LGI Homes, Inc. (LGIH) Earnings Call Transcript & Summary

Great. Good morning, everyone. We are continuing our 13th Annual JPMorgan Homebuilding and Building Products Conference. We're thrilled to have with us LGI Homes. We have CEO, Eric Lipar; and CFO, Charles Merdian. My name is Mike Rehaut. I'm the senior analyst for the homebuilding and building products sector for JPMorgan, coming on 18 years now. And this is our first virtual conference in the new world, I suppose, you could say. But we're thrilled with the lineup. Attendance is up significantly. Obviously, it allows many more people to participate and join in. And so we thank everyone for signing up and all the company participation. Like I said, we have LGI Homes here. This is going to be a 35-minute session, so it will end around 10:20. I think to kick it off, the team at LGI has prepared some slides just to walk through and give people a sense of who the company is, what they've done over the last few years. Then I will join in with a few questions. And then we'll turn it over for -- and I'll moderate and field questions from the audience. We have an Ask a Question link so you can post questions, and I'll pass them on to the management team. With that, I'll turn it over to Eric and Charles.

Well, great. Well, thanks, Mike, and we're excited to participate in today's virtual conference. And before we get started, we hope everyone listening in and their families are safe and healthy given these unprecedented times. Like Mike said, we're going to cover a few slides on our history and then also cover what we've been doing related to COVID-19 and then turn it back over to Q&A. So my name is Charles Merdian. I'm here with Eric Lipar, our CEO. And let's just dive right in. We are on Slide 4, LGI Homes at a glance. We were founded in 2003 in Conroe, Texas, which is just north of Houston here where we're headquartered. We are now the tenth largest homebuilder in terms of homes closed. And we are focused on the entry-level homebuyer, where we build quality homes at affordable prices. In the last 12 months, we've generated $2 billion in revenue, closed 8,297 homes, and we've averaged 6.8 closings per community per month across the nation. We've also delivered strong returns, 23.8% gross margin and 25.9% adjusted gross margin and a 26.4% return on average equity, which has been consistent over the last 5 years. We now operate in 18 states across 34 markets. We owned or controlled over 50,000 lots, and we'll cover a little bit later on what we've been doing since March. And since our inception, we've now moved in over 35,000 families. We've experienced rapid growth. In 2010, we closed just 439 homes in Texas. And since our IPO, we've now increased our annual home closings growth at a rate of almost 30%, achieving 7,690 closings in 2019. We've also increased our revenues from just $55 million in 2010 to $1.8 billion in 2019, a 40% growth rate since our IPO. We operate in 34 markets. We started in Texas. We're now in 18 different states. And at the end of April, we were in 115 communities across the country. A little bit of highlights of our business model. We're an affordable alternative to renting. Our target consumer is renters and first-time homebuyers. We also operate under a 100% spec strategy. We have move-in ready inventory. Our goal is to maintain between 4 and 6 months inventory in either completed or homes in process in every one of the communities we operate in. We also staff our offices with 2 to 5 professionally trained sales reps in each office. And we have a unique and highly successful marketing system that's been proven to convert renters into new homeowners. We also have a superior homebuilding and land acquisition strategy. We are a systems-based company. We follow standardized processes. Each of our employees have a manual to reference for each of their positions, and we also conduct extensive and comprehensive training. Over the last 5 years, we have achieved record-breaking results, and 2019 was no exception. You can see here, since 2015, we've increased our average active communities, at the same time, increasing our average monthly absorption rate, going from 6 closings per community per month in 2015 to 6.7 closings per community per month in both -- in all of 2017, '18 and 2019, doing this while also increasing average sales price by almost $60,000. We've maintained our margins and improved our operating leverage, improving our SG&A ratio from 13.8% to just over 11% in 2019, resulting in pretax net income ranging between 12.6% and 13.6% over the last 5 years. Taking a look at our strong balance sheet. Ending March, we had $118 million in cash, $250 million in liquidity. Our net debt-to-cap ratio of 42% was the lowest net debt-to-cap ratio in the last 5 years, so very strong leading into COVID-19. We had $750 million outstanding in our credit facility and our senior notes, with $300 million in our senior notes due in 2026. And we've also been reinvesting in the business. You can see in our retained earnings line item, we've earned $650 million in profits since our IPO and have reinvested that back into the business. Just to touch on a few of the things that we've been focused on in response to COVID-19. And obviously, our first priority was the health and safety of our employees, customers and those we do business with. We made a number of changes in our field -- in the field, particularly related to office hours and staffing. Now we also changed our strategy in how we work from our corporate office, our corporate personnel working remotely, really focused on making sure that we're following all state and CDC guidelines. Our second action was to focus on cash management by delaying or canceling the majority of our land acquisitions, pushing them further out, deferring our April starts, which reduced our average inventory from 3,600 units in March to 3,100 units by the end of April. We significantly reduced our marketing spend, canceled a number of group meetings, travel and delayed major expenditures. With that, I'll turn it back over to Mike, and we'll open it up to Q&A.

