PulteGroup, Inc. (PHM) Earnings Call Transcript & Summary

Hello there. Welcome to everyone that has joined us this afternoon. This is Susan Maklari, Goldman Sachs' homebuilding and building products analyst. I'm pleased to have Ryan Marshall, CEO; and Bob O’Shaughnessy, the CFO of PulteGroup with me. For those of you who aren't familiar with Pulte, it's the country's third largest homebuilder, having closed 25,000 homes last year with total revenues of $10 billion. The company operates across 40 markets in 23 states. Today's session will be a fireside chat with Ryan and Bob. [Operator Instructions] And with that, I'd like to welcome both Bob and Ryan.

Thanks, Susan. Appreciate you having us today.

Yes. Thank you. I guess, to start with, you put out a press release earlier this week talking about the trends that you've seen in terms of sales for April, with the month down about 50%, but seeing sequential weekly improvement. Can you maybe just give us a little more color on what you've seen on the ground? And maybe including just a bit more detail on the weekly cadence of sales.

Yes, Susan. What we've seen is that as we went into the end of -- kind of end of March, early part of April, things were quite slow. As I know everyone is familiar, most of the cities that we are operating in, we're in some form of shelter-in-place restriction, which I think greatly hampered Pulte's ability to go out and go through the normal kind of sales process. So we really saw kind of a low point in our sales volume. The last half week of March and the first kind of half week of April, so call it that first week in April, that's where we really saw the bottom. We saw things progressively get worse, as I think we got better at selling online, as the customer got better buying online. And then the closer that we got toward the end of April and then even what we kind of highlighted in our release last week, we've really seen some combination of states that are already reopening, more folks that are comfortable going out and reengaging in the sales process in person like they've historically done, in combination with the fact that, I think, we're just better at selling online than what we were 30 days ago. So we're certainly not back to normal run rates that we were pre-COVID. But we feel pretty comfortable, given the overall recovery and kind of reopening time line, that we're in a pretty good spot.

And Ryan, you've spoken in the past about using the traffic to your different websites is kind of an indicator of forward demand. Can you talk to what you've seen there, maybe especially as that's become a bigger part of your sales strategy? Is there anything changing in how you're monitoring the web traffic and using that as a leading indicator?

Well, we monitor web traffic every week, and we always have. I think what we've seen over the last 4 weeks is increasing positive comps week over week. So it's been compounding all in a positive direction. The big change was about 3 weeks ago. We had huge week-over-week changes. We had a really large percentage. And then the last couple of weeks, we've still seen positive gains on kind of week-over-week website traffic. And so I -- we see that as a real positive. We also monitor a number of Google Analytics that encompass a number of generic real estate search terms that we've found to be a great correlator with kind of what overall consumer sentiment is around searching for real estate. There have also been positive gains on that for the last 3 or 4 weeks, positive changes in each sequential week. So I would tell you, there's a number of things going on inside the head of the consumer right now. They've been locked in their homes for the last 6, 7, 8 weeks, and some are probably saying, "Hey, I'm tired at my home. There are all these things that I don't like. This is a great opportunity for me to go find something better and newer." There are certainly concerns around cleanliness and health, and there's probably no better place in terms of being clean and healthy than a new home that nobody else has ever lived in. And then I think we're seeing a bit of a migration from folks that have been living in really dense cities or been -- they've been living in apartments. And so I think there is a little bit of a kind of exodus, if you will, to suburbia, where maybe there's a little bit more space and newer real estate on the market?

Yes, sure. That does certainly sound like a trend that could be helping new home markets as we go through this. The builders, including Pulte, evolve, as you say, adopted a virtual sales process really using technology. As you kind of look out and think about everything that is changing, do you think that this virtual sales process will become a bigger -- play a bigger role even as we kind of emerge from the current situation? Will it be sort of an initial step that buyers take?

