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

Good morning. My name is Michael Rehaut. I'm the senior analyst covering homebuilding and building products for JPMorgan. And it's my pleasure to kick off our 15th Annual Homebuilding and Building Products conference, being held again virtually today and tomorrow. We have an array of homebuilding and building product companies that are presenting and participating in meetings, and we're thrilled to kick off the conference with PulteGroup. We have with us Ryan Marshall, President and CEO, along with Jim Zeumer, Vice President of Investor Relations. This will be a fireside chat. I'll moderate that and ask a bunch of questions to Ryan. There will be also time in this 35-minute session for people that have dialed in to submit a question. And if you'd like to do that, you can, in the digital conference book click on the submitted question tab, and I'll be happy to relay that question towards the end of the session. So Ryan, I'll kick it off here. Again, very much appreciate PulteGroup's long-standing attendance to the conference. Great to see you at least virtually. Perhaps next year, we'll do a hybrid model. But I'm going to kick it off with some industry-level questions and then we'll switch to maybe a little company -- more company specific.

First, I think just hitting on everyone's top of mind here, mortgage rates versus the current demand-supply imbalance, what mortgage rate do you think is necessary or that would ultimately be needed to have a little bit of a cooling of the market in where there's a little bit more of an even demand supply balance, where you don't see still the impressive strength that's still resulting from the imbalance that we see today?

Mike, it's a good question. And I think to properly answer it, you've definitely got to pull out the crystal ball and dust that off, and my crystal ball is sometimes good and sometimes not so good. But specific to the point on interest rates, I think it's just one part of the equation when it comes to housing demand and certainly to the affordability equation is just part of the story. We've had and continue to have an unbelievable housing market where demand has far outstripped what supply is there. I think we definitely have some additional supply coming through the system. But even with what I think we have insight -- the insight that we have to what's coming down the supply pipeline, it's still probably short of what actual demand is. I think with the comments that we made at our -- the end of our Q1 earnings a couple of weeks ago and some of the other commentary that you've heard from some of the other public builders, I think you've heard folks say that things have started to slow a tad from maybe what it was at the end of last year when rates were still in the 3s. So Mike, if I -- it's probably hard for me to give you a specific rate of where you would actually start to see equilibrium hit where supply and demand are equal, but we're probably getting pretty close where we sit today at north of 5%, 5.25%, 5.375%. My guess is we're getting pretty close to a spot where things hopefully can start to reach a little bit of an equilibrium. Now what I would tell you with more COVID lockdowns in China, I think we're going to continue to see some additional and incremental supply chain disruptions that likely kind of hit in the back half of the year, and that's coming out of a period of time where you heard us say publicly a couple of weeks ago that we were starting to see a few wins. That was -- those wins were probably offset by a few losses specific to the supply chain environment. So it's going to continue to, I think, be an interesting back half of 2022.

Great. And that kind of leads me into my second question, where you say that we started to hear a little bit that things have begun to slow a little bit. Maybe relative to your own business, and what you see in the market, any changes in the last 30 or 60 days, changes in terms of moderation in buyer behavior on the margin? I would say, overall, coming out of earnings season, builders have effectively uniformly reported that demand has remained strong through April. But at the same time, there has been some small changes, shorter priority lists, some buyers taking on smaller homes or buying a little further out. So have you witnessed any of those types of changes? And if so, what percentage of buyers might have you seen this across?

Yes, Mike, I'm going to take you back to -- again, to our Q1 earnings. As I think you're aware, we don't give inter-period market commentary. So everything that we'll talk about, I'll continue to reference back to our Q1 commentary. But we did say that we started to see interest lists getting a little bit smaller. And these were interest lists that, candidly, were too large, and we were having to use various tools and mechanisms to decide who actually gets the lot. We're continuing -- the commentary that we gave is that we were continuing to see that in a lot of our communities. But there were some communities where we were going to more of a normal lot release program, where we're releasing 3 or 4 or 5 home sites in a given month, which is the number that we expected to sell. We were still selling through those in the month, but it was taking maybe a little bit longer than the frenetic frenzied pace that we were seeing in the back half of last year. We still -- we mentioned we're still seeing price increases in nearly every community that we operate in. For the quarter, or sequentially from Q4 into Q1, we saw something in the range of 1% to 5% per community. So still pretty healthy price appreciation across the quarter. We've not seen any change, Mike, in the size of the homes that consumers are buying. Our number has basically stayed about the same, and we've continued to see an increase in the amount of lot premiums and options that consumers are spending. So the health of the consumer that's buying is still very strong and candidly got stronger in Q1 relative to Q4 of last year.