Great. Thank you, Charles. I wanted to ask 2 or 3 questions. We already have some questions coming in from the audience. But let me start off with one of the last comments you made with regards to adjusting to the current environment. And you said you delayed some starts in April due to the uncertainty. You typically -- you had said earlier in your remarks that you -- in normal environments, I guess, like to maintain a 4 to 6-month inventory of homes. You have a model that's 100% spec. That's worked well for you. You've managed that model well throughout the years. How has the actions that you've taken, beginning with the pandemic outbreak, how has that changed your month-supply of homes that are out there? And given how trends have progressed over the last several months, where would you say you are in terms of your spec production today versus delaying and pushing off earlier? Would you say you're back to 50%, 75%? So kind of a 2-parter there, I apologize. But one is where would you say your month's supply of homes is as a result of the actions earlier? And how are you operating today given some of the improvement that we've seen over the last 6 weeks?

Sure. Great question. So we ended March at 3,600 units. We also mentioned on our earnings call that we expected May to be between 500 and 600 closings. So using 500, we reduced our inventory from 3,600 to 3,100. So can use the 500 number, that gets you roughly about 6 months. And if you use the 600 number, that's roughly 5 months So we feel like we've rightsized our inventory very quickly by just delaying 1 month of starts And then it's really been a week-to-week response depending on kind of how weekly sales have been going in terms of evaluating what our next steps have been. So we've made our selections for our May starts. We also have a pretty efficient build process. We build between 75 and 100 days. So having a sufficient number of inventory is still available. Meaning, 3,100 units is still a significant number of inventory. We feel like we can adjust quickly, also keeping in mind the uncertainty between how the reopenings are going, paying attention to which geographies make the most sense to get operational back to the new normal essentially quicker and then just evaluating it from there.

And I guess it's one of the first questions that people will ask during one-on-ones and individual meetings, we had a -- one of the builders this morning preannounced pretty encouraging results or anticipated results for May, being closer to flat year-over-year and even April results being better than they expected. You just alluded to your May -- expected May closings range of 500 to 600, any -- given the recent trends and what -- if you were to extrapolate from the builders pre-announcement this morning, continued positive results over the last few weeks, any directional update that you might want to give in terms of -- or just directionally how you're feeling about that 500 to 600 range? If you would extrapolate again from this data point this morning and might push many people to think towards the higher end of that range, but I'll let you speak to that.

Yes. Mike, this is Eric. I can speak to that. First of all, talking about the closings. The 500 to 600 number that we gave for May for the closings, we are right on track for that. Sales over the last couple of weeks won't influence that number since the May closing number is based on March and April sales. So that's one answer to your question. The other aspect of your question and similar to the pre-announcement this morning is what is sales trends looking like. And we talked about on earnings call the last of March was really the low point, got a little bit better in April, especially the back half of April was better than the beginning half of April. And then we even gave an update, the first weekend of May was the best since the beginning of March. And that trend has continued. The last 2 weeks have been even better. So we've had 3 straight weeks of improving sales. We have been, I think, pleasantly surprised how strong the demand has been over the last 3 weeks. And I think it stems from customers really wanting to get out of that rental situation, especially those living in a denser environment in apartments. We are still not spending our full allotment of marketing dollars and being conservative with that. But as states have reopened, we have definitely see increased demand over the last couple of weeks.

