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

Good morning. Really appreciate you getting up early and doing the leadoff slot with us this morning. My name is Buck Horne, I'm the housing analyst at Raymond James. Just really thrilled to be able to reintroduce to you, PulteGroup and Bob O’Shaughnessy, the CFO of Pulte, to talk about housing. Lots of interest in what's going on in the housing market right now. It's about as fascinating and maybe it's frustrating at time. I can remember as a housing analyst covering the sector because of the divergence we see the disconnect between what the market seems to be pricing in and telling us what is about to happen to the housing market versus what is actually happening in the housing market in the field right now. Certainly, a lot of concerns about where interest rates are going to go, but we think that continues to have opened up a tremendous opportunity in stocks like Pulte's as well as other builders who remain very constructive trading at what 5x. This year's guided earnings thrown off 30% plus returns on invested capital, nearly pristine balance sheet. It's really a remarkable time. So with that, I'm going to let Bob try to explain to us what is going on out there and what are we missing, if there's anything to miss. So with that, Bob O’Shaughnessy, thank you.

All right. Thanks, Buck. Can everybody hear me? Is the mic live? Yes. All right. Well, thank you. It's great to be here this morning. It's in-person. It's great to see so many faces, much preferable to small boxes on a computer screen. So I appreciate you getting out here early in the morning with us. What we're going to walk through is just some of our thoughts on what's happening in the housing environment today. Walk through how PulteGroup actually works generally and against that backdrop. And then give you some highlights of our recent performance and how we think we're going to do going forward. Starting with -- we thought it made sense to maybe outline an overall market thesis. It's our perspective that housing needs in the U.S. are about 1.5 million starts per year. Now that's single-family and multifamily. But as you can see on the chart on the screen, we have underbuilt that for over a decade coming out of the Great Recession. We just got there in 2021. But on balance, we've got some unmet demand cumulatively that we think augurs well for the industry going forward. You layer on top of that, that demand and demographic fundamentals are pretty solid right now. We obviously have the big millennial and active adult, 55-and-older crowd moving through the housing cycle. That provides a lot of support and need for housing. The job market is as strong as I can ever remember. You've seen the most recent job postings. The economy is growing. We've got wage inflation, which supports homeownership. And then you couple that with some of the changes that came out of the pandemic, and that is remote work, so people can kind of live and work anywhere that makes them be able to maybe get to some more affordable areas which supports entry-level buying. So on balance, we think the market is actually poised to support housing going forward. So we're constructive on the market, obviously. More support for that. You can see on this page in terms of that millennial demographic, which has become much more active in the housing market lately, we still have highly elevated levels of adults living at home with their parents. So as they mature in their jobs, partner, have children, we see that homeownership is still something they highly desire. And the homeownership rates in the country have not grown to the point where it's higher than historical norms. So we think there's plenty of room for growth going forward. One of the things we get asked a lot about, in general, is the interest rate environment. Obviously, that's been exacerbated lately because we've got increasing interest rates really for the first time in a very long time. It's always worth it to remember while interest rates are increasing, they are still by almost every measure, at historical lows. I've shared this with investors in the past when I bought my first house. I'm a little bit older, but I had a 10% mortgage rate. I thought I got a great deal. So we think that interest rates are important, but only part of the affordability paradigm that the consumer is thinking about, how much does the house cost. And then importantly, what's their wage picture look like? What do they think about the economy, what's the media bias and why are rates going up? So we've long said that there's room for a healthy housing market with rates above 3%. And it all depends on what's causing the increase. So as long as we don't see rapid spikes like we did, for instance, in 2018, which kind of cooled the market, if the messaging around why rates are increasing is understood and not a drumbeat of negativity, we don't think it has a meaningful impact on demand going forward. The thing that we've been asked about a lot lately, obviously, is the supply chain, I can tell you, 2021 was a unique year for PulteGroup. You can see on the slide that our cycle times, how long it takes us to build a