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

Right. Right. So then another question, we'll be kind of asking across the board to most builders, it's just around the gross margins and understanding that yourselves, others maybe or just have shifted the management of the business towards an ROE approach over just purely a gross margin approach. But nonetheless, a lot of focus around today's levels. The industry itself running about 350 basis points on average versus pre-COVID levels. How do you think -- how should we think about gross margins potentially returning to those longer-term averages? There's been different arguments made that maybe they can stay higher for longer. I know that's a phrase that we hear more and more of. Particularly, as you think about land cost inflation as you think about perhaps the land -- use of land bankers in the industry, how to frame -- and certainly, Pulte itself has been able to maintain above industry average gross margins impressively even more so over the last year or 2. How should we think about gross margins for your company?

I know this will come as a surprise to you, Mike, but we actually -- we don't underwrite the gross margins. And while we think a lot about gross margins, it's not the most important thing in our business, and I don't think it should be the most important thing for any of you that follow the industry. The single most important thing in this business that drives value is return on invested capital. And so margin certainly is a component of that return equation, but it's not the only component. So it's part of the reason that we look at the volume or the asset turnover that we're going to do, the margin that we're going to get and the structure of the way that you purchase land. That capital investment piece is arguably the most important out of all of that. We -- and so the philosophy that we've taken and how we run our business is we're trying to optimize pace and price such that we drive the optimal level of return on invested capital. And we think that's what's contributed to the company's success and the ROE success that we've had. And over the last 7 years, 1-, 3-, 5-, 7-year period of time, we've either been the #1 performing total shareholder return or #2 because we've taken that focus on optimizing the return that we generate out of the business. Now you've -- some of you probably heard me say before, we're not going to be margin proud. And a lot of times, folks will say this, well, why are your margins so high? And why are you different than all the other builders? What is it that you guys are doing different? So we'll articulate, we underwrite differently the way we build our commonly managed plans, our value engineering process, the consumer validation, the way we price, blah, blah, blah. That all factors into kind of our margins. Well, why don't you -- I think, there also another question comes, why don't you lower margins and sell more volume? And the short answer is, we're looking to optimize in a world where land is a precious commodity, we're looking to run the pace price balance. Some of that has margin implications in a way that we think optimizes return.

Right. No, fair enough. I mean, as you think -- I mean, particularly kind of moving towards 50% to 70% over time, which, all else equal, would imply a stronger -- less capital and use, higher returns on what you employed. You could argue that margins -- gross margins could slip in that scenario, but your overall returns would remain as healthy as before. Is that kind of thinking in terms of perhaps some of that shift in some of the areas of the business, but still maintaining the overall?

We think about -- in that construct, Mike, you're generally right. Land banking is more expensive than owning the dirt from a cost of carrier or an interest standpoint. And it's certainly more expensive than an option with an underlying land banker. And that's all factored into this overall return equation. For us to go down a path with a land banker, we really need 2 things. We know that we'll give up some margin because you got another hand sitting at the table looking to eat. So we'll give up a little bit of margin, we'll pick up return benefit. So if we can get that kind of equation to work in our favor, where we maybe give up a little bit of margin, but we pick up return, we think it works. And then one of the most important things is we look for risk transfer. That's part of -- it's not just an increase to kind of return that we're looking for in a land banking scenario. We're also looking for a bit of protection, a bit of an insurance policy in the event that there's some kind of a market downturn that gives us more flexibility than what we'd have if we own the land out right.

Right. Fair enough. Maybe shifting to some company-specific questions. I'll ask a couple, and do you want to allow for some questions for the audience as well. I think we have about 10, 11 minutes left for the session. And I'm sure you get this question a lot. You kind of alluded to it in terms of moving margin versus volume per se. But how do you think -- first question is around size and scale. You obviously have a -- you're one of the bigger builders out there, there's still a couple significantly larger than yourselves. So how do you think about your current footprint in size relative to those larger peers? And do you feel there's a need to get bigger? And if so, how might that plan be implemented over the next few years?