Great. I guess also on -- you said -- you mentioned you're still seeing price increases. You alluded to what you discussed on the call. There has been -- I think you guys were one of the earlier builders to report during earnings season. Subsequent to that, there were a couple of other builders talking about rate locks and perhaps other forms of incentives or discounts. Have you offered anything similar in that regard? And if so, what percent of your buyers, and what does that mean from a gross margin standpoint?

Mike, we offer -- we've got our own captive mortgage company, Pulte Mortgage, Pulte Financial Services. Deb still runs that for us, long-time mortgage veteran, which I think you know and a lot of investors know Deb's name. She does an unbelievable job, and we're offering very competitive products, combined with exceptional service. So we really think we can offer a one-stop shop home and financial mortgage product to our customers. In terms of rate locks and buy downs and things like that, Mike, we're definitely seeing more buyers lock earlier. So -- and that shouldn't come as a surprise, I think, to anybody in an environment where there's an expectation that rates are going up, and the Fed has made that very clear, they are going up and they have. I think it's pretty normal for a buyer to say, "Hey, I'm going to lock for as long as I can where I believe that I get the financial -- the trade-off is worth it." A 30-day rate lock, I think, is pretty standard. When you start going into 45-, 60-, 90-, 120-day rate locks, there's a price to that. And so I think buyers and us are making decisions about the incentives that we're giving and how we allocate those to get the rates locked in. We're not seeing much of a change in terms of ARMs, candidly. It was probably less than 1% 90 days ago. We're now maybe in the 1% to 2% range of our buyers are using some kind of a longer-term ARM like a 7/1 or a 7/6, I guess, is the new one, which is 7 months and -- or 7 years and 6 months is the fixed rate and then it goes to a variable. So we've seen a little tiny bit of an uptick, but it's still a pretty negligible number overall. So I think, Mike, the short answer for us is we have all of the tools that I think any mortgage company would offer. We have not done anything systematically where we're going out and buying rate locks for our entire backlog. We think, at this point in time, it's unnecessary. I know it's just one kind of data point out there, but if you listen to some of the economists -- specifically the economists from the Mortgage Bankers Association, his prediction is that by the end of the year, rates will be sub-5%. So we're continuing to work with our customers on an individual basis to make sure that we can give them what they need.

That would certainly, I think, be a welcome news to a lot of people in the industry if there was a little reversal there. I haven't heard that yet myself, so I appreciate you passing that along. Maybe just 1 or 2 others on the industry level, and then we'll dive into more Pulte specific. Just curious about any regional or geographic differences that you might see across the country? I think what's interesting in the last several years is that the market has been almost one large national homebuilding market. They've all been strong. They've cooled down. It's all been kind of together. Have you seen any differences emerge in the last few months between regions or specific markets either remaining unusually strong or maybe coming off of that strength in the last couple of months?

Really, Mike, everywhere has been great. I think, to your point, it's operated very much as a national housing market as opposed to kind of regional or city-specific. The Southwest, Texas -- Austin, specifically -- the Southeast and Florida have been unbelievably strong. So if I were to call out anything as being extraordinary or exceptional, it would be probably the Florida markets and Texas, specifically Austin. The job growth, the price appreciation, the demand for homes in Austin really has been extraordinary.

