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

Good morning, welcome to the second session of our first day of the 14th Annual JPMorgan Homebuilding and Building Products Conference. My name is Mike Rehaut, and I'm the senior analyst covering the homebuilding and building products sectors. And we're excited to have with us LGI Homes, Chairman and CEO, Eric Lipar; and CFO, Charles Merdian. I want to thank LGI for participating, and it's always great to have you. We've followed LGI since their IPO back in 2013. And it's been a tremendous story, a unique business model that's succeeded consistently since their IPO. And I think it's a really testament to the process-oriented approach that they have as well as their unique approach, which I think also allows for a good market position that I think is very differentiated. So I'm going to turn it over to the LGI team. There are some slides that are available on the website that they'll be talking off of. Then I'll have some questions of my own. [Operator Instructions] So Eric and Charles, the floor is yours.

Thanks, Michael. We appreciate the opportunity to be with everyone today. I'll make some high-level opening remarks, I'll turn it over to Charles to go through a few slides before we turn it back over to yourself for questions. So a brief history of the company, I think most people are familiar with this, so I'll be brief. But we started homebuilding in 2003 with 1 community in Conroe, Texas, stayed relatively small, got up to about 4 communities pre-downturn, closing 300 to 400 houses a year. The downturn created opportunities for us. And that's -- also at the same time, bank lending went away. So 2010 to 2013, we went to private equity group route, raised $50 million from a company called GTIS out in New York, really helped us grow the company to 1,000-plus closings a year, helped us expand out of the state of Texas and was able to buy finished lots in markets like Phoenix, Atlanta, et cetera. Like Mike talked about, big day for LGI, November 2013, we went public at $11 a share. Since that point, we have taken that capital and the ability to expand as a public company and taken our closings from 1,617 in 2013 all the way to 9,339 last year, making us the tenth largest builder in the country, currently operating in 35 markets across 18 states, have about 1,000 employees and built 45,000 houses since our inception. One of the things that I think we're most proud of is our systems and processes, really a systems-based company that Mike talked about. The way that we operate, the processes we have in place, the way that we train our people, exactly the same way we've done it since 2003 and the same way we've done it since 2013 as a public company. And I think the results speak for themselves as far as our consistent margins, our consistent return on equity and our consistent absorption paces. So with that, I know a lot of people want to talk about the current market and what we're seeing. Same process, same systems in place, very strong demand environment. We're dealing with a lot of inflation, obviously, lumber prices, et cetera. We're continuing our philosophy of raising prices to offset those costs and maintaining consistently high gross margin as with our guidance. So with that, I'll turn it over to Charles for a little bit more detail on the financial side of it.

Great. Well, thanks, Eric, and good morning, everyone. And if everyone has it handy, flip over to Slide 20, will probably be the best talking point slide to just give a high-level overview. And to Mike's points, one of our hallmarks since our IPO, and even prior to the IPO, is delivering consistent financial results and grown substantially. So looking to Eric's point about -- since the IPO, 2014, we closed 2,356 homes. And last year, as he mentioned, 9,339. So we've seen substantial growth by growing geographically outside of Texas. And in 2013, we were -- about 84% of our closings came from the state of Texas. We've now significantly diversified going across 18 different states and 35 different markets. You can see on Slide 20, one of the other highlights, our average sales price has significantly increased over the last several years. And I'm sure we'll have a few questions about pricing this morning as well. But last year, averaging $253,553 for an average sales price, increasing our revenues to $2.4 billion last fiscal year and, on a trailing 12-month basis, $2.6 billion in revenues. Gross margins remaining consistent over the years. That's part of our philosophy related to being a cost-plus builder and how we manage around gross margin in terms of our pricing plus and how we build on a spec basis. Experiencing some operating leverage over the years, so as we've expanded geographically and deepened in our markets, we've been able to increase our management and senior leadership in the country. And now as we go deeper in those markets, we're seeing substantial operating leverage. We also talked on our last earnings call our efficiency right now in our selling expenses. We're spending less on marketing, about 40% less year-over-year this year on our marketing and advertising spend as demand has been very strong. Pretax net income over the last 12 months is 16.7%. So very happy with our results as we've increased our pretax operating margin first. We've also seen net income increase last quarter, earning $100 million. We've now earned over $1 billion in earnings since our IPO. So a milestone in the past -- in the first quarter and generating 13.7 net income percentage and on a trailing 12. I'll touch real quick on the balance sheet, that is Slide 17. So we can touch on kind of the balance sheet, to Eric's point, about taking our capital that we've raised at the IPO, deploying in the inventory. We've grown our inventory balance now to $1.6 billion, which is only about $50 million higher than where we ended the year and roughly $100 million -- and at the same time, earning over $300 million in the last 12 months allowed us to pay down debt. So our debt is now at just over $400 million, resulting in net debt to cap of 23%. So generating positive cash flow. 2020 was a year where we were able to turn our inventory quick, increased our inventory turns by 30%, now averaging 1.3 on our inventory turns over the last 12 months and, as you can see, our total equity now at over $1.2 billion. So with that, we'll turn it back over to Mike and open it up for questions.

