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

Good morning. My name is Mike Rehaut. Thanks for joining us as we continue our second day, our morning session of our 13th Annual Homebuilding and Building Products conference, now virtual in the new world of COVID-19. We're very pleased to have with us CEO, Ryan Marshall; and CFO, Bob O'Shaughnessy of PulteGroup. Pulte, obviously, one of the top homebuilders in the U.S. with a diversified national presence, both from a geographic standpoint as well as a diversified demographic presence across all major home buying consumer product -- consumer categories, including first time move-up and active adult. As with the prior sessions, the 35-minute session, we have some slides from the company, some prepared remarks, followed by comment -- followed by questions that I'll post to the company. And we also have our ask-a-question feature through our virtual website, our digital conference book, that I'll be happy to pass along to management as well. So with that, I'll turn it over to Ryan and Bob. And again, appreciate your participation, and look forward to hearing your thoughts in the current world.

Perfect. Well, Mike, thanks for obviously inviting us and giving us the opportunity to present. Given the current circumstances, I think virtual is certainly working, and we're finding new ways to work. But I will be honest. I think I do probably prefer being in New York and in person. Let me start by just giving a few remarks about the COVID-19 pandemic, the impact that it's had on our business and some of the responses that the company has taken thus far. I will try and keep my comments brief and save plenty of time for Q&A and a few things at the end. For those of you that are following along, I'm on Slide 5. And our focus to this point has really been about taking care of our customers, taking care of our employees and working with our trade partners to make sure that the homes that we're building are safe. I think we've done a really nice job in reacting quickly and putting out new processes and protocols in the way that we've interacted with all of the above reference parties in such a way that we've worked to do our part. We also want to be really thankful and appreciative to the frontline workers, the health care professionals that have done so much to keep us healthy and to keep the economy moving forward. I'd move now to Page 6. A couple of specific things that we've done as a company to respond to this -- it's really been about protecting and preserving the company's liquidity and balance sheet. So some of the things that we worked to do -- early on, we had a very sizable backlog. And fortunately, in most cities and states, we've been able -- construction that was deemed an essential service. And so we were able to continue to build the homes that we had in backlog. And the majority, the lion's share of the customers that were in backlog, have closed on time without delay. We did -- in a preemptive precautionary measure, we did draw on a revolver, as we've previously disclosed. And we ended our Q1 with $1.9 billion of cash, so we feel very good about the overall liquidity position of the company. As we also worked to assess what the overall impact on the economy and the company was going to be, we did suspend our share buyback program, and we pulled our guidance for the balance of 2020. We have not provided any update to that at this point. I'm on Page 7 now. I would highlight the fact that we did put out a release on May 11, where we provided some additional commentary around our results in April as well as into the first week of May. And it was really encouraging. What we highlighted is that we had nearly a fourfold increase in sign-ups as we move from the end of March when the COVID-19 impact started to where we ended -- the first full week of May. And we were incredibly encouraged by not only what we were seeing on our digital platforms, but also what we were seeing in our sales offices with physical traffic as the majority of our sales offices have now resumed, regular walk-in traffic in addition to appointments. And then further, the update that I provide today, Mike, is that strength, we've seen continue all the way through May. So just as we saw week-over-week increases as we move through April, we've seen that trend continue into May. And so we're quite encouraged by the resiliency of the economy and the resiliency of the homebuyer. You did also likely see, and I'd highlight that we did make some changes to our overhead structure. We had a combination of furloughs, layoffs and senior management pay reductions, which, for 2020, will equate to a reduction of about $60 million of SG&A expense, and, on an annualized basis, translates into about $100 million of savings, the majority of that being people related. Obviously, we've pulled back on travel and a few other things as well. So moving to Page 9. What I would maybe just like to highlight that I think we've done with our strategic playbook, we've really continued down the path of really focusing on delivering best-in-class return on invested capital through cycle. The things that we've done around the way that we're investing in land, the consumers that we're targeting, the way that we're running the homebuilding operations, the focus on the consumer, the focus on quality is all aimed at delivering what we really see is that best-in-class return on invested capital. Turning to Page 10. A big part of that is our capital allocation that's aligned with the return focus. And so we have been a consistent payer of a dividend. We've been a consistent repurchaser of our shares using excess capital, I might add, with our #1 priority being to continue to invest in our business through land. You've also seen us continue to make some investments in making the technology side of our business work better, both with our systems, but also with investments that we've made in companies like ICG, which is our most recent acquisition in Jacksonville, and I'll touch on that just a little bit later in the presentation. On Page 11, what I'd highlight here is that we have really been working on minimizing the amount of land that we own and the land that we have on our balance sheet. That doesn't mean that we've changed the amount of land that we want to control or our appetite for land, but we've dramatically, over the years, shifted the nature of how we structure those transactions and how we own that land. We're really pleased with how we're progressing against the targets that we've set. Those targets were to be 50% owned land and 50% option land. And as you can see from the chart that we have here on 11, we've tried to structure that in a way where about 1/3 of our business is active adult, 1/3 