Great. Thank you for that. I guess another concern that people have kind of shifting back a second to incentives, you mentioned extended rate locks. But I think one big question facing the industry, not just this year, but in the last year as well is the idea around normalization of gross margins. And there's kind of 2 elements to that. One is, if home price appreciation stopped today, how long would it take for gross margins that builders underwrite at to eventually flow through? The other element is, if incentives normalize because they're next to nothing today, what impact would that have on gross margins? I think there's been a lot of debate around the first impact, just the normalization of underwriting. But if incentives were to just kind of kick back to a normal level today, do you have a sense of what basis point impact that would have to your gross margin?

Yes. Mike, if incentives were -- normal incentives for us were something in the 2% range. I think if you went back 12 to 18 months ago, we would have been in the probably 2% to 3%, 2.5% range would be our normal incentive load. Our most recent quarter, we were right at 1% flat. So something in the kind of 1% range would probably be -- an incremental 1% would probably be a more normal incentive load.

Okay. So you're saying about 100 bps to gross margins today?

Right.

Great. All right. Let me shift now to...

Mike, I would just -- I'd highlight -- I'd be remiss if I didn't highlight the fact that while gross margins are important and higher is certainly better, we don't underwrite to gross margins. Our focus has been and will continue to be on delivering great through cycle return on invested capital. And we do that as much as anything through structuring of the land purchase and the way that we own the land. I harken back to some of my days as an operator, as a division president. I had some high teens, low 20s gross margin deals, individual deals that generated some of the best returns that I had in my division. So certainly, we enjoy a very rich gross margin. We're proud of the gross margin that we deliver. But gross margins going up or down slightly is an interesting data point, but it's not what we're focused on and what we really use to drive our strategy.

Right. Okay. No, I appreciate that. Thank you, Ryan. Maybe just switching to some of the company-specific questions. Let's kick it off with just your -- one of your more unique elements of Pulte relative to the rest of the group, and that's your demographic diversity. You've always been one of the most diverse in that regard between first-time move-up and active adult. In the event of a rate-driven slowdown, which would presumably have the greatest impact on entry level, would this change your desired demographic mix over the next few years? Or would you kind of still entertain the current mix that you're at?

Mike, I think we would -- you would see us stay right pretty close to our current mix. We've been very intentional at setting it, where 35% of our business is first time, 40% of the businesses is move up and family buyers and 25% of it is active adult. We've intentionally indexed those first 2 categories to basically what we believe is the size of the prize, if you will, within the market. I know rate differences or rate changes can have a shorter-term outsized impact or benefit to a particular demographic group. But I think if you look over the long haul, 2-plus, 3-plus years, to have a healthy housing market, we need all demographics participating in a constructive way, even if one of those demographics is not your focus. Likely, the buyer that is your focus is selling a home that's going to one of those demographics. So while a builder may get an outsized impact or an outsized benefit in the short term, I think, long term, you got to think about who you want to be and kind of stick to it, which is, I think, what you've seen us do. We've been very consistent in it, and we really like the diversified approach. We think it allows us to kind of win in many different market cycles because we've got a penetration into each of those 3 big consumer groups.

Great.

Mike, I'd add just one other point, which is your land pipeline of what you own today is what your business is going to look like for the next couple of years. I mean, so if you wanted to suddenly say, "Hey, we want to go serve a demographic in a meaningful way", it's probably a 24-, 36-month process to really change the land supply sufficiently to move the needle out in front of you. So these are big tankers, and it takes a little while to turn these boats. So again, any changes, a, we would articulate it; and b, it would be, as I said, 24, 36 months out before you start to see it really flow through the income statement.

All right. Okay. Good. Now thank you, Jim. M&A is a tool that you've used strategically over the last few years, either for -- to augment market positions like American West or demographic exposures like John Wieland. How do you see M&A as part of your future plans? Are there still certain needs across certain markets or product offerings that you continue to look for? And even with some of the smaller cap builders trading at or below year-end book value, how might that figure into your thought process?