house, have expanded to 140 to 145 days, that's from an average in a healthy supply chain environment of about 90 days. So it's a meaningful increase. And Ryan, our CEO, described it sort of like Whac-A-Mole, there's every day a different challenge, whether it's finished wood products, garage doors, anything with glass. Whether it's windows, the duct work that we use for HVAC. So it's been challenging. The unfortunate thing is as you work through these things, you get better at it. So we're learning to do things a little bit differently. We're buying in advance of need. We've actually started to purchase things and store them in warehouses. So for instance, windows. There are 4 or 5 typical window SKUs that we can use in about 80% of our houses. So we're buying them as frequently as we can, and we'll store them in off-site storage facilities. We've also narrowed the option that we give the consumer. So for instance, if we historically offered them 14 choices for something and maybe it's paint colors. We've narrowed that down typically to 4 or 5, and those are things that we've worked with the suppliers to say what's going to be available so that we can reduce some of the noise in the system around outages of specific products. This has all been exacerbated by COVID. So in particular, for instance, in the window manufacturing facilities, which are typically regional, smaller companies. Or even on the trade base, if you have a person or a crew that gets COVID, you lose that crew for the week. So construction, I hope you can appreciate is a fairly linear process. We can't work around those things all the time. So if things slow down, it actually stops the production of the house. So what we've had to do is work with our trade partners, with our suppliers who have been fantastic. But suffice to say, we've seen an increase in the cycle times. We actually don't see that getting better in 2022. We're confident it will ultimately get better, but we think it will take some time for that to work through. Because we've seen -- people ask us about green shoots. We've seen things improve only to move backwards again, whether it's because of COVID or supply chain issues on our suppliers end. In the guide we gave for the year that I'll walk you through in a little bit, we've actually just supposed that the cycle times and the supply chain stay pretty much where they are today. We don't see them getting worse, but we don't see them improving in the short term. So maybe a little bit about PulteGroup. I'll take a step back and walk you through kind of our approach to the market. We -- coming out of the Great Recession, we spent a lot of time trying to figure out what are the drivers of shareholder returns in the homebuilding industry, and the very clear answer to that is returns. So whether it's return on invested capital, returns on equity, returns on assets. And so what we did was we moved to a build-to-order model for the majority of our business. And what that does is it allows us to sell to the consumer what they want rather than what we've built. It also allows them to size it appropriately so, for instance, in an era of rising prices, they can shop with their wallet and say, okay, this is what's important to me, whether it's the option of a bonus room, molded ceilings, pan ceilings, upgraded kitchens, whatever they want to do. And so what we're trying to do is let them select the lot and the house configuration that they want and can afford. We think it gives them some variability to allow for affordability things. And at the end of the day, you can see we've generated close to $90,000 of option revenue on houses. So it's pretty clear when consumers are shopping, they're willing to pay for the things that are important to them. If we pick that -- those things, we may not be right. We do build speculative inventory that is typically oriented towards our first-time buyer. What we'll typically do is start homes that will have limited optionality. So they'll have 2 or 3 choices, whether it's certain kitchen upgrades or flooring or paint colors. But on balance, it's a house that we know sells well for that consumer group, giving them some capability to put fit and finish into it that they're attracted to. But typically, what they're focused on is when can we close. So we want the home to be under construction, so we can offer them a closing date that's consistent for instance, with when their lease ends. Again, this was all predicated on the work that we did to try and drive higher returns. So again, going back about 10 years ago, we reoriented the way we run the business. A, we went to that build-to-order model. We also changed some other things that were pretty substantial inside the company. We changed the way we buy land. We used to have a process that essentially, if a land investment met a certain hurdle, green light. So for instance, if it was a 20% return, we would approve that. And we moved to a risk-adjusted return. So the riskier the transaction, the more return we required from it. Candidly, it made it harder for our land teams to buy land, but we were confident that the return characteristics that we could generate doing that would be