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

Sleep a little bit but thanks for joining in the PulteGroup's discussion. My name is Buck Horne. I'm the Raymond James housing analyst covering homebuilding, residential REITs, timber and assortment of other companies related to the housing sector, lots of interest we've gotten from a multitude of investors about what's happening in the housing market and particularly with homebuilders. Mortgage rate volatility has been at an all-time high for the past year or so, and that has only continued to start the year. Of course, we've got some very encouraging data points. Mortgage rates unexpectedly fell back to 6% or so in January and all of a sudden, buyers seem to have come back in a big way and that was really, really good news for a lot of builders. Of course, now we turn the calendar and it's March and mortgage rates are back to 7%. So we have a lot of question marks now. Can this momentum continue? We'll see. I don't -- I think -- let me know what they can say to us through their last quarter. But nevertheless, a lot of interest and a lot of things happening in the housing market. So let me turn it over to Bob O'Shaughnessy, CFO of PulteGroup.

Thanks, Buck. And thanks, everybody, for joining us here today. We are -- just see if I can get this going here. All right. So what I'll be walking through this afternoon is a little bit about us, just an overview of the company, walk through the overview of the year that we just completed. It feels like yesterday, it's now, to Buck's point, it's almost the end of the first quarter. And then maybe given the volatility and evolving nature of the market, give you a little bit of an update on how we're thinking about the market and how we're behaving. And then I'll leave some time for questions at the end. Looking at the company, one of the most broadly diversified homebuilders in the country. You can see on the map, we cover 24 states, more than 41 different markets in those states, most of the significant MSAs in the country. It's certainly coastal representation, smile state for the high growth as well as in the Midwest, where we've always had a pretty active presence because of our founding being in Michigan. As we go to market, we have 3 national brands. They target the first-time or entry-level builder group, which is buyer group, which is our Centex brand, the flagship Pulte, which is move-up; and then active adult, which is our Del Webb brand. We also operate several regional brands, which have strong regional market recognition among them being DiVosta, which is a targeted builder here in Florida and John Wieland Homes, which is a brand we bought back in 2016, which has a strong second move-up presence in the Southeast. We obviously are also pretty broadly diversified from a pricing perspective. You can see here anything from under $300,000 to well over $1 million are the price points that we touch. Just for perspective, if you look at the mix of these, roughly 40% of them would be in price bands that we would consider entry level. About 35% would be that move-up/buyer and then about 25% being the active adult. So as we think about how the company operates, our strategic focus and our operating philosophy really for over a decade now has been to seek to drive higher return or high return through cycle. And the way we seek to do that is through a superior homebuilding profitability profile. And candidly, that all starts with land acquisition. So we have a risk-adjusted return-based acquisition methodology that seeks to on balance, keep our owned lot position relatively light. So we try and have about 3 years of owned and 3 years of optioned land. Currently, we have 48% of our land book being optioned. It had been about as high as 55% last year, but we walked from some options given some of the volatility over the back half of the year. So that's at 48%. But broadly, we are a build-to-order builder, particularly for our move-up and active adult buyer. We are introducing more spec into the market today. Our Centex, our first-time flag, has been largely a spec build model in general. But given the rate environment that Buck referenced, consumer acceptance of things that are going to deliver in relatively short order, require some spec building, and we've done that. We also seek to be an efficient builder. I mentioned this in a couple of meetings this morning, we have a commonly managed floor plan platform. And if you think about that, it's -- we seek to build the same plan as often as we can. So today, we have probably -- we're looking at fiscal '22, we had 29,000 closings. We have about 1,000 floor plans. So we're building each one about 29x. And you compare that to when we launched this program back in 2012 when we did about 15,000 units, and we had 3,000 floor plans. So we were only building each one 5x. So that repeatability for the trade base allows us to buy and build more efficiently. And then we go to market a little bit uniquely in that we have a standard -- or not a standard, but we have a base price for our house that's competitive in the marketplace. And then we ascribe a value to each lot that we're building on. And then, on the build-to-order business, we charge a fair price, but are seeking to get paid for the options that people choose as opposed to the ones that we choose for them. And so when you kind of shake all that together, if you look structurally, we've enjoyed a richer margin profile than just about any other builder for years that obviously exists today. We can cover that when we're talking about the prior year. And also just a highlight, we are expanding into new markets. I'll spend a second on that in a minute. So looking at 2022, I can honestly say, it was a terrific year from a financial perspective. We obviously delivered 29,000 homes, that was up 1% over the prior year. Our revenue of almost $16 billion was up 18% over the prior year. So that included a 17% increase in price. That allowed us to generate margins approaching 30% for the year, which is up almost 300 basis points over the prior year. And all of that led to a 48% increase in our earnings per share to almost $11 -- or just in excess of $11 per share. Really proud of the fact that on top of that, our return on equity improved to almost 33%, which is a record for the company. And it allowed us to do several things. One is to continue to invest in the business. We invested $4.5 billion in land and land acquisition that will serve as community growth for us going forward. We returned $1.2 billion to shareholders in the form of dividends and repurchases. Dividends have been an increasing rate over the last several years for us. annual spend is about $140 million. So what that should tell you is we spent about $1 billion or $1.1 billion on share repurchases last year, so just under 10% of the company float. And if you look over time since we introduced the share repurchase program, we've actually bought back almost 50% of the company's stock in the last decade, all while managing a very manageable leverage profile, our debt-to-capital ratio on a gross basis is under 20% today. We have a long-term target of operating between 20% and 30%. So we're very comfortable. It's not a mandate. We won't necessarily borrow just to get into that 20%. And on a net debt-to-cap basis, we're sub-10%. So the flexibility of the business affords and the performance allows us to think about any and all of these capital allocation priorities going forward. A couple