Great. Thank you. Another, I think, area of focus that investors will have over the next few months is the credit standards that are out there, the mortgage credit standards. One of the big drivers of -- as you've described to me over the years, your sales pace or your closings rate has been credit standards. The ease and availability of your customers, which are typically entry-level renters, these are people that are more economically sensitive, that are dependent on USDA, FHA, VA loans primarily, and certainly a bit more sensitive to changes in credit standards. So I was hoping to get a sense for how the changing standards -- we've read about them over the last several weeks, how they've affected your buyer. And if it's affected -- I mean, by the sound of it, you certainly had some improvement and continuing improvement. But just curious how the mortgage credit environment plays into your business today and if you think it might impact it in the future.

Yes. Great question, Mike. This is Eric. And certainly, very importantly, when you're dealing with first-time homebuyer, entry-level buyer, someone that's currently [ rent ], the ability to get mortgage financing is important and probably always will be important. And when this pandemic first started, we saw some severe tightening in mortgage standards. We weren't that concerned about it because sales really dropped as well. But similar to sales trends, the mortgage trends have been positive as well. So the mortgage availability for our customers has improved. The qualifying standards are not back to where they were pre-COVID-19, but they're almost there. The credit overlays and the increased credit scores, those are dissipating. Some of the state bond programs are coming back available. And also one thing that's also important in this topic is interest rates remained historically low and even lower today than they were 60, 90 days ago. So that's a real positive for us. Now there is the offset of all the furloughs and all the job layoffs. Those are a negative to all of us in the business, and we certainly lost customers because of that. But we're seeing a lot of strength for the customers that still have employment. That desire to get into homeownership is at least offsetting a lot of the challenges with the job situation.

Right. No. It's very helpful. I think another area of focus for investors on the homebuilding side is the current state of pricing and incentives in the marketplace. Coming out of the first quarter conference calls over the last few weeks, the common refrain from the homebuilders were that prices have been more or less steady. Incentives have gone up a little bit, but perhaps more so in certain instances where there are higher levels of spec inventory. So just want to try and get a sense from yourselves, if you could give us an update there. And how incentives have or have not perhaps played a role with your sales trends? And what are you seeing out there in the market?

Yes. Great question, Mike. Yes. Incentives, just like we have always managed to our business, are not a big part of the LGI sales process. So we are not offering additional incentives and don't feel like we need to do that. When this situation first started, we wanted to be cautious and just see how everything played out. And since that point, we're seeing strong demand. We don't feel like we have a lot of excess inventory or is there a lot of excess supply in the market via resales or other builders. And we have heard and seen and heard other builders talking about doing additional incentives, but we're just not in that position and don't like to do it in our communities. So we have not offered any additional incentives at all. In fact, in April, for our second quarter, we raised prices in the majority of our communities.

And that was in April?

Yes. We do quarterly price increases and look at pricing every quarter. So in April, we raised prices in the majority of our communities.

Right. Okay. No. That's obviously very encouraging. I guess let me turn it to some of the questions from the field, from the audience. A couple of questions around Houston specifically. Obviously, a lot of news around oil prices and the potential impact of the sharp decline in oil prices. And I suppose eventually, if it hasn't already started, any -- although it's been, to be honest, pretty quiet on that front as far as I could tell, maybe you could give us some insights there. How that might affect employment rates and the broader economic health of the market? So if you could just kind of give us a specific update around Houston itself, again, how the recent volatility in oil has or has not impacted the local economy, and in general, what you're seeing.

Yes. So I can start. So we have -- obviously, we have a long history here in Houston being -- starting our business in 2003. And so we've seen a number of cycles over the years, and what that typically has done is enable us to maintain a consistent absorption ratio in all of our communities. So whether it was the last time that we saw oil prices declined in 2014 and 2015, we've maintained consistent closings per community across our Houston markets. Now this one happens to be a little different because it's not isolated necessarily to one particular industry. But a couple of things for us. Houston is a large geographic area. so most of our communities are pretty well distanced between them. So one particular isolated industry isn't necessarily going to negatively affect all of our communities. So we've seen consistent demand in terms of what we would expect and what we're seeing across other markets in terms of response to our marketing, which has been positive. And then there's offsetting industries such as the health industry, the medical field in Houston that is helping with that, and then certainly, some of the other industries that are spread out among the market. So we haven't necessarily seen it in large numbers in terms of a particular area or a particular submarket of Houston that is being hit -- outsized more than the others, but we are seeing demand come in and customers show up in our offices a weekend, so.