So there's certainly value from market share. And we think at the size that we're at today at roughly 31,000 units, and we're in every major housing city, we have national market scale. So I think we -- we're confident in saying we've checked that box. Then we go to what I think is arguably the most important component of market share, scale and that's market share in the markets that you actually compete in. So Dallas and Chicago and Orlando, and you go through every city and you look at your relative market share to the other competitors, that's where we found there is the single biggest difference in business unit performance is the market share or market scale that you have in those markets. So we pay a lot of attention to that. We don't need to be the biggest -- we feel like we need to be on a relative basis, at least 0.5 or half as big as the biggest in the market. It's kind of the line where we see a break in performance. So focus a fair amount on that as well, Mike. We have expanded into a number of new markets over the last 3 to 4 years, Salt Lake, Denver, Portland, Greenville, Columbia, South Carolina, not the country. The West -- the East Coast of Florida, like Daytona, kind of Space Coast area. So there's a handful of places that were good housing markets that we weren't in that we've expanded into, and we think that helps with our growth. There's also a lot of markets, where we think we can continue to organically grow some of the big cities in Texas, some of the cities in Florida, some of the spots on the West Coast, Las Vegas, Arizona example. We think there's opportunities in really good housing markets where we already have operations. We're already performing well. We can put some incremental capital to those teams and continue to take some market share in those spots as well. So one of the other kind of headlines you've probably heard from us over the years is we're not looking to grow for growth's sake. We'll grow if we believe that it makes us better. So the headline -- the big headline is we're big enough today to be considered big -- and so growth is part of kind of where we want to go. We've set long-term growth targets of 5% to 10% annually. Our initial kind of guide for 2024 was to be at about 5%. And with what we've updated in the most recent quarter will be near the higher end of that long-term guide. So it's part of our story, growth, but it's going to be healthy, profitable growth, not just more volume.

Right, right. And so does that also apply to M&A? I mean, obviously, you've made some larger acquisitions, still kind of regional or super regional I'm thinking of American Homes in Vegas or even a few years before that, John Wieland. So those were bigger of size. The industry by and large seems to be more on the -- you could even argue smaller kind of bolt-on. So how do you see M&A kind of fit into that?

Yes. We look at almost everything, that's another advantage of kind of being big. And as in many markets as we're in as we see every potential deal that's out there for sale. We're pretty picky. We're looking for markets and consumer groups that we think add to what we have. The 2 that you mentioned, Wieland and American West were 2 of -- 2 great examples of that. Probably my favorite of that bunch was American West. It was a heavy land option deal. So while it was an acquisition, and we got some finished lots part of it. We got over half the lots that we got control of came as an option from the seller that sold us the company, which was kind of nice. It was also the way that we got into Denver, the same seller, owned a big master plan in Denver, and so that transaction also opened up a door for us to open up our Denver division. So there are a lot of synergies that came from the American West transaction. So just to put a pin on that in that, Mike. We look at a lot of things. We're really picky. We want to make sure that it's a market that we want to be in and that it actually improves kind of our size, scale, profitability, consumers that we can target and focus. We're not necessarily interested in doing just big M&A so that we can say that we're bigger.

Right. Fair enough. We have a few -- about 5 minutes, maybe a little more left to the session. I'll open it up to Q&A from the audience, if anyone has any questions. If not, I have a few more of my sleeve, but I think we have mics on the table.

Can you tell us your debt ratio is seen pretty nice in order. How far would you push it, if we had a nice acquisition. And can you tell us over a cycle, how acquisitions may come from entities not as well capitalized to you?

