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

Good morning. Welcome to the Day 1 of the 16th Annual JPMorgan Homebuilding and Building Products Conference. My name is Mike Rehaut. I'm excited to start off the day. We have a great 2-day agenda, 18 companies across our universe, 8 homebuilders, 1 land developer and 9 building products companies. We're thrilled to start off the day with Pulte Group, CEO, Ryan Marshall's with us, along with VP of Investor Relations, Jim Zeumer. The format of the conference will be predominantly fireside chat. I'll start off with a series of questions. This is about a 35-minute session. And if you would like to ask a question, there is an ability to do that through the conference portal. You can click on the Ask a Question icon and those questions we fed to me. And we'll go from there. Hopefully, there will be enough time for everyone to ask and get answered. So I'm going to kick it off again with Ryan and Jim. And I think the first question that most people are interested in is just to the extent possible, any update on demand trends. How do you characterize? And I guess, specifically, there's been a lot of talk obviously in the last month or 2 or 3 even about the somewhat of a return of demand to the marketplace not coincidentally alongside rates stabilizing, even pulling back a little bit, which is very typical. Curious, number one, Ryan, would you characterize the recent improvement in demand as being consistent with seasonality? Or do you feel like it's something a little stronger than normal at this point in time and the year?

Yes, Mike, so maybe I'll start with -- we've not given any kind of market commentary update since we released earnings a few weeks ago. So just maybe as a kind of housekeeping item, a lot of my comments, we'll kind of refer back to the comments that we gave then. We did talk, Mike, through the third week of April, which is when we released earnings for the first quarter that we were continuing to see a really strong build of momentum coming out of the first quarter and into the first 2 or 3 weeks of April. So with that being said, I think if we look at some of the fundamental drivers of that strong demand, those same drivers are still there. Predominantly, we've got really tight supply, especially on the resale side, which is making the new home opportunity, a bigger piece of the total market than it's ever been. So I think it's a real tailwind for the industry. Rates have continued, I think, to moderate, settle in and combined with -- that combined with at least in the case of Pulte Group, a reallocation of our incentives predominantly directed toward interest rate buydowns that allow a consumer to get into a 30-year fixed mortgage at really attractive rates that are sub-5% on a 30-year fixed mortgage, I think it really works to address some of the affordability challenges that we've seen from the consumer. So broadly speaking, Mike, we are very confident about the health of the consumer, what the inventory situation is and kind of what that means for our ability to continue to sell homes.

Great. And by the way, my enthusiasm of jumping in and starting off on the questions, I should have first said, welcome, and thank you for joining and kicking us off today. So very much appreciate you guys being here and participating. So please excuse my jumping right in there.

We'll try to do our job like a good leadoff hitter, Mike and get on base don't hit me by a pitch or anything like that.

And I don't know, my arms are getting rustier by the day, but I'll try my best. So I appreciate that, Ryan. And it kind of leads me to my second question around affordability. You mentioned the rate buydowns and sub-5% is -- we've heard more about probably in the mid-5s where the buydowns have been able to go. Curious on -- maybe you could just walk us through, number one, the mechanics of what a buydown costs if you're going from, let's say, where the prevailing rate is, I don't know if that's, let's say, argument say 6.25%, 6.5%. How much does it cost to buy it down to 5.5% or 5%. And maybe just kind of take us through the mechanics of it a little bit.

Yes, Mike. So the mechanics of it are pretty straightforward. We're going out into -- we're using our mortgage company, and we're going out and we're buying tranches of mortgage commitments in the market. And then we've got an obligation to fill those. So we've effectively created a ladder of tranches of forward commitments at certain rates. There is an upfront fee that we pay to essentially secure that commitment. And then there are some additional incentives that need to be paid on the back end by the individual deal that goes into that commitment. So today, with the prevailing rate kind of be in mid-6s, maybe even low 6s the cost effectiveness of getting to 5% rate as an example is the economics are much better for us today than they were 60 days ago. So today, that's -- to get to a 5% type 30-year fixed is probably costing us around 5 points. right there in the kind of 5- to 6-point range. So it's not inexpensive. The biggest thing for us, Mike, is we've been able to reallocate other incentives toward that. So it's not and you probably saw from our Q1 gross margins and then even the guide that we gave for Q2 on gross margins. It's not having detrimental impact to our ability to deliver outstanding best-in-class gross margins. It's simply been reallocating the available incentives to things that really matter for the customer.

The only thing I'd add to that, Mike, real quick is that what we're seeing with the consumers, they're not taking the rate buydown all the way to 5%, for example, they're actually taking more to 5.25% maybe even 5.5% is very common. That gets them sort of their monthly payment. And then they're looking to say, okay, give me the rest of the associated incentives on something else, it might be closing cost. It might be I want upgraded floorings, I want better cap nets or countertops, something like that. So the consumer has a number in mind and we're able to get them there. And it's actually -- it's been interesting. It's a little bit higher and kind of the -- where Ryan was mentioning all the way down to 4.99% or 5%. I think it's pretty consistent with a couple of the John Burns and some others who put some numbers out there that says the sweet spot is kind of around 5.5% in terms of what consumers are looking for.

Right. And so maybe you're talking about 5 or 6 points of total incentives or hit to the gross margin, but those numbers are, again, more or less being fully baked into your current guidance, your current gross margin level.

That's correct.

So I guess in that context, how would you view today's level of affordability? Because obviously, I think that's one is still the big concerns that are out there, affordability metrics, are still pretty stretched relative to history. You're seeing a good level of demand where you're able to get those incentives down or add -- allow those incentives to maybe make things a little more affordable than people realize. But how do you view your current product in that affordability matrix. And is this something where over the next year or 2, we should be thinking about adjustments to price point to even better solve for that affordability equation.

