KB Home (KBH) Earnings Call Transcript & Summary

Good morning. My name is Mike Rehaut. Thanks for joining us. We're continuing with our afternoon -- the last session actually of our morning of our 14th Annual Homebuilding and Building Products Conference here at JPMorgan. We're excited to have with us KB Home. We have Jeff Mezger, Chairman and CEO; Jeff Kaminski, CFO; and Jill Peters, Vice President, Investor Relations. This will be a fireside chat format. And if the audience has any questions, please submit them through the Ask a Question function or button on the website. I'll turn it over to Jill for a couple of opening remarks, and then we'll go into Q&A.

Great. Thank you, Mike, for hosting us this morning. We have just a few comments to start out with. Housing market conditions are robust, with favorable demographic trends, particularly with respect to first-time buyers driving demand, along with low mortgage interest rates. First-time buyers accounted for 65% of our deliveries in our 2021 first quarter, an increase of 11 percentage points year-over-year. On the supply side, existing single-family home inventory is low at 2.1 month supply and even lower in many of our markets, especially at our price points. This limited level of resell inventory, together with the underproduction of new homes over the last decade, enhances the favorable backdrop. Because of the longer-term nature of the factors creating strong market conditions, we expect demand to remain solid for the foreseeable future. Our personalized build-to-order model emphasizes choice and generates high levels of customer satisfaction. We are proud to be the #1 customer-ranked national homebuilder in third-party customer surveys, including TrustBuilder and ConsumerAffairs, based on the 2020 rankings among large production homebuilders. In addition, our homes offer the highest energy efficiency based on the Home Energy Rating System, or HERS, Index, which helps our buyers lower their long-term cost of home ownership. As a result of our differentiated product, we have long ranked among the highest in absorption rate across the industry while producing a significant improvement in our return on equity and gross margin, particularly over the last 5 years. In closing, I would like to note that in light of our approaching May quarter end date, we will not be providing an update on net orders or related metrics today. In addition, our reference points will be the commentary we provided on our 2021 first quarter earnings call, which was held on March 24. And with that, I will turn it back over to Mike.

Great. Thanks so much, Jill. Appreciate it. That was -- that -- you took off my first question, which was what the orders were going to be this quarter, so I'll have to skip to the next. Maybe we could just focus -- so what I've done with these fireside chats, in general, is ask a few industry-level questions, and then we certainly have, for all the companies involved, many company-specific questions. So in that type of approach, let me ask a couple of broader, bigger picture questions before we get into KB specific. First is just more, I guess, how to think of demand this year overall. I know yourself as well as most builders in the industry over the last quarter or 2 have been selling below the true pace of -- the true level of demand that's out there, in other words, limiting sales pace. Every builder, more or less, has said, "We could have sold more, but we're trying to manage to our backlog, manage to production, trying to match price with cost properly," which all is very rational and reasonable. But at the same time, it begs the question, even with normal seasonality kicking in, if there's still a spread between where you're selling and where demand is, you can have demand come down, but still not really see it in your numbers in the back half of the year to the -- and in fact, be able to maintain a type of a sales pace. So is that a reasonable way to think over the next 2 or 3 quarters in terms of perhaps how the industry -- how order trends might progress? Or are there other factors that we're not taking into account?

I think your comments, Mike, are appropriate. There's such an imbalance of demand and supply, with demand being incredibly strong. If we see a seasonal slowdown, we typically drop about 5% in the third -- our third quarter versus second, and then another 5% in the fourth quarter. I think demand is so strong and supply is so limited, I don't think we'll see the normal cyclical softening. Like others, we are balancing our sales. As I shared on our last earnings call, we're balancing our sales with our starts pace and what our start capacity is based on our community mix and optimizing each asset, and we'll continue to do that. So I expect our sales to remain pretty consistent right now.