Yes, Mike, we -- M&A is something that we've taken and always on view towards. So we look at M&A all the time. More recently, it's been smaller, local kind of single-market type builders, private builders for the most part. I think you've had a number of private builders for various reasons that have decided they're going to sell their company, whether it was -- well, the reasons are many, and I'm sure you can imagine what some of those reasons are. We -- when we look at those opportunities, we really look at their land book and we say, is it a market where we need more land, and then which consumer group is that going to give us access to and how does that overlay with our existing business? You mentioned American West. Part of the reason that we loved American West was because of the optionality that we got with that deal. So we bought some lots, about 1/3 of what we totally controlled with that particular acquisition, 1/3 of what we bought and put on our balance sheet. The other 2/3, we had an option, a rolling option on over the next 3 years. It also gave us access to a part of Las Vegas that we were not in. And so it really kind of checked so many boxes strategically that we said, this is exactly the type of acquisition that we want to do. So as we think about kind of M&A going forward, we're really looking for kind of key markets where our market share isn't quite what we desire it to be, and can we augment that through M&A? And then the next piece will be what does the land book look like that we're buying? And how is that structured compared to our long-term strategic goals? In our most recent earnings call, we highlighted that we want to move to -- closer to 65% to 70% of the land that we control being via option. If we go to an M&A transaction and that takes us further away from that goal, that's certainly going to kind of weigh on our thinking and weigh on or thinking about how we consider or think about a particular M&A opportunity. As far as the public builders, Mike, you've been around this industry a long time. I think public to public M&A is hard. The integration risk is real. So I think you'd have to have a pretty compelling reason and something pretty special in putting 2 public companies together beyond just the fact that maybe it's a good deal. I think you'll always see from us that we're thinking about these strategically and how does it help us with what we're trying to do long term.

Great. Thank you, Ryan. Maybe just shifting also to the ICG acquisition that you did a couple of years ago, actually about 2.5 years ago. At the time, there was one site in Jacksonville producing off-site wall panels, roof trusses, floor systems, other services. Can you just kind of give us an update in terms of where you are in terms of expanding this acquisition across other areas of your footprint? And any update regarding your long-term plans for this business?

Yes, Mike, it's gone incredibly well. First off, it's been an interesting exercise through COVID because you're seeing some of the supply chain impacts to that business even sooner than what we -- than what we see in the homebuilder side. So I think we've probably learned a lot there and gained a lot of valuable insights. The integration into our homebuilding operation has gone incredibly well. We couldn't be happier. And specific to the first site that we acquired, which was the Jacksonville plant, we've increased our production capacity there by about 50%. So if you can imagine, when we bought that company, there wasn't a single unit of Pulte business running through that plant. It was all done with outside customers. We've maintained almost every one of those outside customers, and then we fully integrated all of our Pulte business into it. And we've done that by expanding the production capacity of the plant with some additional square footage and better equipment, better technology. So I think it's really been a win, not only for the customers that we were serving when we bought the business, but for our own business. So we're happy with Jacksonville and really thrilled with the team that came with us through that acquisition. We've just recently opened up our second facility in the Southeast part of the U.S. So it's serving a lot of our business in the Southeast. And that business is coming up to full capacity as we speak. We're probably at about 50% operational capacity today. I was up there about 3 weeks ago with some members of my team just taking a look at it as that plant came online, it's pretty exciting. And then, Mike, in terms of the long term, we want to have about 8 of these plants total. So we're 2 -- we've got 2 under our belt. We've got about 6 more to go. We'll -- we're going to be -- we're going to move with intent, but we're going to be thoughtful about the rate of expansion and make sure that we can effectively integrate it into the housing operation, which is the key.

Thank you for that. And when you -- do you have a sense of -- I don't know. You tell me what the right metrics are in terms of measuring success, but I'm thinking either a gross margin impact from production and cost efficiency standpoint, a cycle time impact? I mean, what are the types of metrics and the amount at which those metrics can improve, should we be expecting once a plant is fully rolled out? And by the way, the 8 plants that you mentioned in total, I'm curious what footprint -- what percent of closings that would cover for your company?