of our business is first time and 1/3 of our business being entry level. And you can see the progress that we've made there, in particular, on the entry level. And then on Page 12, this ties into the point that I was making about being land lighter. As of the end of Q1 in 2020, we've got about 160,000 lots under control with a little over 40% of those being controlled via option, and that includes our legacy Del Webb communities. If we were to exclude the legacy Del Webb positions, that percentage goes well over the 50% mark that we've targeted as an ideal range. We've taken our desire for this to be our -- the way that we want to control land. And we've even implemented that in the way that we've handled mergers and acquisition, most notably with American West, which was a company in Las Vegas that we acquired last year. We got 3,500 lots through that acquisition, and over 2/3 of that purchase was controlled via options. So we're quite pleased with what that opportunity has done for our business in total, but specifically for our market in Las Vegas. I'd move to Page 13 of our slide deck, and I just want to touch for a second about our very disciplined underwriting approach that we've taken to purchasing new land. We use a proprietary rating scale where we've got 13 points of risk that we assess for every potential transaction. Based on the risk of each of those 13 points, we essentially develop an internal credit score. And based on that internal credit score, internal risk score, that determines the hurdle rate that we require before we greenlight an investment for our business. I think Bob O'Shaughnessy and our Asset Management Committee, their oversight, along with myself and our chief operating officer, the change that this has made for our entire business has been a significant step change over the last 7 to 8 years, and has been a major contributor to the way that we've been able to push our return on invested capital even higher. Page 14 is another leg of that stool, and that's around our commonly managed plan platform. This is something that we work -- we've been working on since 2012, where we've been designing better plans. And when I say better plans, they're designed better. They're consumer-inspired. They've got the feedback worked into the designs of how people want to live today. They're value engineered. They're really efficient floor plans to build. And then once we've done that, we're able to build those same plans over and over and over again. And today, we have 80% of our closings coming from the entire business, are out of about 500 floor plans. This is down from 3,500 floor plans just a short 5 or 6 years ago. So the progress that we've made there has been tremendous and is another contributor to the company's overall success and margin profile. That leads me into the comment that I made about ICG. I'm on Page 15 now. Our most recent acquisition was to acquire the operations of Innovative Construction Group, which is a comprehensive frame shell, manufacturer located in Jacksonville, Florida. And this ties in very nicely with our commonly managed plan platform and where we believe the industry can continue to go from an overall innovation standpoint as we get more efficient with the amount of labor that we use. And Mike, the feeling that we have is that there are structural challenges inside of the labor profile of this industry that are going to persist for some time into the future. And by being more efficient in the way that we build homes, using technology like we've gotten through the acquisition of ICG, we're encouraged about what this can do for our business in totality. Certainly, as I think everybody's aware, there are some geographic limitations as to how far these products and materials can be shipped. But we believe over the long term, over the next 6 to 8 to 10 years, we've got the ability to take the expertise and the learnings that we'll have from ICG and use that to expand into future factories and plant locations in other locations. We're incredibly excited about the team from ICG that has joined PulteGroup. The principles of that business are now part of our team. We've -- and we've also talked -- you've probably heard us talk in some of our public commentary. We were excited going into this opportunity during our due diligence period, and we've only gotten more excited in the 4 months that we've had to work with the ICG team since the acquisition period. So maybe just in summary, Mike, I turn to Page 17, and then we can maybe wrap up, and I'll take a few comments and questions. But we've really worked to implement a different business playbook that's focused on creating long-term shareholder value. Our focus on our customer through the quality of our products and the customer service that we provide, we believe, is unmatched. The focus that we've put on the culture of our organization, specifically the work environment that we provide for our team members and associates, we believe, gives us a competitive advantage in attracting and retaining the best and brightest talent in the industry. We've continued to invest in high returning, well-located, risk-adjusted investments from a land standpoint. And we've done that more and more through a less risky option structure, which we believe bodes well for our business over the long term. We've maintained very disciplined operating practices around the way that we're building, the safety and the quality standards that we're demanding in our business. We've continued to improve asset efficiency, the speed at which we're turning our house inventory, the speed at which we're turning our land inventory. All of that has allowed us to generate predictable and consistent free cash flow from operations, which has allowed us to grow the investment that we've been making into our business to pay our dividend, and then -- and also allowed us to take the excess capital that's being generated from that free cash flow and use it to return to shareholders, which we've predominantly done through share buybacks. So we're thrilled, Mike, with the strategy that we have, and we're thrilled with how the business has been performing. Obviously, we've run into -- the entire country, the entire world has run into an unanticipated event with COVID-19. I'm incredibly pleased with how our team has responded. I think it speaks to the level of maturity and experience that we have with the managers inside of this company. And while it has been hard work, and it hasn't been easy, I think we're well positioned to come out of this time of uncertainty -- as positioned as well as we've ever been. And if the trends that we've been seeing over the last 2 to 3 weeks can continue, I'm encouraged that housing has got continued bright days ahead.