Great. Thank you for that, Jeff. I guess one of the other key areas of concern that we've heard about exceedingly, and I'm sure it probably comes up at least, in one form, once or twice, I would say, most of your calls with investors, I presume, is the strong levels of price appreciation and affordability. On a national level, probably talking about up 10%, 15% year-over-year, at least on just broad industry statistics in the first quarter. How do you view the current rapid rate of price appreciation from an affordability standpoint? Do you feel that it might make the industry a little more vulnerable down the road, and people kind of think of the back half of '18 as a period where, after some robust price appreciation over the prior 2 or 3 years, you had a move in rates, and it created a slowdown? How do you think about those dynamics as it relates to where we are today?

Well, we're certainly sensitive to affordability. I keep referring to it as a simple math equation. People make so much money. They can afford so much of a mortgage payment, and they want to be a homeowner. So how do you make those work? The other influence, however, is how strong a demand level you have. And the stronger the demand, the higher up the income brackets you can go and still have plenty of demand, even at the higher price points. But as we look at it, '18 was a great example because you did have price, you did have interest rates, we responded pretty quickly in about a 6-month period. I call it a rotate left. We took all of our communities and repositioned the model parks to a little bit smaller houses and dropped our prices right back down. I use that as an example of how flexible and nimble we are to think we opened new models across the footprint in a 6-month period. And effectively, in many communities, we dropped our average selling price, about $15,000 to $20,000, doing that. So we're mindful of affordability when we approve a new investment. It still has to be attainable by the median household income in that submarket. And once we open, we'll be opportunistic and take all the price we can, but we're watchful of any signs that it's slowing. And when we make new investments, we put it right back down at the median household income levels. So we think we're well positioned to take advantage of this and not -- if prices run a little bit, we'll still be fine.

Right. Okay. Great. Being -- with that said, I mean, you kind of highlighted, I just mentioned, you kind of referred to sort of a pivot that you made in the back half of '18 a little bit against a move in rates. Certainly, everything, all the stars are aligned today. What would you think would be the couple of areas that investors should think about in terms of risks to the current demand profile, be it rates, be it other potential flies in the ointment, even potentially supply coming back online, which I think, when you think about the tightness of the secondary market, clearly, it appears that there's some flow over from the existing home sale market into the new market because there's simply not a lot of supply today? So what would you feel are the top 2 or 3 risks to demand that we're seeing currently?

I think the demographics of demand, the millennials, the Gen Zs, all the buyers that are out there, and it's still a very large age cohort that hasn't been served yet, I think that's going to be a driver for quite some time. Consumer confidence influences it and incomes influence it. And right now, I think demand will stay strong for quite some time. The watch out for us is do you price past affordability, and do you have to correct. On the inventory side, it's a pretty incredible dynamic right now. The national numbers will be a 2-month supply resales or 1.5 months. Most of the markets we operate in, in particular, at our price point, the inventory is quoted in a number of days, 3 days, 5 days, 7 days, 12 days. And when you have that kind of an inventory situation with the demand, this combination could run for a while. But I would suggest the investors keep an eye on inventory levels, not the national headline, but what's going on in each of the cities that a company operates in and watch the inventory level and, in turn, the price spread between new and resale. And it was the classic supply and demand on the resale side, when supply dried up, prices moved. And in some of our submarkets, resale was priced higher than the new home side, and now that's moving back into equilibrium. Historically, you get a 10% to 15% premium over resale. And with no inventory on the resale side, prices move up. We keep that kind of a spread, and everything will be in balance. But I would keep an eye on inventory and the price spread, new and used.

Great. Maybe on the topic around affordability and price spreads and different types of products. During the past earnings season, we had one builder talk about the fact that in some markets, their products are going a little bit above the FHA loan limits, the homes that they're selling. Cited even some markets in California, maybe Pacific Northwest. In general, the comment from the builder was it's not an issue at this point. There's an ability to either shift into a conventional, put more money down. I was curious what you're seeing in your business in this realm. Number one, if you can just remind us what percent of your buyers use FHA. And number two, if you can give us a sense, if you have it, roughly speaking, what percent of the homes that you're selling today are perhaps above the FHA limit and if you view this as a risk or a potential issue.