Susan, look, I think buying a home is not an easy process. And so I think part of it is the opportunity for us to improve our tools, and we've made huge strides in the last 30 days. That being said, I still think we have some room to go with certain brands of our company. And as I think you're aware, we operate under a number of different brands, Centex, Pulte Homes, Del Webb, John Wieland. We have a number of regional brands. And depending on the consumer that we're targeting, the level of optionality and complexity that goes into that design and buying process varies. Consumers, I think, for a long time, have always taken that initial step of doing research and kind of sorting things out in their own mind, online or on the web or digitally. My supposition is that, that's going to become an even bigger part of the buying process, and where I'd ultimately like to see our company go is that you can transact online. There's not very many things in this world these days that you're not able to buy on your own time, from the comfort of your own home. I'd really like, without sacrificing any of the unique things that I think we offer in terms of overall customer experience, I really like our company to be in a place where we could transact online more so than what we do today.

Okay. That makes sense. And you mentioned the different brands that you operate in, and one of which is your active adult brand Del Webb. Can you talk to what you've seen there, especially maybe given the fact that this demographic is -- is more at risk with COVID? And how you're thinking about positioning that product or any changes that you're thinking of making there to kind of adapt it to this current environment?

Yes. Susan, it's obviously given that they're -- the communities are predominantly over the age of 55, they're a group, as a general rule of thumb, that is more vulnerable to the coronavirus situation. So I think they were initially very cautious. And that certainly, we saw that in the way that they were behaving inside of our communities, meaning existing residents, but also new buyers. What we -- I would tell you, the tide is kind of turned with that buyer group. And what we've seen as of late is they're anxious to reengage. So they're actually pushing us to reopen amenities, pickleball courts, fitness facilities, pools, the amenity centers. It's as if this group really craves the belonging and the comradery and the friendship and the fellowship and the lifestyle that these communities are really known for. And they've missed that. We've -- they've been -- as I said, they've been pushing us, and we've really been probably slow playing -- not slow playing, but we've been going a little bit slower in an effort to be cautious and be thoughtful about how we reopen. On the sales side, we've actually seen that group be a little bit slower. Because you can appreciate a lot of times when folks are retiring, they're going to a destination location. Airplanes are pretty critical to that, and we know kind of what's happened with the overall travel. So as long as folks have been able to engage with us online to do some of the initial shopping, or they've been local to the market such that they could go to the sales center, we're seeing that continue to move forward. As to your question about whether or not we're going to make big changes to our product, I -- we're always evolving, but I don't know that we have any specific changes that we're going to make directly as an outcome of the current pandemic to the Del Webb product. I think there will absolutely be changes to some of our family product, in our first time product, as a result of pandemic and the change in behavior that I think we're going to see. But I'm not sure that there's as many that are as applicable for Del Webb buyers.

Got you. Okay. And speaking of your first-time buyer, you commented on your first quarter call that you expect that part of your business to account for a larger percent of your sales or to further rise over time. Can you talk to the drivers behind that? How much of that is company-specific versus the market more broadly?

Yes. Well, it's company-specific in that the land that we buy, we specifically buy with a buyer group in mind. And what you heard and you've seen from us over the last 3 years is we targeted the first-time buyer group to be 35% of our product mix, which is where we're at right now. And we would expect to keep it right around that level, which we think indexes us to what the market opportunity is. Certain builders have over-indexed. They've made that entry-level buyer 70%, 80%, even 100% of their business. One of the things that we're known for and we think is a competitive advantage that we offer or a strategic advantage that our story offers is that we have 35% of our business in the entry level. We have 25% of our business in the active adult retiree market and the other 40% is in our first move-up, second move-up luxury product, which really caters to families.

Got you. Okay. And we've got a question on the webcast. Going back to the comments that you made about seeing people perhaps moving out of denser urban environments into more suburban environment. Do you see that move coming more within existing MSAs? So people, say, leaving New York City and going out to the suburbs or people leaving downtown Atlanta and moving out. Or is it more of a wholesale move of people moving from, say, New York to Charlotte? Or what have you? And is it more of a continuation of the trend? Or is it really a step change that you expect as it relates to maybe particular cities and regions?