Thanks so much, Ryan. I appreciate all the comments and the slides, a great overview, obviously, along with some commentary on some of the recent trends.

If I could start off, and we, again, for those in the audience, please continue to send in your questions, and there'll be time for -- plenty of time for questions from the audience. But I'm going to kick it off with a few of my own. Just on your commentary around the order strength or the improvement continuing into May, as you probably are well aware, this past earnings season, there's been a pretty wide range of April results out there from the different builders. But the uniform piece of data that's come out is that there has been consistent improvement as the month has progressed. And you've pointed to that as well in your quarterly call and in your more recent update. I was hoping if -- given the wide range of results that have been reported so far, at least on a preliminary basis. And even yesterday, we had one of the smaller cap builders, Meritage, talk about what they expect to see in May, which is a further improvement in April. I was hoping to get perhaps a little bit more granular with the rate of improvement that you've seen. And I know you've put out the 400 sales and asserted those numbers. But from a year-over-year decline perspective, when you're talking about April down 50%, what does that mean in terms of what you're seeing in the first half of the month versus the back half and to the extent that you've seen further improvement into May, how should we think about either in a range or a degree of magnitude around that down 50%. What have you been seeing in the last few weeks in order to, more properly, think about May and June as these trends continue?

Yes. Mike, tough question there. There's a lot in that. So I'll try and kind of pick through it and give you some relevant points. As we mentioned, we were something in the order of around 100 sales in the last week of March. Moving into April, we were north of 400 in the last full week, first part of April, first part of May. So we saw almost a fourfold increase in a 30-day period of time, which, I think, speaks to how rapidly things have changed. And then based on the commentary that I just gave, we've continued to see an acceleration of demand as we've moved through May. So specific to your question about relative -- performance relative to prior year, we highlighted that April was down around 50%. And while I don't have the data off the top of my head about what that was week by week, I think you can probably interpolate just based on where the early part of the month's weekly sales were versus the last week. So certainly, the back half of the month was much better on a year-over-year basis. I do think we want to be a little careful how thinly we slice the weekly and monthly data. And so while we've been very transparent, and we've put out more intra-quarter updates than what we historically do because we think it's the right thing to do, candidly, and we want to give investors and the analysts as much information as we can, I do think we -- the best answer is, let's wait until we get to the end of the second quarter. I think you'll have probably April being a little weaker, May being a little stronger. The hope would be that June's even better. And you can get maybe a more fulsome-rich picture about what the forward outlook might be as we look at full Q2 data.

No, I appreciate that. Maybe coming at the current environment from another angle, I think one of the observations that we've had in terms of the range of results that the builders have reported for April and even into May, you have some builders that are down 10%. You have other builders that are -- such as yourselves, that are down 50%. MDC is another example of -- at one end of the range. It appears that the more spec-driven-oriented builders kind of had, in general, arguably more mild declines than build-to-order-oriented builders. And I wanted to get your sense of -- if that observation is accurate. It appeared to us that there was a pretty decent level of consistency with the spec production builders being on one part of the range more fairly consistently. So if you feel that that's kind of an accurate depiction of the marketplace that those spec builders are perhaps doing a little bit better through near-term demand dynamics or whatnot, and if that's the case, if that causes you to adjust or shift, at least in the near term, your approach to the market as a result.