It's certainly not an issue today at all. It could be if the markets really tighten up because, normally, FHA provides liquidity to a buyer that is a little more challenged, in particular, a first-time buyer. But I shared some statics on our last earnings call that, to me, were interesting and speak to how strong demand is today. 65% of our deliveries were to first-time buyers, the highest percentage we've had in many years. Our average LTV was about 87%. So these first-time buyers, on average, were putting down 13%. With our ASP, that's about $50,000. That's not an FHA buyer. So putting down $50,000. FICO scores were around 720. This is an incredibly strong first-time buyer cohort that we're dealing with today. As a company, in our book of business, about 25% to 30% is FHA. That's been coming down over the years, in part, because FHA has an extra mortgage insurance premium that pushes the payment higher than a conventional loan. So if people can qualify for the conventional loan, they get a lower interest rate. It's kind of backwards with what FHA has normally provided for that borrower. So if we bracket the median income, our product is typically available to FHA. I don't have a percentage, but it would be the majority of our communities today are priced within FHA range, but our buyers aren't using it today. We're very heavily conventional.

Right. Thank you for that. And I think that's different than maybe 5 years ago, where you would see -- you would have seen a higher level utilizing FHA.

Yes. There were years our government percentage, FHA and VA, was 70%, 75%. So it's down significantly from those years.

Right, right. Maybe shifting a little bit -- we're maybe about at the halfway mark, maybe coming up to it. And again, I'll remind our viewers that if you would like to ask a question, feel free to click on the Ask a Question function. I'd be happy to pass them along. I'm not used to being in a position where I get to ask question after question after question, not your typical earnings call. But maybe shifting a little bit more towards KB specific. Obviously, the FHA question was as well. But kind of bigger picture, I wanted to just shift gears a little bit, could you talk about your geographic footprint as it stands today and the market share that you have within that? And maybe talk about where you think you are, where you want to be in terms of, let's say, top 5 market positions, where the opportunity is as you see it going forward over the next 3 to 5 years from that perspective, where the opportunities are, how you see yourself over the next few years from a growth perspective, a growth opportunity.

Sure. Well, for starters, Mike, we like our footprint today. We're in about 35 cities around the country, predominantly the Sun Belt, all fast-growing economies, mostly builder friendly, but good environments to be a homebuilder in. We have a stated goal of being top 3. Top 5 is a stepping stone to get there. And all those numbers got blurred, if you will, with what I now call the pandemic speed bump. And you'll see our share continue to grow as this year evolves based on our sales rate and where we're headed. But internally, we -- our approach right now is to go maximize our scale and our market share in these served markets and, at the same time, do a few bolt-on cities where we can grow a business over time. That will be a nice supplement to the current footprint as our business matures. And a good example of that would be Seattle, which we entered without a lot of fanfare a few years ago. It's now solidly profitable. It's a meaningful contributor. It was profitable in its second year. We're now in our third year, heading into our fourth year, and it's a real contributor to the company. And we just announced over the last 6 months, we entered Charlotte, which -- big market. We were there once before. We like the market, and it's a follow-on to Seattle where we can have this supplemental growth, while we really push for share in our served markets. And the markets that we're in today, without Seattle or Charlotte, at the peak, we did about 25,000 homes, the previous peak back in '06, '07. So we think we have a lot of upside where we're at. It's the best way to grow, is the organic growth in your served markets. As long as we can sustain that, we'll keep bolting on a couple of cities here and there to continue to expand the footprint while pushing the top line.

And on the top 3 goal, how many of your markets are you top 3 today? And I don't know if you know or feel where you can be in terms of that number 3 or 4 years from now.

Well, it's a goal across the footprint. If we can't get to scale, we don't want to stay in the market. I actually don't know the specific number that are top 3 or top 5. As I said, it all kind of blurred, and it's now settling back out. I would guess a handful are top 3. So it tells you we have a lot of upside to get to that kind of a scale in the markets we're in, and we have a strategy to get there in every market. So it's real upside for the company right now.