Susan, it's early. My view would be we're going to see both step changes and an evolution. To your point, there's been an outward migration of -- from the city center of Atlanta to the suburbs for some time, or from Manhattan into the surrounding suburban areas. But I think you're also going to see some folks that leave certain cities and go to maybe less dense, less populated areas in the Midwest. We're -- you're seeing some of these second tier-type urban cities that have got populations of, say, 1 million people as opposed to 7 million people really start to become economic engines and quite popular, especially among the millennial crowd. So I -- my view would be it will be an opportunity for both as it pertains to us. I think the places where we'll be able to take the most advantage would be in cities that we're already doing business in. And you're going to start to see folks that are more comfortable leaving kind of the city or leaving the kind of first ring of suburban area, and they're looking for opportunities to get out and get a new home in maybe some of the less dense areas, but still allow them to have access to more densely populated city environment in less than an hour, as an example, whether it's part of -- near the train, right?

Yes, got you. Sure. Ryan, something else that we saw as the whole coronavirus situation came through was that it seemed like builders who were more spec-focused incrementally maybe gained some share in April. We certainly saw that. Generally speaking, their sales trends were maybe a bit better than what some people had been expecting. Pulte has been very nimble with specs over the last several years or so. How are you thinking about the role of specs, especially in this kind of an environment? Are you changing your approach to specs at all?

We're not, Susan. In fact, we've slowed down a lot of our speculative building as we went into this. It was a time of great uncertainty. And so we were, like most companies, we were really looking to preserve the great liquidity that we already had. And so one of the -- on a monthly level, one of the biggest areas that we spend money in is in our house construction. And so it was an easy place to kind of pull back and manage risk in an uncertain time on the speculative side. That being said, we still do build some specs. We've never been a huge spec builder. It's never been part of our strategy. We're more in the camp of, we believe, the most profitable, best way to run our business is to build sold inventory or to just build sold homes for a customer. Where we've introduced specs in the past has typically been to aid in the production cadence of how we're moving down a street or in a multifamily building. Or occasionally, we'll get cancellations from somebody that agreed to buy a home and then they canceled for whatever reason. And so you'll have a spec kind of self-generate. So we've always been right around 25% of our overall construction volume is -- has been spec. We believe that's about the right number. In the current environment, we probably dropped a point or 2 from where we've historically been running. But we're not making a bet, if you will, that now is the time to be increasing the amount of spec homes that we build.

Got you. Okay. And as we think about the current environment, too, can you talk to what you're seeing on the direct cost side. What is your ability to realize savings there as things do slow down and we enter this really kind of recessionary environment?

Yes. Susan, it's Bob. I'll take that. Obviously, one of the biggest outlays we've got is on house. It's -- the vertical construction cost is about 50% of the total sales price of the home. So we're keenly focused on that. We had come into the year with a view that the total spend would be relatively modest on a percentage increase versus the prior year. And what I would tell you is we've worked in a collaborative way with our trade partners to try and find ways to reduce costs. That's an ongoing process. And candidly, it's an always ongoing process. But certainly in today's environment, we're working to try and find ways to either reduce the elongation of cycle times, which I think everybody is feeling a little bit because of social distancing and some of the supply chain characteristics. The cabinets as an example of -- had struggles, although back online. So I think we're in a position where we have an opportunity to work to try and reduce those costs. We're doing that. I don't know if it actually takes cost backwards versus that low inflationary environment. But certainly, that would be our goal.

Okay. And Bob, a big part of Pulte's strategy has been focused on maximizing returns. And so as we do enter a period of greater uncertainty and possibly just sustained weaker demand, how do you think about maintaining that strategy? What will change in there? And how do you -- how are you kind of adjusting the business to make sure that you still hold to that core focus?