Yes. Mike, I think the way that I would approach that is we've set a strategy in place with the percentage of spec homes that we build and the -- really, we've built our model around a IIB build order model. We do believe for the long pull, and we're making investments and making decisions in this business that will play out over the next 3 to 5 years. So with that as a backdrop, I'd move to maybe the last 30 days of April, I think, certainly, within our own business, we did see an uptick in the number of spec sales that we ordinarily see as a mix of overall sales. And so if you happen to have a builder that had excess inventory, and a larger percentage of your inventory was in spec homes, I do believe that there was a benefit to that. And so I think you see that in that limited sample of numbers that have been reported for April. And I think that's mostly being driven by what I'd refer to as urgency buying. As the pandemic has played out, in particular, in the entry-level space, if you had an individual or family that was in an apartment, and they felt the need to say, "I don't want to live in a densely populated apartment building anymore, my lease is up. I still have a job. If I can go find a house right now, meaning one that's done, I'm going to make the decision and do this right now." And so I think if you happen to be over-indexed against that buyer profile, meaning entry-level, and you were over-indexed against inventory, you may have seen a short-term kind of pickup in April sales. I don't believe that, that benefit persists, Mike, through time. I think that normalizes at some point. My guess is it likely already has based on our own data, that the amount of quick move-ins we've seen decrease week-over-week over the last 4 weeks, which tells you what was there has largely been consumed, probably not too dissimilar from the toilet paper at the grocery store. When it's gone, it's gone. And so as we look to kind of what the future is, we're going to continue to build specs. About 30% of what we start as a percentage of overall production is spec inventory. We hover between kind of 25% and 33%, 34% depending on the quarter. And then the rest of what we're doing is our IIB build model. And going back to what I highlighted in some of our prepared remarks, we've got a real through-cycle focus on delivering best-in-class return on invested capital. And we think one of the best ways to do that is by maintaining a high margin profile, which we believe our build-to-order model helps to support.

Thank you for that, Ryan. I guess moving on, I've got a couple of questions from the audience around regional markets. Obviously, this is -- points over the past cycle. The whole country has kind of acted very similarly when there's been certain types of shocks versus others. In other cycles, you have different parts of the country performing very differently from one another. So as you've seen the markets play out over the last 6, 8 weeks, and, again, we've had a couple of questions on this come online virtually already, maybe you could kind of walk us through which markets are standing out currently as being stronger than others. And if you can comment as well, including your comments around Houston and Orlando, which has kind of been more topical as of late with the oil price volatility or Houston with the significant furloughs occurring with Disney in Orlando.

Yes, Mike. So the first comment that I would make is I would suggest that the performance of markets has, first and foremost, largely been tied to the shelter-in-place orders that states, cities or municipalities have taken on. So places like Seattle, Northern California, Michigan, Pennsylvania, where we were in full shutdown mode, those businesses have suffered. And until they reopen, and most of them have now, but they've been later in cycle to reopen, I don't think we'll fully know kind of how they're going to perform. The cities and states that have performed better have been the ones that have been more aggressive on their willingness to reopen the economy. And I'd highlight the Southeast, Georgia, the Carolinas, Tennessee, those are all places that have performed incredibly well relative to the rest of the country, but that's also part of the country that have been more aggressive in reopening. We have -- we're also watching just in terms of kind of risk areas. We're watching cities and/or states that have a high concentration of employment in a particular industry. So Las Vegas is one that I would highlight. It's an industry that largely runs on tourism and travel. Certainly, there are other things there, but that's something that is certainly going to be impacted. And so we'll have to watch what the overall job situation is in a city like Las Vegas. You asked about Houston and Orlando. I'll start with Houston first. Certainly, oil had some struggles. It appears to be somewhat reversing as we're getting more cars out on the road. I'm seeing some positive stories on the oil front. But I'd also highlight that Houston is not a 100% oil-dependent city like it maybe used to be. There are segments of Houston or micro economies in Houston that are, but there are other parts of Houston that are just as diverse from an employment standpoint as any other city in the United States. So we're finding our Houston business to actually be performing quite well. In Orlando, I think we had some early concerns on for similar reasons as to what I mentioned about Las Vegas. But we have seen our business in Orlando also hold up and performed pretty well. So for the time being, Mike, I think what we need to continue to pay attention to is what happens as cities and states start to reopen. What happens with layoffs and job loss, how quickly do those come back, et cetera? And yes, so I guess I'll stop there. And Bob, I know you're on the line here. Anything you'd highlight on states or regions that I haven't touched on?

Not that you didn't touch on.

Great. I think also one of the key questions that people are trying to figure out right now is the mortgage credit standards. That's been kind of a moving mark over the last 4 to 6 weeks, 8 weeks. How has those changing standards by some of the banks and the overlays that we've heard about, how have those -- how has that impacted your business over the last -- in the current environment?

I'll let Bob take that one. Mike, it's gotten better, but I'll ask Bob to share a few details.