Great. Thanks, guys. Appreciate it. I'm going to try and keep this relatively brief, so that there's some time for Q&A as well. And I certainly have more questions to fill -- more than enough questions to fill the whole time. So let me start off with a couple of industry-level ones and then drill into a little more company specific. First question, I guess, which is more of a focus for those focused on the entry-level buyer, which is your company in effect. We have heard from one of the builders this past earnings season that a certain portion of their home sales were done at prices and mortgage balances that were above FHA loan limits. So I wanted to kind of ask you around this, if you have a sense of, a, what percent of your business is FHA; and number two, what percent of those, if you have any sense, are done at mortgage balances above the FHA loan limits. And if you see this as a risk at all, how buyers are maneuvering around this line in the sand and how you think about it for the industry.

Yes, Mike, this is Eric. Great question. Yes, the vast majority of our first-time homebuyers buying from us is still FHA, 75% plus of our business. The overall percentage is coming down right now because of our wholesale business, it's 10% to 15% of our business. And then also, we are seeing some investor activity in our communities. And they tend to be more cash or conventional buyers. But of our core customer, that renter, it's predominantly FHA. And then if you put VA and USDA with that, then you're at 90% of our business. We have very little challenges with FHA limits, only in really the more expensive housing markets we run into that. And sometimes, even in the specific community, it's like the most expensive 2 of the 5 floor plans that we offer. So it comes up in California, Seattle, Portland, Denver, and that's really about it. Also, I think, important point is it's not a huge negative, partly masked by the overall market right now. But if we go above the FHA limit, which require 3.5% down, conventional financing at 5% down is readily available. In fact, your mortgage insurance is less expensive than FHA, if you have really good credit. So an additional 1.5% down payment, it's not a huge headwind as well if you do get above those FHA limit.

So in effect, is it fair to say that in those instances where you're above, the buyers typically have the flexibility to push for another 1.5% down and get the conventional? Is that what...

Yes. Yes. And just like underwriting, we look at the FHA limits when we're underwriting a new piece of land. If we're above the limits, we'll take it into consideration but not part of our factoring in decision on whether to buy that piece of property or not.

Okay. Great. Great. We typically have a question on industry level around demand trends for the second half. And it really doesn't apply to you because your closing pace actually typically gets stronger as the year progresses. So I'm going to push that one aside. But maybe just talk about production rates and supply chain management. For a company such as yourself, your whole -- what are your key attributes or key parts of your strategy, your approach, is asset turnover and moving through the land at a fairly rapid pace. How do you see the ability to continue to flex up supply chain shortages? All the builders are trying to obviously increase their starts pace. At points, you might sell ahead of yourself a little bit and you actually did that in this most recent quarter. How do you see the competition and the availability to keep that production rate high or even flex up where you need it?

Yes. It's a great question, Mike, and this is Charles. I can start. And I think you definitely saw in our first quarter results, the backlog which typically last year, in March of 2020, we had about 4,000 units under construction, either complete or in process, with just under 1,900 units in backlog. And this year, we saw a similar number of units in inventory with well over 5,000 units in backlog. So it definitely has shifted where the typical historical program of selling a customer a completed home and moving them in, in 30 to 45 days has definitely shifted due to the strong demand. So I think what we're evaluating in terms of our production capacity is, on a market-by-market basis, probably not a surprise to you, but for maybe some of the other investors listening in, I mean in Texas, we have the most capacity in terms of from a production. We've done it before. We've done, for example, in our Dallas market and San Antonio, we've run at a pace as high as 30 starts a month in a single community. So we can push that in select areas. Don't have as much ability to do it, like you said, given the supply chain pressures and labor pressures, but I think our system has allowed us to probably do a better job at that just because our trades have been able to ramp up with us. And then we just manage the supply chain as best as we can. We can't control delivery of windows or shifting appliances but make the adjustments that we can. We haven't seen a significant delay in delivery times across the country. We're pretty consistent in terms of our average build time, 75 to 100 days. It's about what we've been averaging our range this year compared to last year. So I think where we can, we'll push production up. And really, it's about -- pipeline management for us this year is if we can run at a pace of 10 in a particular community, then we're just scheduling it out and that's what we're going to run. If we can push that to 20 or 24 in a community, then we'll do that as well. So that's how we're thinking about it.