better. We also sought to reduce complexity in our build process to drive costs out of the business and introduce some specific pricing tools that were designed to try and drive higher margins. So fast forward 10 years, Pulte has, for several years, been a leader in margin in the space. I think that is reflective of all the work that we did. And we also wanted to be efficient with our overheads. If you look at our overhead leverage as a percentage of sales through time, it's been improving as we've grown. So we're scaling the business well. So driving stronger operating margins. We also, as part of the land work, sought to try and increase the amount of our land bank that is controlled via option. Obviously, that's capital efficient. So from a return perspective, it's very attractive. But at the same time, perhaps more important to us was that it affords us some level of mitigation of market risk. The example I'd like to give is we had targeted 50% of our book being optioned. Today, I'm happy to report we're at 52%. We'll try and drive that number higher as we go forward. But we are -- if you think about that 52% of our book, we have a couple of hundred million dollars of options at risk against that. But the forward purchase value of that is almost $5 billion. So if we owned all that land today, the cost of carry and the market risk associated with that far outweighs, we think, the value of the options that we have. So as we improve the business, you can see on the charts here, today, we enjoy a return on equity of almost 30%. We've seen substantial improvement in our gross margins. And again, we were coming from an industry-leading perspective there to almost 28.5% to 29% in the guide that we've given for 2022. So with the strength of the business, we're obviously trying to invest in the business for growth. We have entered new markets, Denver and Portland are 2 markets that we had identified as wanting to be a participant in. We're starting to stand up operations there. We've also tried to leverage our overheads a little bit better in certain markets that are adjacent to markets where we operate today. An example of that would be the Triad in North Carolina. Columbia, South Carolina; Columbia, North Carolina; the Space Coast in Florida. So taking the teams and the capabilities we have and just broadening their footprint a little bit, we think, allows us to grow our business. So the pictorial here is really just, I think, everything I've just described. So we invest in the business. We think we're making good land investments. We're not growing for growth's sake. It's to drive high return. We've become a much more efficient homebuilder. It has yielded a business model that generates significant free cash flow, which we can use to further invest in the business, pay our dividend, repurchase shares. And maybe I'd like to spend a moment on this. It's the way we've elected to allocate our capital. We introduced this -- I guess it was in December of 2014 at an Investor Day. And what we had highlighted then was just we talked about, we wanted to grow, we wanted to grow with the market or slightly in excess of it. And so our first and primary objective was to invest in the business. I'm happy to tell you that for fiscal '22, we've given a guide of spending between $4.5 billion and $5 billion in the business. That would represent an increase of between 7% and 19% over what we did in 2021. Always worth it to highlight. There's land acquisition and development included in that total. So about half of that would be for the purchase of new land. The other half would be spent developing land that we already own. We've highlighted that we want to pay a dividend through cycle. We've indicated we would grow our dividend with -- when we have confidence in the business model that can support it again through any cycle. Happy to report that we've been increasing the dividend through time. We increased it 17% last year, another 7% coming into 2022. Interestingly, the cash spend on that has remained relatively constant through time. About $140 million in 2022 based on the share count that we had at the beginning of the year. That's largely because repurchase activity has actually shrunk the share count outstanding. So while we've increased the dividend pay rate because of the shrink in the total flow, cash has remained consistent. And we highlighted that we would use excess capital to return to shareholders in the form of share buybacks. During 2021, we bought back almost $900 million worth of stock. And I'm happy to report that our Board authorized an increase of $1 billion to that. We announced that concurrent with our earnings in the first quarter -- of the fourth quarter, sorry, which left us with about $1.4 billion of share repurchase authorization on a pro forma basis for 12/31 of '21. And what's important against this backdrop is we want to operate with modest financial leverage. When we introduced this back in '14, we said we wanted to operate between 30% and 40% gross debt to capital. Based on the strength of the business and the cash flows over time, our balance sheet has improved to the point where we highlighted in our earnings release that