Yes. I'll take that last one first, Mike. We think with 8 plants, we can get somewhere in the 60% to 70% of the total closings from our company can be impacted by those 8 plants. So that's the rough range that we're operating under. It will -- geographically, it will mostly be Southeast, Texas, Southwest, a little bit of Florida. We probably won't do a ton in the Midwest or much in the Northeast when it comes to off-site manufacturing. Our footprint there is so geographically diverse and kind of spread out. To make the economics of these plants make sense, you need kind of concentration of volume in a pretty tight radius. In terms of impact to the business, Mike, I think you hit 2 or -- 2 of probably the 4 things I'd highlight. So if we can buy materials better, and we can manufacture them more efficiently, that will certainly give us a gross margin benefit. We also believe that the integration of that supply directly with our homebuilders, we think there are some synergies there that give us some incremental leverage as well. Whether that flows into gross margin or into overhead efficiencies, it drops to the operating margin line for sure, so we think there's some benefits there. And we believe that we get candidly better quality with the stuff that's coming out of the plant versus maybe doing things in a more conventional way. The other piece that I would tell you, Mike, that we're probably not talking a lot about right now, but over the, let's say, the next decade, I think we're going to continue to have challenged labor shortages in this industry. This is one area where we think we can kind of help ourselves by being more efficient in the way that we produce the frame shell components of the home. So is it going to solve all of the industry's labor challenges? No, definitely not. But it's certainly something that we think we can do to give us a little bit of an advantage. So we're seeing real benefits to kind of the bottom line today in the business that's being impacted by the current plants. We haven't publicly disclosed what that is because it's such a small piece of the overall company. But as we get more plants online, we'll be very transparent about the incremental benefit that we're getting and how that extrapolates into the full enterprise.

Great. Just a reminder, we're about 7 minutes out to the end of the session. If anyone has a question -- I have a couple more, but if anyone listening in wants to submit a question, there's a submit a question queue. I see one there, so we'll get to that in a moment, but we do have about 7 more minutes to complete this session. So let me ask 1 or 2 more, and then we'll see if there's any other questions as well in the queue. You mentioned your lot option target, Ryan, of 65%, 70%. Getting to that target over the next, I would presume, a year or 2, how would that change your cash flow generation? And given your strong balance sheet, should we just simply be assuming a higher portion of cash flow or capital rather to be allocated to share repurchase as a result of your cash flow needs to decrease and the businesses is naturally generating a higher level?

Yes, Mike, there's a lot to unpack there. So I'll quickly touch on it. #1, let me talk about the shift to more optionality. If I take you back 5 years, 5.5 years ago, when I took this job, we set a goal to go from about 30% option to at least 50% option, and we're there today. The process of doing that, I think, has unlocked a number of benefits for the company, cash flow being one of them. And so you combine the benefits of less cash in the business because of more optionality, along with a housing operation that's frankly running incredibly well, the cash-generative properties of this business are extraordinary. And what that's done is it's given us options. We've been able to continue to invest in our business in a pretty meaningful way. We've been able to pay down some debt. We've been able to raise our dividend, and we've been able to buy a lot of the company back through the share repurchase program. So I think, as you look forward over the next, say, 2 to 3 years, and we want to go from 50% option, where we sit today to 70%, you'll continue to unlock to your point, Mike, more cash, and it will simply be because you've got to put less into the business. We haven't quantified what the number is, but it will be pretty significant. In terms of what we do with the money, I think it gives us a lot of flexibility, Mike. What we've said about our share repurchase program is it is one of the tools that we use to return excess cash that we don't invest in the business back to the shareholder. A primary -- goal #1, is going to continue to be our own business. As long as we see high returning opportunities to invest in that, that's what we're going to do. We'll pay the dividend, certainly, which is a fairly low cash spend today in the $125 million a year range. We'll continue to look at that and the balance will go back to share repurchases. So we've -- because it's a second or third priority, we've stopped short of giving guidance around share repurchases and rather just said, "Hey, we're going to be a consistent predictable buyer, the dollar amounts will probably change, and we'll kind of report the news as it happens." So what I'd want our investors to hear is, we're going to continue to be very active in the share repurchase market. The dollar amounts will probably change based on what we're investing in the land.