Yes. So we're very comfortable with kind of where we're at from an overall debt perspective. Today, we sit at 16% gross debt to cap and basically net debt 0. If you go back over the last 8 or 9 years, our original target range of debt was 30% to 40%. We modified it 3 or 4 years ago to 20% to 30%, and we're clearly inside of that today. Probably the most important thing when we think about debt is we really think about capital allocation. And our priorities are invest in our business, which we've been doing at a growing rate almost every year. In fact, '23 to '24, we've increased our investment into the business by 16% from $4.2 billion or $4.3 billion to almost $5 billion in new land investment. We paid our dividend or we will pay our dividend. We've increased that in about 7 of the last 9 years, the most recent increase was 22% or 23%. We're buying shares back with the excess capital that's being generated by the business, and we've repurchased about 50% of the company over the last 10 years, and then we've even started talking about if there's money -- still money left then we'll start retiring debt, which you've seen us do over the last couple of years, we've done selectively kind of going in and picking up some available debt that was trading below market. So the debt ratio is really an outcome for us as opposed to a driver. Could the business handle more debt? Sure. Does it need to handle more debt? No, because we're running a really high-performing, well-capitalized business that is doing all of the -- we're literally doing every single one of the critical capital allocation priorities that we have. And so that's the biggest thing that we've done in thinking about kind of our debt level. In terms of M&A stuff we see what might create some incremental pressure. Candidly, I thought we would have probably -- given the current lending environment, I thought we would have seen more because of stress that maybe smaller local kind of builders might run into as they ran into kind of debt refinancings, et cetera. We haven't seen, honestly, a lot of stress there. I think part of it is most builders, if you're in this -- if you have land supply and you can get things built, you're pretty profitable. It's a pretty good operating environment. And so I think those -- and I don't have visibility into everybody's individual situation. But for the most part, folks have been able to either work with their existing lenders or find family office-type money or kind of wealthy individuals that are continuing to be willing to kind of back them. So deals are out there, but I wouldn't say that there's anything that's been on sale and any kind of really high stress type opportunities because of financing.

I have a question over here. I thought that was an interesting stat that an SBUs economics changes once you get over 50% local share. Can you talk about some of the dynamics that happen when you go from, say, 45% to 55%?

Yes. I probably can't slice it quite as thinly as 45% to 55%, but in some work that we did, we saw the breakpoint was at about 50% relative market share that the returns of those business units that were over 50% market share in an individual market, they performed better. And I think it goes to a couple of things. You get arguably better access to the land development community, so you get probably first choice at land you're in a better position to negotiate with land sellers, with trade partners. I think you also have an opportunity to have better talent as well that comes to us as our employees. So I think there's a lot of synergistic events or benefits that come from having local market scale.

Just curious on that, unless is there any other questions from the audience or -- I was just kind of curious on that point around the markets. Do you have a breakdown of the number of markets that you're in that are above that 50% threshold versus below? And I would presume that the goal is to have all of them above but maybe give a time frame on that or how you think about it?

Yes, Mike, we do -- we have that data inside the company. We don't -- we haven't readily disclosed it. It's not the hardest thing in the world to figure out. So it's not as if folks really want to see it, that you can find it. Yes, we focus on a lot. So one of the things that Bob and I do, Bob and I spent a lot of time traveling in markets when we're not doing things like this. And we're in the middle of doing strategic reviews with our division teams. That kind of our positioning in each of the markets is something that we spend a lot of time on. And if we're kind of below that relative market benchmark that we'd like, then we kind of lay out plans to say, hey, how do we get to a point, where we think we've got better market share position. Now the one caveat that I give there are some markets and take Dallas as an example. Our Dallas business is much smaller than a couple of the other big builders there. But stand-alone, it's still 1,700, 1,800 units a year. It's a really big business. So there are -- as with anything -- any of those kind of stats there are exceptions to the rule.

Sure. Great. Well, that does it for this session. Thanks so much, Ryan. Appreciate the participation, as always. Nice to see you in person again.

Next year, Mike, I think we actually need a fire for the fireside chat.

The -- I think there's an open air across the street there we might get be something, but we'll see. Anyway, thanks, Ryan. We'll resume at 9:00 a.m. with Mohawk Industries.