So to paraphrase your answer. Consistency so far, not -- no red flags as of yet?

Correct.

No. Sales have been good in Houston over the last couple of weeks. So no impact as of yet. No negative impact at least.

Right.

Great. We had another question from the virtual audience around your balance sheet. You highlighted, Charles, through the slides that your net debt-to-cap is below as it's been for several years. Still though, as the questioner accurately poses, it is still higher than some of your competitors. Obviously, LGI is a little different positioned in some of the larger competitors in that you're much more of in a growth trajectory. So the balance sheet is going to be adjusted for that and primed for that. But either in the current environment or over the next 2 or 3 years, maybe you can answer in both context. What are your goals for your leverage? And how do you see -- where would you like your leverage to be in the shorter-term and over the next few years?

Sure. No. Another great question. So I think since our IPO, our target leverage was around 50% in terms of gross debt to cap. And we typically have maintained not very much cash on our balance sheet and managed it through our revolving credit facility. And really, it depends on the real estate inventory. We manage the debt through what we buy and how we look at what we maintain in inventory. Like I mentioned, 3,600 units at the end of March makes up a significant balance of our real estate inventory in vertical construction, which we've really proven over the last 30, 45 days that can be monetized fairly quickly. If you go back to our balance sheet slide, we ended March with a similar inventory balance, just under $1.5 billion, so [Audio Gap]

You're frozen...

The revolver by keeping an eye on how much we have invested in our inventory balances. So as far as the target ratio, again, going back to where we've been before at kind of [Audio Gap] approaching, using the credit facility and the senior notes and really getting to a point where our scale and our size was enabling us to fund the majority of our growth through our operations, so through our earnings and reinvesting most of the growth through our income that we were generating. So I would expect that we would see our net debt-to-cap stay somewhere in this range. It's going to depend a little bit on how quickly we come back in terms of going back to those deals that we either deferred or canceled or how quickly the recovery is. If it's a faster recovery, we may see that number tick up a little bit so that we can finance it and take advantage of going quicker. If it tends to kind of stay with what we're seeing right now, then we'll see a little bit more of a measured approach in terms of balance sheet management and maintain it somewhere in the current range that we're at today.

Okay. So again, just to make sure I heard you right. And at least from my end, I don't know who's from the audience's end as well, but you froze for a moment or 2 during that answer. So just to make sure I heard it correctly. Your -- the current leverage range is where you're comfortable at. It could even go up a little bit, closer to the 50%, to the extent that the environment normalizes. But otherwise, you wouldn't -- you don't necessarily, at least today, given what you're seeing, have a goal to lower it further.

Correct. That's right. Great.

I have a couple more questions. And then I think we're about 8 minutes out to wrapping up the session, so I think it's gone well, and we still have a couple more questions to go. One area, I think, that's come out of this downturn, obviously, is a pretty strong focus on not just pricing and incentives, but price point. You guys have always positioned yourselves for the entry-level buyer at an affordable price. How have -- have you seen any changes in mix? Obviously, within most of your communities, you offer a range of, I believe, about 5 different price points within each community. I'm curious if, over the last 6, 8 weeks, there's been any shift within your communities further towards the low end? Just what we're hearing from other builders is, on a broader basis, that the entry-level buyer has remained the more vibrant part of the market. I'm just curious, within that -- if within that lower price point or entry-level buyer's range, if we're still shifting -- if we're shifting down a little bit just given the pressures on the economy, et cetera.

Do you want to take it?