Yes. It's a fair question. And as you said, our strategy has been to generate returns through cycle. I wouldn't want to set a target. We've enjoyed a really sort of rich return profile for the last few years. Naturally, if we've got smaller volumes, if the business isn't quite as big going forward because of the pandemic, that will have an impact because income is going to be one of the primary drivers of return. And so pricing becomes an important element of that. Good news is the pricing environment has remained pretty stable. I think everybody realizes that given the pandemic, price doesn't solve what the consumer issues are today. So pricing has remained pretty firm. In fact, where you see incentives in the market, whether it's co-bro commissions. I mean it's typically where people have a lot of standing inventory, which there isn't a lot of. We've got low resale. We've got low supply of new homes on the market. So that actually serves us pretty well as an industry around pricing. Obviously, the other thing we can do is control our costs. Everybody has probably seen, we put a release out earlier this week, where we took actions that between reductions of force, furloughs and other cost-saving initiatives, we've eliminated on an annual run rate basis about $100 million of spend. All of those things will serve to support the return over time. The other thing we've done, and I think consistent with what you've heard from other builders, is we've reduced the amount of money that we're spending on land today, both in terms of new acquisition and development. And what that does is it reduces the total investment, obviously, makes the return characteristic a little bit easier to reach. We are still in market. What we've done is worked with our land partners to try and create an opportunity to defer spend. So we have not walked from a lot of transactions. We just wanted some sign to see how the market behaves. But again, if pricing can hold, we're controlling our expenses, we've reduced our land spend, all with a view towards trying to continue to generate return through this time.

Okay. And you've obviously, over the last couple of years, given the dynamics in the market, and company-specific efforts, too, have seen really nice levels of gross margins. As we go through this, how do we think about what the trend will be in gross margins relative to SG&A? And how those will each contribute to the overall operating performance, say, operating margin?

Yes. It's interesting, margin is always the bigger contributor. If you think about it, our most recent quarter was at 23.7%. In SG&A, we've pulled our guidance. But if you think of it, the historical 10% or 11% of revenue, so it's easier, I think, to see that the margin is the bigger contributor. But what we're trying to do is manage all the levers, right? So as we think about earnings going forward, it's how do we maximize the margin that we're generating, how do we minimize the cost that we've got so that we get to an operating margin that is healthy. I think the market will dictate to some degree what our pricing dynamics are going to be, but we can control, over time, our total spend. So I think they're both important. Obviously, margin a little bit richer contributor, but we're focused on all of it.

Okay. And obviously, all of the efforts that you've made over the course of this prior cycle was really to reduce the cyclicality and better mitigate risk in the business so that you do get those returns over the cycle like we've talked about. As we now enter this recession, what should we be watching for or looking to, to determine the true effectiveness of those efforts?

Well, Susan, I think -- it's Ryan. I'll take that one. I think it will come from a couple of areas. Number one, on the land side. The riskiest part of the balance sheet of any of the builders is the land that they own and then the structure of how that land is contracted to be purchased. And we believe that how -- what we have been doing over the last 7 to 8 years and the amount of land that we own, the way that it is structured, i.e., owned versus option, and then the location of that land in an A, a B, a C market will be the things that will separate the high performers from the low performers in a down market. As we came out of the last downturn in 2011, we have intentionally implemented a strategy where we said we would be a performer of 3 cycle as opposed to just a great performer on the upswing and a underperformer on the downswing, which is historically how I think you saw -- you would have seen a lot of the industry, not just our company, but the homebuilding industry behave. And it was largely because of the way they purchased land. So 2 of the things that I guess I'd highlight that we've done different. The amount of the overall land that we own. We own just over 4 years' worth of supply. And then number two, the number of -- or the percentage of lots that we option. Over 40% of the lots that we control are held via option. What that really allows a company to do and us specifically is as the market potentially changes on pricing, if it were to change on pricing, you've got the opportunity to go to the land seller and work to restructure, renegotiate at current market values as opposed to have already -- you made that purchase a year ago or 2 years ago, and so you're kind of stuck. And if that's the case, you're going to -- you would see a degradation of margin and then, ultimately, an impairment if the margins were to fall far enough. So we really believe that we've done something different and unique in the way that we've managed the balance sheet. A year ago, I know Bob and I often had a conversation with investors where we'd say, you may need to have a downturn to really kind of prove out that the steps that we've taken really work in a recessionary-type environment. So not that we were begging for it, and not that I think anybody is happy that we're in the situation that we're in, but I do think you will see from our company our land strategy proved to be quite effective in managing through a more difficult time. Further to that, Susan, I think the way that we've been running the company from an operations standpoint, we've got great cash generation. The company has been generating a lot of free cash flow on an annual basis. And that will allow us to be opportunistic if and when there are opportunities to make, whether it's investments in land, investments in the consumer, investments in M&A. There's real opportunity that the company has because of the way that we've positioned the balance sheet.