of other successes for 2022. I mentioned we've expanded into 5 markets: Denver, Sacramento, Columbia and South Carolina, Portland and Oregon. So today, we really do touch just about every MSA of significance in the country with the exception being probably Salt Lake, which we are working towards trying to enter. Happy to report that we've opened our second off-site manufacturing plant. So we acquired a business in Jacksonville a few years ago, and we've been seeking to ramp that across the country. At some point, we expect to have somewhere between 6 and 8 plants open. So we opened our second one in Florence, South Carolina. And so this is wall panels, floor cassettes, trust manufacturing that then gets trucked over to the job site and assembled on site. So we're excited about that opening. And then equally excited about being named a Fortune 100 Best Company to Work For, we were actually 43rd on the list. Super proud of that, especially based on it being based on the feedback of our employees. So I'd be remiss if I didn't mention that as for all the good things that happened in 2022 and there are many, it was a challenging time. Buck talked about it, the Fed raised rates 7x. We saw mortgage rates effectively double during the year. New and existing home sales actually declined. Single-family starts dropped 11%. So a little bit of sand in the gears for lack of a better word. And interestingly, that volatility has pushed people to want to get into their homes a little bit sooner rather than signing a contract and taking delivery 8 or 9 months later and all the exposure they have to rate risk around that. So interestingly enough, as we look at our business, we've been running at about 35% to up to 40% speculative inventory starts. 60% of our sales, that's 60% of our sales during the fourth quarter were actually spec. And so we've been willing and starting a little bit more, especially the supply chain is improving, but still a little bit ragged. And so, we're -- as we approach the coming year, and maybe I'll switch to that. How are we going to behave? We are a production builder. And so what you can and should expect from us is that we're going to continue to develop the lots that we own. We're going to build houses on it. We're going to find price. On our most recent call, Ryan, our CEO, mentioned we're not going to be margin proud. Our goal is to produce and sell homes. That allows us to keep our production machine working, our overhead efficiencies. And even for the consumers, they walk into a community, if they see trades and activity, that sends a different message than if there's nothing happening. So that's what we'll be doing. We did not give an annual guide for closings, but we did give a production universe guide -- and so that's 25,000 units, which would be down. If that were our closings, that would be down from the prior year. Worth highlighting that's including 18,000 units in production in the year, plus 7,000 units that we expect to start and complete during the year. I'd highlight that there are opportunities to influence that. So if the market is good, we will start more homes. If the market is weaker, we might actually reduce our start cadence. And with the supply chain being that it is, our actual cycle times are elongated relative to historical norms. We're at 166 days today versus a historical norm of 92. So we'll be seeking to actually carve time out of our cycle times. All of those things can influence that available closing universe for fiscal '23. But we will be paying attention to the market as opposed to being mandating the total number that we're going to build. Similarly, on land, I mentioned we invested $4.5 billion in fiscal '22. We're actually managing our pipeline aggressively in the market conditions we face today. So our total lot position is actually down 8% versus last year. We walked from 52,000 optioned lots during the second, the third and fourth quarters of last year. We had a cost associated with that of $64 million. But from my perspective, that's a relatively inexpensive form of insurance against what would have been $2.1 billion of land acquisition spend and then development spend on top of that for deals that just, from our perspective, didn't pencil anymore. We expect to spend $3.3 billion in fiscal '23. That's about 30% down from the $4.5 billion last year. I will highlight that our acquisition spend is really where that change is happening. Our development spend is going to be about the same as last year, going to represent 65% or 70% of our spend this year. And so we'll pay attention to the market. We'll want to see a little bit better value proposition before we were going to increase the spend, but we have the financial flexibility to do that. And notwithstanding the decrease in spend this year, we will be increasing our community count in fiscal '23 by between 5% and 10% over the prior year. Thinking about capital allocation, it drives a lot of the decisions we make in the company. And hopefully, this is positive in your perspective. We're not changing our approach to capital allocation at all. Our first and primary objective is to invest in the business at high return. We'll see how the market behaves, how sales come, how the land market operates, whether there are increases or decreases in pricing. So we'll be opportunistic, I think, there. We will continue to pay our dividend, and we -- you can and should expect to see us in the market repurchasing our shares, all while trying to manage against that modest leverage profile that I talked about. Yes. So maybe taking a step back, longer term, we remain bullish on the market. We are of the view that the strong demographic trends that have aided the past couple of years will continue for years, both ends of the barbell, the Gen Xers and the millennials. The millennials are certainly coming into age where they're ready to buy houses and we've seen some activity in stepped-up activity over the last several years. And we've got a unique kind of period in time from a supply and demand perspective. We have been underbuilding in our perspective, the housing need in this country for a decade. Normal for us in terms of total new should be about 1.5 million, that's including multifamily, 1.5 million. You can see that we just recently got back to that level in the last year or 2 and structurally underbuilt 4 years before that. And so we think that, that, coupled with the fact that folks are in mortgages, 90% plus of the mortgages today are sub-5%. And so people have a challenging decision to make to sell their home because they're going to have to go out and pay for a little bit more. So we think that, that resale market is going to be relatively tight for the foreseeable future, which, again, provides an opportunity for us. I mentioned this, kids are actually finally starting to move out of their families' houses. If any of you have kids at home, hopefully, you can enjoy the benefit of that. And so, in conclusion, a great year in 2022, really strong position from an operating and financial perspective to deal with whatever the market delivers to us in 2023. We're going to work to make sure that our production machine is as efficient as it can be to reduce house construction costs, to reduce land development costs as well as to just reduce overall cycle time, which would be the potential to be significantly accretive to our returns and continue to invest capital the way we have. With that, I will stop and see if anybody has any questions.

