was 4.5%, 4.9%. Then if you went and looked at the most recent week, rates that we were offering and others were offering were more in the mid-5s. So what happens is as rates go up, we're still offering a very similar spread, but the rates are ticking up. So that's going to have an impact because it is a cost to us and/or the customer in terms of what we can do. There's also limits to what you can do just on the mortgage. You can't give more than certain percentages depending on the type of mortgage in terms of incentives. So there's limits to what we can do. But the spreads that you've seen historically could stay in place in terms of if it goes to 8%, we can offer 6%, whatever that number ends up being. The other thing, obviously, is you can see our margins, despite having to give those types of concessions, have improved. And we were at 23% in the most recent quarter. So there's also room for us to do some things on price if we have to or other incentives. And I think other builders are in the same boat. I mean, sales pace is the most critical thing. I mean, you obviously want to make margin, but you need to keep the factory running and delivering homes. And so we'll have to do what we have to do. We do that by community. We look at how each community is performing. And if the community is slowing down and having a couple of weeks with no sales, we start to figure out what to do there. What do we need to do on the incentive side? Or is there a salesperson issue? Anything that you can think of to try to make a change. So we'll see. I mean, the most recent weeks, sales have been basically consistent with where we've been running. Seasonally adjusted, September is generally slower. But I would say, seasonally, it's been fairly similar. We'll see what happens this week with the rates and the news that came out this week with rates, so -- but so far, we've been able to manage through the rate increases that have been happening.

Counterintuitively [indiscernible]

It has -- it can do that, it can do that. How much is too much? I mean, what happened in May, when it jumped significantly very, very quickly, that -- people didn't -- that didn't get them off the fence. They all went, "Whoa," and they all waited, right? Adjusted to the new rates, we kind of stabilized in the 6s for a while, which I think got people comfortable that, "Hey, that's the new rate," and they came back to the market. So part of it is how fast the rates go up. Other questions?

So when we think about just the overall industry, [indiscernible] what in your mind kind of [indiscernible] from building faster [indiscernible] supply, [indiscernible] what do you think the bottlenecks are [indiscernible] because demand seems to be there, so...

I would say for us, and I think for others, it's on the land side. Land development during COVID initially slowed, just like we all slowed initially, too. And then with the supply chain issues and other things, it slowed land development. And we're -- as you saw on our community count slide, we're basically flat over the last 3 years. We would have expected to be up. But we've had communities that are taking longer to get through land development to get open because you can't get what you need. Utilities, frankly, are a challenge, transformers. And so they delay both getting communities open for sale. And they also sometimes end up delaying deliveries because you can't get the meters. So there are just things that have slowed, I think, land development down. And so I think that's probably right now the biggest bottleneck. And then finding land in the right place, it's always been a challenge. But I think it's continuing to be a challenge in terms of finding the right properties to move forward.

[indiscernible]

Yes. So I think, as you saw in our margin, we benefited a lot from the supply chain starting to loosen up. So during COVID, supply chain was extremely challenging, as everybody talked about. Our construction cycle time extended to 7 or 8 months on what would normally be 4 to 6, 4 to 5, something like that. Cost, getting materials, costs were going up. A lot of that has loosened up. Our construction cycle times are about 30 days better now than they have been. So we're still not back to normal, but now we're probably more in the 6- to 7-month range instead of 7 to 8. That helps on the inventory turn side. But in addition, that means that materials are becoming available. So that helps hold back price/cost increases. And labor has been less of an issue as well. So I think overall -- and lumber has helped a lot, frankly, year-over-year. So right now, labor, supply material, not a -- it's not a major issue. Certainly, there are materials that are going up, inflation doesn't help. I mean, we're certainly seeing cost increases in some of our areas. But with the slowdown that happened as a result of the rate increases, that gave us some leverage to go back to our trades and say, "Hey, you guys, we raised prices with you or increased costs for us by paying them more during COVID when it was really hot. We need to keep going. You need to help us out here and come back down on price." So there's been some movement, I think it's helped us this year. Will that continue? We'll see.