Great. Great. And that kind of leads me to the next question, which is around community count and you said managing your pipeline. Obviously, you noted on your most recent call that you expect 2022 community count to be similar to '21 end, and that midpoint is roughly flat with 2020 end. So how should we think about community count going forward? And obviously, to be honest, I was a little surprised to hear you comment on 2022 last quarter. So now, of course, we're going to say, well, what about '23. But I mean how should we think about the path going forward over the next few years, particularly as I think you recognize that sales pace is at a pretty elevated level today?

Yes, Michael, it's a great question. I think the concept of community count is really just timing. And I don't know if we're able to say challenges in the community count is one of those great problems to have. We're just selling out communities more rapidly. They're 8 closings per month per community in the first quarter compared to, I think it was 5.4 last year, first quarter. So we're running 40% to 50% absorption higher, and we just sell out communities faster. So it's all about timing. 2022 it looks like the community count is going to be similar like we talked about, because any new project that we're buying right now is going to be raw land. There's no finished lots available to buy or if there are, in a very unique situation, will be very competitive, and we're probably not going to win that bid and overpay for finished lots. So we're buying land right now for '23 and really mid- to end of '23 and getting into '24 community count. We're seeing good value. We're approving a lot of new communities. But that's a good challenge. We like the concept of not increasing community count just because we envision absorption staying strong. If absorption is slow, which nobody should want, our community count is going to accelerate. I mean we'll be at the high end of our range this year if absorption is slow or there are some bumps. And I don't think anybody really wants that. So if we keep at a similar pace, we're going to continue selling out communities faster and it's really just timing of getting the new ones open.

So is it fair to say then that the current plans that you have in place would support growth in '23 and beyond with sales pace aside? Obviously, you've had a pretty strong growth trajectory over the last several years. Maybe to look at it from another angle, your growth has primarily been achieved through geographic expansion.

Right.

How should we think about growth for LGI over the next 3, 4 years? Is it further markets? Is it deeper in your -- into your existing markets? Could there be more demographic diversity, which is -- an area that you went into, for example, Terrata Homes, kind of more of a mid- to high-priced product or at least relative to your basic product. How are the different ways should we think of growth for LGI going forward?

Yes. I think if you went to Page 10 or anybody, let's go look at Page 10 of our investor presentation, 3 ways that we grow: organically through our wholesale channel, LGI Living then also through M&A. So those are the 3 ways that we're going to grow. I think also it's important, Michael, and we're starting to talk to investors about this as well, is we're becoming a mature company. Our guidance is essentially to close more than 10,000 houses this year. Our goal is to get to be a top 5 builder. We think that's about 17,000 houses a year. But the growth, as you say, in growing community count and growing closings, that's not the #1 priority. I mean we plan on growing because we plan on taking advantage of opportunities as they come up, but maintaining our margin, making sure we're maintaining our returns for our shareholders, making sure our return on equity remains strong, don't go buy deals just to buy deals -- certainly, we could make bad decisions and grow community count. And that doesn't seem like a good idea to us. So I think that's a consideration we look at. And even now, the year we were going to close 10,000 houses, which appears to be this year with a community count guidance of 112 to 120, we thought we'd be closing 10,000 houses when we had 150 communities 2 or 3 years from now. So it's just so accelerated on the absorption pace. The market is still strong right now. If we go to our historical averages on closings, 3 years from now, we may be closing 10,000 houses with 150 communities, which is good community count growth. But at 6 closings a month, the math says we're going to close 10,800 3 years from now, which doesn't really get everybody excited, but that's how we look at it. Just stick to our process, stick to our systems, focus on returns and the closings of community count will be a result of that focus.