Okay. That's very helpful, Ryan. We also have a question coming through on the webcast just around the company's liquidity position. I know that you drew down on your revolver earlier this year. Can you just talk to how you're thinking about the liquidity of the business? And how we should expect maybe working capital to further that as we move through 2020?

Yes. Obviously, we did draw in March on our revolver, and it was really a -- let's make sure that we're going to be okay. We didn't know exactly what was going to happen. And so as an abundance of caution, we chose to draw, obviously, it leaves us with a very significant cash position. And we've obviously terminated our share repurchase programs. We did just approve a dividend, which would pay about $30 million in the July pay period. But we've also obviously restricted the amount of money that we're investing in land. And so we actually continue to believe, even today, that we'll be generating cash. And so as we look at capital needs, we typically look over a 3-year period. We've got, obviously, a little bit shorter bias given everything that's going on in the world today. So we've slowed down spec. Like I said, we've taken down the programs. We've slowed down our land spend. I think we will need to see how the market behaves over the next 30, 60, 90 days to see how much money we are going to choose to invest in the business. We obviously have the opportunity and the ability to pay down the revolver draw that we made. The only other real significant cash flow item we've got is in the first quarter of next year, '21, where we have about $425 million of notes that mature. And I think you would -- right now, the capital markets are wide open and actually very attractively priced. I think we'd be making a decision when we get closer to that date, whether we refinance that or pay it down. Again, we've -- if we are able to generate cash during the year consistent with maybe at a lower level, but the same kind of cash generation on volume that we've had for the last couple of years, we've got a lot of choices that we'll be able to make. And so we feel good about our liquidity. We feel really good about our balance sheet. What Ryan talked about in terms of the land profile helps that. So we believe if the time is right, we'll have choices and be able to take advantage of opportunities.

Okay. And so then kind of thinking about all of this, would you say that it's fair to kind of forecast or to assume that Pulte can generate positive returns, even in a year with housing starts down 20%, 25%, wherever we're going to sort of end up in that range?

Yes. Again, I wouldn't want to put a target out for returns. But certainly, we think we can be income-positive, yes, as long as pricing holds. We've obviously pulled all the levers that we can. We're managing our margins. We're managing our pricing. We're making sure that we're competitive in the marketplace. We have reduced our expense structure. We have reduced the capital load coming into the business, which makes return a little bit easier. Yes, so I think the variable in that, that's hard to really predict is pricing. And as long as pricing holds, yes, I think we would fully expect to be -- return positive even with the business down 20%, 25%.

Okay. Recognizing we have a few minutes left, I do want to touch on ICG because it's something that I think is really unique to Pulte. Can you give us an update on the business, how it's been coming together initially? And obviously, recognizing that there's been inherent changes, just given the coronavirus and everything that's kind of changed since January. But just give us an overview of how you're thinking about that? And what it could mean for Pulte as we look forward?