So Mike, the short answer is I think affordability remains on the challenged side. It is -- that being said, it's much improved from where we were a year ago. And the markets that were most challenged from an affordability standpoint, I think those are the markets where you've seen the biggest price adjustments. Some combination of those price adjustments in the really challenged markets, smaller price adjustments kind of more broadly across the United States, combined with the mortgage rate environment stabilizing I think we're in a workable spot from an affordability standpoint. Mike, you hit the nail on the head. Historically speaking, affordability and the cost of housing remains too high. And I -- but I don't see anything structurally changing as it relates to the supply side -- the supply side of the affordability equation that's going to change that. Entitlements remain very difficult. Land development is taking as long as it ever has. And so there's not going to be an opportunity for a whole bunch of new supply to come on the market. And we've effectively reduce the amount of available resale supply by 25% to 30% just by virtue of you've got so many buyers that are locked into low interest rates, and they're just not willing to give them up. So through some combination of reduced new home and lower resale supply, Mike, I think supply is going to remain tight for the foreseeable future, which I think, provide some stability or some floor underneath home prices generally. And in that time, at least the forecast that I'm seeing suggests that rates are going to continue to come down. The most recent one that I saw suggested something in the kind of 5.25% to 5.5% for the actual market 30-year fixed rate. And then if we continue to see some wage inflation, maybe those 3 levers of asset price plus wages, plus interest rate, we end up into a livable zone when we're talking about affordability.

Right. And in terms of the actual home price, the product that you offer, how would we -- how should we think about ASP from Pulte over the next year or 2? I mean, is this something where -- because some companies have talked about potentially trying to actively lower their average selling price through over the next year or 2 or 3 adjustments to floor sizes attached versus detached, but anything on the drawing board in terms of trying to actively if not lower, let's say, blunt the typical normal increase in ASPs over the next couple of years?

Yes, Mike, we -- I think we've done a nice job historically, and we continue to focus on this, where when you go into many of our master planned communities, we offer a number of lot sizes. So we'll typically have product that's as small as 30 feet wide that will very often offer a 30-foot-wide product, a 40-foot wide product and then a 55-foot wide product. Those will go on 3 different lot sizes. So the 30-foot-wide product, as an example, those are homes that are typically 2-bedroom, 2-bath or 3-bedroom, 2-bath, and they're in the 1,400 to 1,700 square foot range. So that product line is always meant to be our most affordable targeted at, in some cases, an active adult buyer that's downsizing or in the case of an entry-level, first-time buyer, that will be the first home that somebody buys coming out of an apartment or a rental home. So I think in our portfolio, Mike, we've got a wide variety of product that's very affordable. To even be more efficient with land values and really stretching those -- the residual cost of the land over as many homes as possible. We use townhomes. We also, in some communities, will use quads, which are effectively 4 single-family homes that are all single story. So we're also -- we're using some motor court type products that really leverage and get efficient with the use of driveways. So you've got a shared driveway area between 6 or 8 homes that help to really drive some affordability in some of the high-cost land markets. So I think from a product portfolio, Mike, I'd put our product line up against anybody in the industry in terms of options that allow us to drive affordability. Beyond that, the consumer has got the ability in our system to choose as much or as little as they want -- they want to from -- if they can afford it or we can make choices on fit and finish and structural options that keep the overall cost down. And then maybe just the last thing, Mike, we have over the last 4 to 5 years, made a deliberate push to have more of our product line be affordable, first-time entry level. Today, it's 40% of our business. We have the other roughly 40% is move up and about 20% is active adult. So we continue to be very geographically focused, but also geographically diversified, but also diversified in terms of the consumers that we're serving. And with 40% of our business being first-time entry level, that is helping to push our price point further down from maybe where we historically would have operated.

Right. That's a good point. I appreciate that. Maybe just switching back to incentives for a moment. Maybe you could remind us where we are in that life cycle or the current cycle rather. Where were incentives plus discounts at its peak, perhaps at some point late in '22? Where are they today? Where do you think they might be as things continue to normalize.

Well, Mike, my view would be most of your price -- your downward price adjustments in most markets have taken place. And unless you've got some kind of an odd poor position, poor location, poor product choice. I don't necessarily anticipate seeing any further downward price adjustments. In fact, most of our communities, we're actually seeing price increases. They're smaller in nature relative to maybe what you would have seen 18 months ago, but some combination of small price increases or reduction in incentives. We're seeing prices kind of move up. As we highlighted and talked on our most recent call, Mike, demand is good. And there's such short supply that we are seeing some relief of pricing pressure on the -- from the consumer, and we're starting to go the other direction.

Mike, just keep in mind that the timing difference between when we may take a contract and when we're going to close that home. So for example, in Q1 of this year, our incentives were, to use your word in terms of peak, they were still at 6%. I mean, which was up over Q4 and would at this moment in time, be the highest we've recorded in the recent housing cycle. So you do just have to be mindful of the fact that you've got a quarter, maybe 2 quarters, even though we're doing a little bit more specs of the closings are a little bit more real time between when you sign that contract and when you're going to for purposes of our reporting, realize that incentive.

No, that's a great point, Jim. And maybe this kind of brings me back to the original question. So if you're saying -- and part of it was certainly on the trends of pricing as well, which is kind of -- it's always one side or the other of the same coin. But just focusing on the incentives and discounts, you mentioned 6%, Jim, in the first quarter, and I guess that's the high watermark. Where are incentives plus discounts trading poly on incoming orders?