So with that being said, Eric, I mean, certainly, with 10,000 closings a year, that's a lot more mature than 2,000 or 3,000. What comes to mind is if you're not growing at all cost per se, which is obviously a more mature way of running a business than maybe other builders in past cycles, what comes to mind is other ways to potentially return -- to do with your cash, to do with your capital, if it's not being fully blasted towards growth. So obviously, everyone thinks in terms of share repurchase and maintaining a strong balance sheet but, certainly, share repurchase being part of that equation. How does that come into your capital allocation algorithm? And to the extent that you are inflecting, let's say, at this point and over the next 3 to 5 years, how should we think about share repurchases as part of that mix?

Yes. I'll let Charles talk about share repurchases. I'll just make the comment on the capital as far as land and also maybe on M&A. From a land perspective, we're talking to our acquisitions team about this. And going back to my previous comment, let's make sure we're making great decisions. Right now, it's competitive, more builders are looking at entry level, more builders are looking at further out locations. And right now, when the market is as good as it is, and everybody reads it's a very good market, even though we're dealing with some inflation pressures, demand is through the roof, now it's not necessarily the time to go out and buy a lot of land or invest there because we're going to have opportunities. And instead of buying a land project right now, things are going to turn. There's going to be more opportunities over the next 6 months or a year or 2. We know that's the case as it always is, and we'll be able to capitalize on that because we've put ourselves in this position. Also, M&A, I think right now, we're going to start seeing more opportunities for that because in this market, one of the words that comes up a lot is uncertain. And the private builders are uncertain on what to do in this market. They have never dealt with these rising costs. Their ability to get lumber or get supplies to build houses is more challenging than us big, public builders. So we're going to see more opportunities. We've already closed -- most of you probably saw the announcement within the last 2 weeks. We bought a builder in the Minneapolis market, a very small builder, but it's an example of some opportunities that are coming up. We would not have been able to buy that builder or not have been able to buy that builder at the price we got it for if it wasn't for the uncertain market. So I think we'll see more of those opportunities ahead. We're certainly seeing more packages right now. And I think we're going to take advantage of that. And then I'll let Charles talk about buybacks.

Yes. Yes, so our capital philosophy, turning back to Slide 17 as a talking point, just kind of going back to where we ended March at 23% net debt to cap. We've got some dry powder, if you will, from our leverage targets, our 30% to 40%. So we think that long-term, our operating leverage from a debt standpoint should be in that range. So we're obviously below it now, which gives us the ability to increase inventory and finance that with some debt. I mean if you look at the inventory increases on a year-to-year basis, talking about going back to community count growth, from '17 to '18, we increased inventory by about $300 million that -- we did an acquisition in Raleigh, the Wynn acquisition, at the end of '18. And that was an $80 million acquisition. We moved -- from 2018 to 2019, we also saw a $300 million increase in inventory, and then that's relatively tapered off since '19 to March of '21 partly because of the speed and the turn increase back to inventory turns increasing. So if inventory turns more normalize, if you will, or go back, just like we think about absorptions from a budgeting standpoint, we'll see some of that investment in inventory grow to what we would see as a normal inventory turn cycle versus completed homes. We have very few completed homes right now, less than 700 completed homes at the end of March compared to about 1,600 in March of 2020. So I think as we see that shift happen at whatever point it is, we'll finance that with that, get our leverage back into our target range. And then, given our scale, as Eric mentioned, getting to the stage of being a more matured company, then we think that's going to give us some free cash flow to either look at more M&A opportunities or participate in share repurchases. And you see on the balance sheet there, we've purchased about $25 million last quarter, going from $66 million in treasury stock to $92 million. We mentioned on our call that we think, historically, we've leaned more towards we're going to be opportunistic. We see disconnects in the market, and we're shifting that language a little bit more to systematic and regular as part of a regular part of our capital program. So we think share repurchases are a regular part of our capital allocation from this point forward, at the scale we'll manage that to that 30% to 40% leverage target.