Yes. Yes. Sure. I'll take the first shot at it. So I think the majority of our communities experience the most of the closings. We do offer 5 floor plans typically in a community, but the majority of them are always slanted towards the bottom range anyway, right? That's historically where we've been on a community-by-community basis. So I think part of what we're seeing, as Eric mentioned, having historically low interest rates has helped. I mean I think that when you have a combination of rising prices and rising interest rates, we typically would see more of a shift because most of our customers are coming into our offices, and they're looking to buy the most home that they can afford within their budget, whatever that may be. So they may come in and look at the first most affordable plan and then move up to the second plan or the third plan, depending on what meets the needs of their family and what they're looking for. So I don't know that we've necessarily seen a noticeable shift. I think some of that we drive ourselves as well in terms of which plans we select, because we're building by spec, we typically will have what's available in inventory based on what we've started. So it's a little bit more driven by what we have in inventory to some extent as well across the different communities. So I would say, so not much -- not a significant shift in terms of directly related to affordability, and I think that's a good portion, offset by the fact that interest rates are low.

Yes. And I can add a little bit to that, Mike. I think Charles is right on. Interest rates are helping. Customers tend to put a lot of emphasis on what they qualify for as far as that monthly payment being so important. And I think they usually buy as much as they can qualify for within reason. But the other thing that I think separates LGI that we're comfortable with is we build a lot of houses on 1,100, 1,200, 1,300 square foot in the communities. And that seems small relative to our peer group, but someone living in a 800 to 1,000 square foot apartments coming into a new home that's 1,200 square feet, 3-bedroom, has a yard, has a garage, that is a big upgrade for that customer.

Great. Another question from the field around construction cycle times. There -- you could argue, I mean in the early days of this outbreak, there were some -- there was some disruption. I mean certainly, new residential construction being deemed an essential activity across most states, I think, preserved that the ability to continue to construct homes. But still, I believe there were some levels of disruption out there in the early days. I was wondering if you could characterize how construction and construction cycle times are today? Are they comparable to before the outbreak? Are they 50%, 75% or are they even better given perhaps an overall reduced backdrop in demand over points and people are looking to work and continue to get out there? So any color around the construction backdrop would be helpful.

Sure. Yes. We've seen very little impact to the overall construction cycle. I would agree with you that first week, maybe into the second week, there is everybody getting used to what they could and couldn't do. But I think a couple of things that worked to our advantage as well is that, because we have a very systematic approach to our construction schedules, we have limited number of trades in our houses at any one point in time to begin with. I think that helped manage the social distancing rules as well. I think the other thing that we focused on by eliminating April starts and really kind of focusing our attention on the homes that were already under construction, particularly the ones that we're delivering, quickly enabled us to really just manage the process in a way that eliminated any delays we see. We have great relationships with all of our trades. They've been really great to work with along the way and just really haven't seen any disruption to any of our cycle times.

It's great to hear. One last one and I think that will do it for this session. So again, thanks. Thanks again. In your history, I believe you've done one, correct me if I'm wrong, one relatively small acquisition. Certainly, at least for a period of time, there was some real disruption in the industry. So -- but -- and a lot of capital, land spend, deployment-type plans were kind of put on hold. But at -- to the extent that things continue to normalize, maybe you could talk about -- and we don't have that much time left, so maybe a brief answer, if you could. How are you thinking about M&A if you actively look at a pipeline and if M&A could play a larger role than in the past? Or are you more content to grow as you have been?

Yes, Mike, great question. I think we're more content to grow as we have is the short answer. We've made 2 very small acquisitions, Oakmont Homes, which I believe was 2014; and Wynn Homes, which was 2018. So we made 2 small acquisitions, both in the Carolinas. And when we look at a company acquisition, unlike some other builders, we're not looking to buy their systems. We're not looking to buy market entry. We're not looking to buy their people. It's really just looking at the land value and the assets and looking at it from a land acquisition standpoint. And those type of purchases really work well in a distressed environment. And depending on how your outlook is over the next 6 months to a couple of years, maybe there'll be some opportunities like that and maybe there won't be. But we'll be players in the M&A space and more of a distressed market for somebody looking to get out of a personal guarantee and focus on small private builders would also be the only focus we have on M&A.

Great. I appreciate that. And that brings us to the end. So I want to thank again CEO, Eric Lipar; CFO, Charles Merdian of LGI Homes. Really informative. Great update on the business. So I want to thank you very much. We will resume the conference at 11:00 a.m. Eastern Time with Taylor Morrison. Thanks again, and we'll see you at the top of the hour.

Okay. Thank you.

Thank you.