Okay. Great. I actually got a flurry of questions. We only have about 4 minutes left. So let me try and get to a couple of the questions from the audience. There's a couple of rate-related questions. Let me combine them. One is, with rates rising, what is the lag effect or anticipated spread from anticipated land price changes to home price changes? Also, there was a question about, with rates where they are today, what's the chance of starts being flat next year? So 2 different types of questions around rates, but I'm trying to be efficient from time.

Yes. So the land market, Mike, I think, has been and will always be very efficient. Land sellers, they know what the residual -- what their land residual is relative to what homes are selling for. They can reverse engineer into that pretty quickly. So barring some change in asset values, I wouldn't expect to see any kind of change in the land market. It's competitive, continues to be competitive. I wouldn't anticipate any big changes in the land market. If things slowed a tad, you might see some better terms, maybe the ability to have some more optionality, things of that nature, where, over the past 12 to 18 months, it's been a lot of big bulk kind of cash deals. Sellers haven't been as willing to do options. It's been a seller's market for sure. In terms of kind of starts, Mike, I think that really is probably more about what's going on in the supply chain. Demand, I'd reiterate, similar to what we talked about in our Q1 call, demand is really outstripping the supply that's there. It's probably less of a -- the gap between demand and supply is a little narrower than what it was, but it's really been a supply issue, and you've seen that in all of our cycle times. We were used to building homes in 90 to 100 days. And our most recent update is we're now at 145 days. So that's a big change from where the industry used to operate going back kind of the pre-COVID cycle times. So as the supply chain normalizes, and we can shrink those cycle times back down to more normal type cycle times, that, I think, is going to be the big driver on starts this year versus next year, not the demand equation.

Right. No, that's a fair point. Two last ones here. I might go a minute or 2 over, but a couple of good questions here. One, just quickly, what does Pulte source directly from China that would make their shutdowns cause any supply chain issues for Pulte?

Yes. It's less about the stuff that we directly source, Mike, and I think it's more about some of the components. So things like appliances. Are there components in the appliances that are China-based? Are there components in electrical and lighting components that are China-based? In terms of things that we directly source from China, I think it's very small. But the supply chain is global and it's big and complicated and there are tentacles that I think go everywhere. So if I were to tell you the things that I would anticipate kind of having the biggest issue, anything with microchips, I think, has been and will continue to be a problem. And then the other one would probably be electrical components, whether it's breakers, transformers, things that go into lighting fixtures, those are the things that I would anticipate having some ripple effect from further Chinese shutdowns.

Right. One last one here, and I know we're going maybe a minute or 2 over, but I think it's also an important question. And it's more company specific. What do you think the public markets are missing about the Pulte story during -- I'm sorry, given the current valuation? And I would just add, not just the valuation of the whole group, but specifically Pulte's relative valuation to some of your peers given where your margins and returns are, generally at the higher end of the group?

Yes, Mike, I think that's what the market is missing is the return profile, the return on equity, return on invested capital, return on assets, whatever metric you want to use, they are, if not best-in-class, near best-in-class return metrics. That ought to come with a higher premium than what the market is currently giving us. I think the other piece that the market is missing is the change in risk associated with homebuilders relative to what we were in 2005 and '06. These companies -- ours specifically, we own way less land, we option a whole bunch more and the amount of debt in these companies today relative to where they were 15 years ago is radically different. So is homebuilding risky? Absolutely. Is it cyclical? Yes. I don't think we're going to change that, but what we have done in the way that we've capitalized our company and the way that we're managing risk is radically different from where it was 15 years ago. And so I think when you look at the cash-generative properties of this business, the returns that are being driven and the risk profile of the business, they ought to be trading at a much higher value than what they are today.

Great. Thank you, Ryan. That's a good place to end. And again, appreciate your time, your participation. As always, it's always a pleasure to see you, and hopefully, next year in person or sooner than that. We'll conclude the session now. Thanks for joining, and we'll see you again soon.

Thank you.