we now think we can operate through time with a debt-to-capital ratio of between 20% and 30%, down from 30% to 40%, which just represents the strength of the current balance sheet and the go-forward cash flow generation. I'd be remiss if I didn't mention we did pay down some debt in fiscal '21. We had a maturity, but we also elected to use some of our capital to buy down some of our nearer-term maturities. So really rock-solid balance sheet today gives us a lot of flexibility going forward. So looking at how we go to market, we have 3 primary national brands: Centex, Pulte and Del Webb. They serve the first time or entry level, move-up. And second move up for Pulte, and active adult for Del Webb. We also have 3 regional brands that we use that have come to us through acquisitions through time. We use those where we think they have a presence in the market that is meaningful. So John Wieland Homes and American West, which is in Las Vegas, John Wieland is in the Southeast. And then DiVosta, which is an age-targeted brand here in Florida. As we go to market, we serve essentially all price points. You can see here everything from sub-$300,000 to $750,000 and above. Looking at our footprint, we serve the majority of the major metropolitan markets in the country, very active in the smile states down in the South. But also a very active presence in the Midwest where the company was founded. And what we think this does both geographically and demographically is it offers you among the most diversified builders available, which we think serves us well in kind of any market conditions. One of the other things that we've strategically focused on is off-site manufacturing capabilities. So think of this as the construction of roof trusses, wall panels, floor cassettes. We invested in a company here in Florida. It's in Jacksonville called Innovative Construction Group. We bought it back in 2020. And interestingly, as we looked at off-site manufacturing, there are several benefits to it that we identified. Obviously, they can be really efficient with purchasing. They are very efficient with laser-guided cutting and computer modeling to build homes. There's much less waste in the process. So we think we get a cost advantage. But perhaps more importantly, as we looked at it was in a world where trade capacity is somewhat limited and the number of people who are working through the process are shrinking, we think that it affords us an opportunity to create a more dedicated workforce. So we're pleased with the progress on that. As we invest for growth, we've highlighted we're up to 228,000 lots under control. We think that this gives us the opportunity to increase our community count by 11% going into fiscal '22 or through '22. And I've noted 52% via option. I think we've covered everything on this slide. I'd highlight our debt maturity schedule is very attractive. Debt to cap at 21.3%, almost 0 net debt to cap, $1.8 billion of cash at the end of the year with cash flow generation expected in '22 off of a business model that we think generates an almost 20% return -- operating margin, sorry. We also get asked a lot about single-family rental. We are active in the space. We announced a partnership and agreement with Invitation Homes, where we'll build jointly with them. So these are communities where we'll go in, build some for rent, some for sale. For us, it's actually an ability to expand our business because we have a partner who's willing to commit some capital and take assets -- houses on a dedicated turn. So we can get through assets a little bit quicker, so the returns are attractive. And it allows us to do some deals that we really wouldn't have done on our own, whether it's because of size or depth. We obviously are continuing to evaluate the space, but I don't think you'll see us selling 1s and 2s to different single-family rental partners. Maybe the highlight for me is against the really challenging backdrop for fiscal '21, our team delivered an outstanding year. You can see sign-ups up 8%, closings up 17%, revenue up 26% due in part because of the pricing increases, margins up over 200 basis points, net income up 38%. EPS up an even greater 43% because of the share repurchase activities that we have. And as I highlighted, a return on equity approaching 30%. Looking at '22, we think it improves from there, candidly. Community count up 11%, affords us more opportunities to sell. We're actually constricting sales in most of our communities today. The demand environment is very strong. Against that backdrop, we're projecting a 7% increase in closings to 31,000 units. Average sales price up 11%. So we'll see revenue growth close to 10%. Gross margins, as I mentioned, up another 200-plus basis points. Controlled SG&A spends on operating margin, again, approaching 20%. So maybe in summary, and we'll see if there are a couple of questions. We're focused on our customers, our employees, engagement is important to us. We're going to continue to invest as long as we're constructive on the market, which we are today. We'll maintain the discipline that's gotten here and we'll continue the allocation of our capital. With that, I'll pause. Questions?