I think I'll fire one quick one at you. There's a lot that's not in your control, but kind of now see the environment where mortgage rates have gotten to that 7% threshold once before, right? So we had that October, November timeframe. What lessons have you learned from that year, if we're to say 7% for the foreseeable hypothetically, what did you learn from all kind of [indiscernible] apply to the spring time in terms of changes to operations, incentives? What do you think you've learnt in the past couple of years?

Yes, it's a great question. And I would tell you, it's more about the means by which we implement incentive packages. And so it has been a while since we needed to think about rate support to the consumer. And we actually launched in January, so a learning coming out of the third and fourth quarters as rates really kind of jumped that for some consumer, the ability to get them into a 30-year fixed rate instrument, and it didn't have to be a certain number, but just giving them certainty at that rate really benefited them. And so, we launched in January a 4 1/4% rate. It moved up to 4 3/4% and now we're at 5% or 4.99%, but it's interesting because not everybody takes it. But what it does is it starts the conversation, it gets eyeballs and starts the conversation. And so we've got a tiered approach that says, okay, today, you can get 4.99% if payment is your primary focus or you could do 5 1/4$ or 5 1/2%. And then what we've done is that the money that would be available or would have been spent to buy at the lower rate, we can apply to down payment and/or some other upgrade on the house. And so we're letting the consumer actually choose that. But starting the conversation saying, here's a value indicator to you. Now you tell us what's important has really proven to be pretty effective.

How does that -- with 4.99% do you have 1 or 2-year kind of intro rate…

30-year fixed.

30 years, buy them entire..

Yes, it's not inexpensive. But what -- the other thing is we were offering incentives anyway. And so what we've done is kind of oriented the -- we've oriented the sales team to say, okay, here's the pot of money that we have available, use it in whatever way serves the customer best. And so if it's rate buydown because they're totally focused on payment because hopefully, you can appreciate if you spend -- make up another $10,000 on incentive to buy down rate, it has a much more 4:1 probably impact on monthly payments versus dropping price. But everybody is motivated by different things or maybe they don't have the down payment. And so what we're trying to do is start the dialogue about what's important to them. But what hopefully it translates into is not necessarily -- or I should say it this way, we haven't said your incentive package was X, and now you have this on top of it. It's just -- we've just put another arrow in the quiver of the sales force to say, here's something that you can help when you're working with the customer.

Well, we've heard it across the entry mean, the breakdown by rate buydown program seems to have been a lever that seems to have had the most effectiveness in this environment. But just hypothetically, as you run this through your mortgage company, what is that cost for 100 basis points, if you're going to buy it down for 100 basis points, what kind of gross margin impact is that to you guys?

About 4%.

Rough math, 400 basis points -- but you're giving the -- I mean 100 basis points off the more, that's like a 10% purchasing power or the equivalent of a 10% markdown on the price of the house.