Yes. Susan, we're really excited about what ICG has brought to our business and, frankly, the opportunity that we see over the long run. This is a strategic investment that we made and a -- kind of strategic initiative that we've laid out over the last several years, and it was really all around the idea that we've got a real labor shortage on the construction side. And there really hasn't been any major advancements in labor efficiency or technology in the last 50, 60 years in construction. ICG solves both of those things, or at least goes a long way in helping to solve 2 of those things. And so the ability to use robotics, to use 3D printing, to use computer-aided design and do that in a controlled environment in a factory, it makes perfect sense for us. We looked at a number of different possible solutions. We found ICG in Jacksonville. What we found with that group is a group that has had a great operation, that they were supplying both to the residential construction as well as the commercial construction side. The owners and the founders of that business have joined our team. They're very smart, aggressive, kind of hungry entrepreneurs that have really, I think, brought a cutting-edge mentality on the construction technology front to our company. And so as it relates to coronavirus, I don't see a whole big change coming there and impacting that business. So obviously, we'll see kind of what volumes do ultimately in the space. But was -- as part of our underwriting, we stress tested the highs and the lows of what the flexibility of that plant could potentially do, and really nothing has deviated from our original underwriting going into that acquisition. So we're probably -- now having owned it for 3 or 4 months and having the opportunity to work with that team, but closely, we're more excited about it today than we were even 3, 4 months ago pre-acquisition.

Yes. Okay. That's good to hear, Ryan. And it seems like 3 months or 6 months ago, a lot of builders were talking about technology and ways of adapting technology and taking different approaches to the construction process. Do you think that, in some sense, the downturn will give you a little more space perhaps to test some of these things? And could ICG prove to be even more of a strategic advantage as we eventually come out of this recessionary environment, leaving you with a better understanding of how this really works and able to truly adapt some of these processes?

Yes. I don't know that I would correlate our success there with the recessionary environment. We had a view on what we believed needed to happen in our business and needed to happen in our industry, and it was more like an 8- to 10-year-type plan. And so I don't think 45 days into a pandemic would be the time to say that, that's going to materially alter the way that, that 8- or 10-year old -- plan ultimately plays out. We believe while a lot in the industry have talked about innovation, there hasn't been a lot that's been done with it, Susan. I think we've actually put our money where our mouth is, and we made a major step in acquiring ICG. And so not only do we have kind of the physical plant location, we've also got the talent, if you will, the capability to -- inside of our company's employees and as partners to help us expand that into other locations, which is, I think, where the real opportunity is. So if the downturn maybe creates, where you could maybe potentially see an opportunities if the downturn creates an avenue that expansion becomes a little easier to make happen, that's possible. Time will tell.

Yes. Okay. And we've got one last question, which is around land. Can you talk to any changes that you're making as you approach the underwriting process? Pulte, obviously, specifically, has developed a very deep detailed process for analyzing your land deals. Has that or will that change at all here? And maybe along with that, too, can you just talk to how you're balancing the -- obviously, reduction in land spend and kind of differing some of these purchases. But how do you weigh that against the need to support growth as we do come out of this? And the potential that housing could perhaps see a much shallower downturn than what people had been expecting even just 6 or 8 weeks ago?

Yes, Susan, it's Bob again. We have not changed our approach to the evaluation of land. And so our risk-adjusted return profile, Ryan talked about our desire to have optionality, I'd say that's actually increasing. It doesn't really change the way we go about assessing land. But the ask when we're negotiating with folks is for optionality. And so the simple answer is really no change. To your second question, that's -- it's something that's evolving, candidly. So we've got a process that we've set up where we're actually looking again. So we've got a process that reviews all land transactions that get approved. We are now in a process where before we move money on lots today, we're asking where, why and how. And so I think as we go forward, depending on the comfort we have in the actual demand profile, would influence our willingness and ability to want to buy more dirt today. Having said that, our land teams are still out looking. We haven't exited the market. If we see things that other builders that we either had interest in before or appealing to us, we're going to look at them, and we're going to think about buying them. Somebody other's -- somebody else's decision to exit, it may be an opportunity for us. So what we want to do is keep the lens on, okay, if we're making the commitment, do we believe we can earn a return off of it. So scale isn't the driver of that, but incremental return.

Okay. Got you. Well, I think that we've kind of come up on our time now. So I think we will end it there. But thank you to both of you for your time today. I really appreciate it. And hope that everyone who dialed in also found it a good conversation.

Thank you, Susan. I appreciate you hosting Bob and I and giving us an opportunity to talk a little bit about the company.

Me as well.

Yes. Thank you. Have a good rest of your day.

You as well. Be safe.

Bye-bye.