Great. Great. No, that's helpful. Maybe just shifting, a couple of other company-specific questions. And we have about 6 minutes or so to the end of the session. [Operator Instructions] I think gross margins are obviously so challenging to predict, just given it's based on market pricing and the level of incentives that are out there, or not that you guys offer incentives but, just in general, the level of pricing strength that's out there. But SG&A, I think, is an area that's often a little bit more under control. You highlighted this year cutting, pulling back on some of the marketing spend, just given how strong demand is. Right now, you're guiding to 9.5% to 10% of revenue. That compares to 2020 at 10.1%, 2019 at 11.4%. Where can this go over the next few years? Certainly, part of it is a function of growth, but is there leverage -- is there additional leverage with higher revenues? If there's flat revenues, could you see this have -- be vulnerable to maybe a little bit of a reversion if marketing dollars go up as demand normalizes? How should we think about SG&A over the next couple of years?

Sure. Yes. I think we think of it as really the 2 different components. So in the selling line, selling is predominantly variable. So the 80-20 rule, we usually referred to selling is 80% variable and 20% fixed. So in our selling costs, you're going to have your advertising and marketing spend, which historically has been more fixed than variable. This year has been certainly more unique in that category by not having to spend what we normally would. And then you have commissions and then our office-related expenses operating our information centers, which that component tends to be more fixed on a community-by-community basis. So our advertising and marketing spend this quarter over first quarter of '20 was about a 50-basis point improvement year-over-year. We offset that with increase in realtors. As Eric mentioned kind of earlier that we are seeing more realtor traffic. So that was about 20 basis point impact. So net effect of about 30 basis points. So we would actually forecast or model is that we think SG&A -- the selling part has an opportunity to increase as a percentage of revenue as we get back to something more normalized. So there's not a lot of operating leverage in that component in the near term. We'll see as we get further out. And then on the G&A side, the discussion about geographic growth or in the markets we think that we're going to be in long-term, I think the focus is expanding deeper into the current markets we currently operate. So that is an advantage on the G&A side. We've built -- our division presidents across the country are established. We've got a well-established VP group. We still have some room to grow in terms of those positions in some of our markets that we're just getting started in. But I think there's some upsides on the G&A side. So those 2 may offset over here in the near-term. Additional expenses in selling might be offset with a little bit of leverage benefit on the G&A side and then really focused then on the pretax number. Historically, or at least prior to this year, we said 12.5% to 13.5% is where our 2015 to 2019 average had been, so living in a pretax margin world in that 12.5% to 13% range and then 2020 coming in at 15.5% and looks like 2021 is going to be favored as well, so we think we've permanently shifted that up a little bit into more of the 13% to 14% plus range. And so that's how we're thinking about it long-term. We think we can sustain that by managing margins, managing overheads and generate really strong net income margins and continue to double in size.

Right. One last one for me and we'll -- we're kind of at the end of the session. Just on demographic and price point diversity and kind of the mix of your business. You mentioned before, wholesale that's -- you estimate that being 10% to 15% of your closings today and you like that from a product diversification standpoint or customer diversification standpoint as well. How should we think about the mix of your business, if you think about -- it seems like Terrata was kind of a -- I don't want to say an experiment, but you're kind of dipping your toes at another price point, seeing how it worked. That doesn't appear to have been something that you've grown since then, maybe it's just been fairly limited. If you think about your core entry-level business or first-time buyer business versus wholesale, versus potentially other product or demographic price points like move up, how should we think about that going forward relative to your expected mix this year?

Yes. I think it's going be similar, Michael. The wholesale business is very, very positive about that. It's been very accretive to the company in our earnings and our absorption pace, very excited about that. Our focus on the entry-level first-time buyer is not going to change. That's our strength. We're really good at it, and that will continue. The Terrata brand has been a success. When we first got into it, we looked at it as opportunistic. There was a couple of communities that came our way. We're able to buy finished lots and get into those projects and with more of a luxury series home and it's created great returns. Over the last couple of years, we just haven't seen those opportunities as prevalent. That's not a brand you go out and buy a bunch of raw land and do a big master plan with multiple product types. That's not really our core business. But I think in a market that gets softer for whatever reason, there's more opportunities, we could quickly expand that brand as well. It's just not the time to do it right now.

Okay. Great. Fair enough. I appreciate that. And I want to thank you again, Eric and Charles, for your time and your participation today. We are going to be moving on. We'll have a short break in our schedule today. And we'll be resuming at 10:55 with Meritage Homes. Again, I want to thank LGI for their participation. And we'll resume at 5 minutes to the hour with our next session. So thanks again.

Yes. Thank you.

Thank you.