It's a big differential that's why interestingly, not everybody goes all the way on rate because they say if there's -- if you're spending $8,000 on that and you would spend $8,000 on something else, they feel like that's terrific because they get value on the mortgage payment and on the house.

Yes. Now you guys commented a little bit, I think, on your call about January trends, January, you've seen some bounce back in demand. Certainly, other competitors have noted January was much better than kind of December, and there seem to be some follow-through from others being reported about February, at least the early part of February. You've got a cross segment into a couple of different price points and consumer groups. Was there any noticeable difference in the demand coming back in January between consumer groups or was it pretty standard?

It was strong across the board. I would tell you, geographically, the West Coast was probably the slowest on a relative basis in our universe. And I think it's a function of price and the rapid rate of increase in the past. Having said that, again, even there, we saw an improving picture October to November, November to December, December and into January, even in those markets that have been a little bit more challenged.

Any questions from the audience? Yes.

[indiscernible]

I don't know that I'd say anything is quite efficient. And sorry, the question is, has the supply chain is a little ragged, where has it improved? Where is it not? What you're seeing now is more episodic than systemic, honestly. I don't think there are any real systemic gaps in the supply chain. Things like we have been experiencing windows and cabinetry having to order 24 weeks in advance whereas our historical norm was 4. The one thing I might point out that's an issue that I don't see a simple solution to is power. And so some of the electronics that you need to power a community, I'm not talking about the house now, but the power community is in short supply. And without getting into a lot of detail, the potential sanction of the steel that needs to be used for that is in -- there isn't enough of it, honestly, to make that which it needs the government has mandated. And so that's one that I think will be around for a while. But otherwise, it is more episodic, I would say, than duly systemic. And so we've got programs in place that are designed to drive our much elongated cycle times down quarter by quarter by quarter. It will take a little bit of time and effort, but certainly, we've got the plans in place to try and do that.

Rick?

[indiscernible]

Yes. So the question is what's our exposure to build for rent for short-term rental and single-family -- sorry, or both. But yes, we announced a couple of years ago a relationship with Invitation Homes, which was designed actually for us to widen the aperture for land acquisition. So what we wanted to do is build a business with that space that would be 7,500 units over 5 years, so call it 1,500 units a year, and we are on track to do that. Our idea was actually to partner with them and create an opportunity for a community that may not have met all of our underwriting standards REIT too big to say, why don't you partner with us, we'll use our expertise to entitle, develop and build the houses and we'll deliver them to you on a schedule that would allow us to generate returns while we -- so we bifurcate the community, half of it would be for them, half of it would be for us. And we were successful on that front. We've also got relationships with other single-family rental enterprises. And where we are today is probably on the shorter end of the curve. So this is -- their interest today are typically within units that can deliver in this next 6 months as opposed to longer term, which is the type of stuff we're doing with Invitation. So we have an appetite for both. We've indicated we think maybe it could be about 5% of the business. We don't want it to be that much more than that. We don't have an interest in owning those communities and renting them up. We think that the capital cost of that is too significant. We also don't do a lot of spot sales. We will make a couple of units available quarter-by-quarter, but we're not putting a big book out every quarter for people to sell or for those folks to pick over. The logic being we don't have that many finished units on the ground, and so we'd rather sell them retail.

[indiscernible]

Longer term prospects on the housing market.

All right. Yes. So again, we -- demographically, we've got 2 big groups moving through a buying phase in their life. So the folks that are becoming active adults were going to be downsizing, which we think is a great opportunity for our Del Webb. And similarly, the millennials who are now in prime purchasing age, you couple that with the fact that we've underbuilt. So we've got a shortage of supply from a new perspective in the country, generally. Again, our belief is that 1.5 million is the number of new starts, that's including multifamily that the company needs just for either replacement and/or population growth. And so we've -- since 2011, we've underbuilt that. So there's a cumulative deficit and depending on how you look at the math of 2 million to 4 million units. And literally, in the last year or 2 is the only time we've built to that 1.5 million unit level. So we think we've got a relative undersupply there. Then you add on to the fact that the existing space, which is always the largest competitor that we have as a new builder is somewhat undersupplied, month supply is low across the country and just at every market you look at, in part because people are sitting there with a 2 3/4% or 3% mortgage who if they trade out of that house, they're going to have to pay more for their next house at a higher mortgage rate, so they're not incented to do that. So you've got folks as they age, their family expands, they get married, they're moving, they have a need, and they just don't have that much inventory to access, again, is a good opportunity for us to sell to those people. And I don't think the entitlement background and opportunity in this country is getting any easier. It's harder to get land entitled. So the specter of a bunch of new inventory coming is pretty limited. Just to name a few.

You want to finish it up?

No.

Okay. So thank you much. Appreciate you joining us for this. Thanks to Bob and Jim, and we have a breakout downstairs if you want to talk more housing and homebuilding. Thank you, everybody.

Thanks.