Okay. Great. I wanted also to shift to capital allocation a little bit. Over the years, KB has engaged in share repurchase. I don't believe, correct me if I'm wrong, if it's been as prominent in the last 2 or 3 years. But with your debt to cap right now around 30%, net debt to cap, pretty strong balance sheet, obviously, debt paydown has continued to be an area of focus, how should we think about share repurchase going forward over the next 3 years? I believe we -- my notes say here that it's been a fairly minimal amount over the last 3 years. So how can debt repurchase -- I'm sorry, share buyback, how does that figure into KB's capital allocation strategy going forward?

Sure. As you know, Mike, over the last now 4 to 4.5 years, we've generated incredible amount of cash and really strengthened the balance sheet. Started with our returns-focused growth effort. Now moving forward, still focused on returns, growing the top line and continuing to expand our operational cash generation. We have a balanced approach. We keep sharing that priority #1, grow the top line, quality growth, grow your revenue, grow your profits, and that's what we're doing and investing in that. But within the balanced approach, you touched on it, we've continued to delever. Whether it's reducing debt or growing equity, our ratios will continue to improve. We've increased the dividend twice in the last couple of years. Strategically, I think it's good to align with about 1.5 yield, and that's what we're close to right now, and we'll continue to do that. And if we generate a lot of cash and fuel all our growth and continue to delever, we may look at share buybacks. It's not in the short run. Right now, we're focused on primarily top line.

Okay.

Good news is we have the ability to do all of the above, and we'll continue to be balanced in what we do.

Okay. Great. I have a couple of more. I do want to pass along a question from the audience, though. Question is around lumber prices. The question is, are you seeing any weakness or relief on lumber costs as futures have begun to come down?

It takes a little while for the future price to bleed through to what you actually pay at this time. And in our markets, we have a different pricing calendar and time line in each of our markets to balance out the lumber cost movements across the whole footprint. As you know, the lumber futures peaked at around $1,700 a board foot. They're back down to $1,300, and they've come down 6 or 7 days in a row. So I do think we're past the peak in -- with this product. And I'm hearing anecdotally about supply starting to grow a little bit. So if supply is coming back, pricing is coming down. I think you're seeing it come back in the equilibrium. We never took the full hit up to $1,700 a foot because of how we buy our lumber, so we didn't get that back. And over time, we expect to see it to come back down. But hopefully, knock on wood, the worst is behind us right now on lumber.

Great. Maybe shifting gears a little bit to some of the bottoms up or demand level trends. I wanted to hit on sales pace for a moment. Your absorption rate at roughly 6 per community per month is actually at the high end of the industry. Do you view this as sustainable? And do you think, if you restrain this pace, you'd be able to achieve more price and further improve your margins and returns?

A couple of thoughts, Mike. We just got done talking about affordability, and we are sensitive to that. So I don't know that we want to expose the communities to push price too far. Our stated goal right now is 5 a month on average. And so if you're going to average 5 for a year, you'll do a little more in the spring, do a little less in the winter months. If the opportunity is there to push above that in a community with a lot of lots and an above-average margin, we'll push the pace along the way. We'll take advantage of the opportunity. But in our view, the sustainable expectation would be 5 a month over time. Opportunistically, you may go above that, like we're doing in this incredible demand environment.

Okay, okay. So then, I mean, when you think about the levers to growth, I mean, classically, you think about sales pace and community count growth and number of stores and the number -- and the amount you can sell through those stores. So if you're indeed kind of at the higher end of your sales pace spectrum, turning to community count, you've mentioned that on your last earnings call, you expect community count at -- by FY '21 end to be up single digits year-over-year. For '22, you're targeting at least 10% growth. Is something in a 5% to 10% range a good way to think about KB over the next few years just given your lot position and your current land purchasing plans?