Feel free to chime in if anybody has a question. Let me start with the 1 quick one, maybe. Just -- on the affordability question that people have, have you guys done any stress tests in terms of you're looking at your backlog, if rates go up 100 basis points or whatever the number is, how does that affect your buyer group? Would they have to go back and get more for the down payment or adjust their product? Or how do you think about the risk of rising rates to the backlog?

Yes, it's a great question, and we get asked it a lot. The good news is the buyers in our backlog actually have really strong credit scores, our average FICO score is 750. And even for the entry-level buyer, it's 660, 680. So we don't see a lot of risk to people falling out of the credit box. So debt-to-income levels are still strong. If we need to, we have opportunities to seek more down payment and/or offer different products. We've got a financial service company that serves -- it's a wholly owned captive that does about 85% of our customers that use mortgages -- actually use our mortgage company, so we have good visibility. So we feel pretty good. The other point always worth noting, everybody in our backlog now has seen prices appreciate behind when they contracted. So they've got some value coupled with their deposit that is an incentive for them to move forward.

Okay. I saw some hands up there.

Bob, could you please comment on the composite decking market probably like [indiscernible]. What percent of your homes are built with composite decking and you see that going up and maybe that's an alternative to high price of led.

It is. There are certain markets where it is more prevalent than others. We are evaluating using it. I think it's a little bit more expensive. But it can be a cost-effective replacement, especially given what's going on in the lumber market. So we evaluate that essentially market by market, depending on the availability of lumber end product. But we do use it. It is not the majority of our use though.

So you'll use it?

Where it makes sense, we would sure.

Saw a couple of other hands up anyway and they always want to jump in. Yes. So maybe in terms of leading indicators, if you can share anything with us in terms of the demand that's out there, I mean, any changes in either website traffic or have you noticed any change in behavior of buyers changing their option spend or the lot premiums or anything that would suggest that they're starting to get stressed on home prices?

Candidly, no, not today. The consumer -- and again, with that build-to-order model, they are actually deciding what they can afford. And so I think you have seen generally some move to smaller product, and that's been over the last 6 to 12 months as people come in and they say, okay, maybe I want -- I need a 4-bedroom home. They may select the 2,200 square foot version of it versus a 2,400 square foot version of it. But traffic remains really solid. We had highlighted in our earnings call that we saw sales activity be consistent all through the fourth quarter, which is not the norm. Typically, we would see a seasonal kind of dip and that had continued in through January. And honestly, we're constricting sales mostly around production capabilities, we could sell more houses today.

So around that, I mean, can you give us some context for how many communities are under sales rest -- you said the majority relative to where it was in maybe the fourth quarter to where it was in January. But how many -- if the supply chain was functioning normally, if maybe the labor component is a different issue. But like how many more houses, theoretically, would you normally be selling absent these supply chain issues?

Yes, that's hard to know. I think I could probably characterize it a little differently. If the supply chain normalized, we would be building a lot more homes. And so the 31,000 homes that we've projected to build and close this year might be higher by as much as 10%, just on the current backlog conversion. And if we were able to convert our backlog more quickly, we would certainly be able to sell more houses. How many? Hard to know.

Yes. All right. Last question. Go ahead. Yes, right there.

What do you think the cap on the gross margins is you think can grow gross margins going forward from the...

Yes, that's a -- we get asked that question a lot too, and that's a more challenging one. Obviously, as time goes forward, I didn't highlight it, but the supply chain dynamic has driven inflationary aspects for us as well. We've highlighted 6% to 8% increases in our vertical construction costs for fiscal '22, that's on top of 10% that we saw in fiscal '21. Our land bank always gets more expensive, but we're buying through time, and so it's a relatively modest growth. So pricing would be the determinant of -- and I know that's an obvious statement, but that would be the determinant of margins. Important for me to say we don't underwrite to gross margin. We underwrite to internal rate of return on investment. And I'm happy to say that we haven't changed our underwriting screen at all. And so the land that we're buying today, we think enjoys the same returns as the land that we bought 3 years ago when we bought it. So I think margin will move dependent on price in the market. I think we believe we can continue to generate best-in-class margins.

With that, I think we have to adjourn, but we've got lots to talk about downstairs if you'd like to join us in the breakout. Thanks, everyone.

Thanks.