Yes. So for us, about 70% of our business goes to the GSEs, so Fannie and Freddie. A high degree of liquidity there, good execution in the market, so really no issues and no real tightening of the credit box. Jumbo market was a little bit impacted by this, but we've got great relationships and see strong liquidity there, so no issues for us. Where you've seen more noise, I think, is at the FHA and VA levels, so the [ govi-type ] space. Certainly, we've seen credit standards tighten there. The good news is that we've seen a relative improvement. And so we see pretty good liquidity down to 620, with economics that make some sense to us. Below 620 on the credit spectrum, your -- it gets pretty expensive. So looking at our business, about 20% of our business goes through FHA, VA channels. And the average FICO score on that most recently was about 680. So we -- the business we are doing is at the higher echelon of that entry-level buyer group. And so the good news is we haven't had much disruption at all. We've had to think about it. We -- our sales teams understand the parameters that we're working in. But like I said, we've got good execution. We've got good liquidity. I think for builders that might be playing at lower price points, it may be a little bit harder because you can appreciate, for that buyer group, there's just a limit to how much they can do. A tighter credit box makes it harder. They may not qualify, but they've got a really attractive interest rate environment. And so that helps them. And so on balance, I think it's a more challenging market, the lower you go on the credit box. To your point about banks, it's interesting, the banks are in the refinance business mostly now. So new money origination isn't really high on their list of things to do as they try and work through their own book of business. And so, interestingly, the mortgage market has pretty solid margins. We talked about it on our first quarter earnings call. Our margin mix was actually richer than normal. And that typically happens when the banks are focused on refinance business as opposed to new money origination. The only other thing I'd offer to Ryan's point about the market getting better, certainly, the GSEs and their resolution on what to do with forbearance is a positive. And so the ability to take the payments that people are deferring today in forbearance and add them on to the end of the mortgage we think actually will help with liquidity in the housing space as those people come off much less likely to become a foreclosure because really all they're doing is [ packing ] payments on it at the end. So we think that was positive.

I appreciate that. I know we're coming up on time, but I just have one more quick question, if I could squeeze in. We've got a couple of these on this topic from the field, and that's just around your active adult business. I think, obviously, in general, it's a great diversification driver for the business, an important demographic in general and for your company. At the same time, we've heard over -- during this particular period that the active adult segment has been a little bit more impacted by the stay-at-home and by the current dynamic and the COVID-19 itself, obviously. Just curious if you could kind of bifurcate. If you took out that segment, what would your remaining business be of that down 50%? Just trying to get a sense of, certainly, we've heard that it's acted a little bit more -- it's been a little more challenged than the other segments. So it's getting a sense if that's the case for yourselves. And what would that down 50% be if you strip that out?

Yes. Mike, we're actually really encouraged by what we're seeing in the active adult business and what we think the long-term prospects from that particular buyer group will be. Certainly, early on, it was the group that was being told to shelter-in-place because of their age. They were higher risk. And I think they largely complied with that. What we're seeing today is that as the travel restrictions are coming off and the shelter-in-place orders are being loosened, we're seeing that buyer group actually reengage. So we're really encouraged by that. Just anecdotally, the residents that live in our -- existing residents, homeowners that we had to live in our developed communities, they've been very aggressive in kind of pushing us even maybe faster than we were comfortable as a business in reopening our pools and our pickleball courts and the lifestyle amenities. And so I just -- I share that anecdotally because it's a group that actually appears to have even a little higher risk profile at this point in time in terms of they want to get back to normal life. And I -- we do believe that, that will translate to the buyer as well. We also are really encouraged by this buyer group because they're not as dependent on a job as what an entry-level or a move-up buyer is. They've likely already retired or they're getting close to retirement. The stock market has come back. They're arguably maybe more confident in their ability to buy and do what they want to do than any of the other buyer groups. And so while it was a little bit of a drag relative to how it's performed in the first quarter. We'll see how that continues to improve, but suffice it to say that we're encouraged by what I think that buyer segment will continue to do for our business.

That's a great point and a good way to end. So I appreciate your -- we're actually a few minutes over. So appreciate your participation. As always, it's great having PulteGroup continue to be one of the mainstays of the -- of our conference year in, year out, and we don't take it for granted, and we appreciate it very much. So I'm going to close it off here. We'll be resuming the conference at quarter off with D.R. Horton. So 11:45 Eastern Time. Thanks again, Ryan and Bob. Be well. Stay safe, and we'll talk again soon.

Thanks, Mike. You, too.

Thank you.