I'm not going to reaffirm our community count, or Jeff and Jill will give me a virtual kick through the computer, for this year. But what we shared on our call, Mike, we already own everything for '22. We're investing in '23. Our community count queue is just like it was at our last call, and that is our primary growth driver going forward. We shared on that call a minimum of over 10% next year. In the meantime, don't forget about the backlog position we have. Our backlog at the end of the quarter was up something like 50% year-over-year. So you have a very large backlog that you're converting to revenue. You're continuing to grow the backlog with our current sales pace, especially here in the second quarter where you had the pandemic comp last year. So you have a large backlog you're going to end the year with, you grow your community count, and then you go from there. So we expect at least a 10% community count growth going forward, not just '22, '23 and beyond. If we get that community count and you get a little ASP mix, your revenue growth should be around 15% a year. And that's -- strategically, that's the minimum we want to go achieve.

Great. No, thank you for that. That's helpful. We're kind of winding down on questions. I don't believe there's more in the queue. I'm going to ask 1 or 2 more and then let you go on your way. I think a basic one -- look, obviously, it goes without saying, and we've said it a few times already, we're in a very, very strong environment today. Both demand, supply, the lending backdrop is good. What keeps you up at night over the next couple of years? I mean, obviously, there's a lot of execution that needs to be done, but that's kind of your day-to-day. I mean execution is a constant requirement. What are the things that "keep you up at night" that -- either on an industry level or a company-specific level that you feel are the top couple of areas that you really need to make sure you have your finger on or be able to react to that could change what you're seeing today?

I spend a lot of time on making sure we have quality profitable growth. It takes a lot of people to grow your top line, a lot of senior people, I'll say. You need good management development. You have to keep expanding your bench. So that's one of our top challenges right now. Which markets to enter, and is it the right time, and how do you enter it is taking up some of our time right now. And third for me is take advantage of this opportunity, grow the company, but be mindful that we're in a cycle, and make sure you're positioned to thrive if things slow down. And that would really be the top 3 for me today.

Okay. Great, great. Maybe one last one, and I'll let you guys go. Wanted to ask around the move-up buyer segment. I think Jill, in her prepared remarks, talked about the exposure to the first-time buyer and, I believe, well over 60%. How does the move-up buyer figure into your plans over the next few years? Do you see your demographic exposure changing at all? And if so, would that be by design or more just reacting to the market?

The saying I like to use, Mike, is that we move with demand. You think about our business model, we have these broad -- a broad array of footage and price in every width. So depending on how the market environment is, you offer bigger homes, you offer smaller homes and you move with the market. But when we're targeting the median household income in that submarket, you're catering to the largest demand segments. And today, the largest demand segment is 80 million millennials and 70 million Gen Zs, that's 150 million people that are going to want to buy a home. And I would expect our mix to continue to tilt toward that buyer cohort. Over the years, there's been years our move-up mix was 50%, 60%. It moves with the market. We can move up and down, depending on where the strength is. So it's part of why we don't say we want to be a first-time homebuilder or we want to be a move-up homebuilder. We want to be an affordable builder that personalizes homes and is attainable for the median income in that submarket. Now whatever buyer shows up, we'll take it. But right now, I would expect first-time buyers will continue to be a large part of our mix for quite some time.

Great. Great. Well, that really does it for me. So I'm going to conclude a couple of minutes early, but I think that covered a lot of ground. And again, I wanted to thank KB Home, Jeff, Jeff and Jill, the 3 Js. I appreciate the time, and I appreciate -- and it really does -- it's not lost on me. There's a lot of -- a lot that's put on to a schedule every quarter, and I appreciate you guys making time for us. And we will -- we'll be taking a break. We'll be going into the kind of a lunch break, and we will resume at 1:15 with one of our few building products companies presenters today, Trex Company, followed by a few other builders as we progress through the day. So with that, I'll say thank you, again, and we'll see you again a little bit later.

Thanks, Mike. Glad we could join you.

Thank you, Mike.

Thanks, Mike.