Forestar Group Inc. (NYSE:FOR) Q1 2023 Earnings Call Transcript

Forestar Group Inc. (NYSE:FOR) Q1 2023 Earnings Call Transcript January 24, 2023

Operator: Good afternoon, and welcome to Forestar’s First Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. I will now turn the call over to Katie Smith, Director of Finance and Investor Relations for Forestar.

Katie Smith: Thank you, John, and good afternoon, everyone and welcome to the call to discuss Forestar’s first quarter results. Thank you for joining us. Before we get started, today’s call includes forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Although Forestar believes any such statements are based on reasonable assumptions, there is no assurance that actual outcomes will not be materially different. All forward-looking statements are based upon information available to Forestar on the date of this conference call, and we do not undertake any obligation to update or revise any forward-looking statements publicly. Additional information about factors that could lead to material changes and performance is contained in Forestar’s annual report on Form 10-K.

Our earnings release is on our website at investor.forestar.com and we plan to file our 10-Q tomorrow. After this call, we will post an updated Investor Presentation to our Investor Relations site under Events & Presentations for your reference. Now, I will turn the call over to Dan Bartok, our CEO.

Dan Bartok: Thank you, Katie. Good afternoon, everyone. As always, we appreciate your interest in Forestar and taking the time to discuss our first quarter results. In addition to Katie, I am pleased to be joined on the call today by Jim Allen, our Chief Financial Officer and Mark Walker, our Chief Operating Officer. Mortgage rates rose at a record pace during 2022, as a result housing affordability has been severely impacted. New home sales fell 15% in November from a year ago and December housing starts were down 25% from a year ago. Despite those headwinds resulting in a revenue decline of nearly 50%. Our gross profit margin increased 390 basis points to 21.9%, and our pre-tax profit margin was 12.9%. The real story here is the transformation that Forestar has undergone over the past five years.

We have become the largest pure play residential lot manufacturing company in the United States. We have built a platform and assembled a team that is flexible and focused. We have further strengthened our balance sheet and look to be opportunistic in ways that will continue to build shareholder value. We have a strategic relationship with D.R. Horton, America’s largest builder, and we have positioned ourselves to expand our customer base as we consolidate market share. The housing market is going through a period of transition. We are disciplined and have been proactively reducing land acquisition over the past 18-months. We have been staging development activity at our projects to be prepared for when the plan for residential lots increases.

Our flexibility enables us to quickly adjust to meet the needs of our customers. We continue to strive to maximize returns, while we plan and prepare to return to periods of rapid growth. Having a growth plan is one thing, but we have the capital structure, the operational flexibility, a strong customer relationship, and most importantly, the team execute that plan. Forestar is better positioned than ever to serve current and new customers and consolidate market share. Jim will now discuss our first quarter financial results in more detail.

Jim Allen: Thank you, Dan. In the first quarter, net income attributable to Forestar was $20.8 million or $0.42 per diluted share, compared to $40.5 million or $0.81 per diluted share in the prior year quarter. Consolidated revenues for the quarter totaled $216.7 million, compared to $407.6 million during the first quarter of 2022. We sold 2,263 lots during the quarter with an average sales price of $90,100. We expect continued quarterly fluctuations in our average sales price based on the geographic location and lot size mix of our deliveries. We expect demand for residential lots will continue to be impacted in the coming months as homebuilders align starts to a new sales pace. Our pre-tax income for the quarter totaled $27.9 million, compared to $53.5 million in the first quarter of last year.

Our pre-tax profit margin of 12.9% was 20 basis points lower than last year, driven by reduced operating leverage. Our gross profit margin was 21.9%, representing an improvement of 390 basis points over the prior year period. In the first quarter, SG&A expense was $22.9 million or 10.6% as a percentage of revenues, compared to $21.5 million in the prior year quarter. While our SG&A expense as a percentage of revenue was higher than we would like, the absolute dollars were down 3% sequentially and has decreased for the last three quarters. We will continue to focus on controlling our SG&A costs, while ensuring that our infrastructure supports our business. Mark?

Mark Walker: As for current market conditions, we are starting to see greater contractor availability with front-end trades and continue to stage development on a project-by-project basis. Despite single family home starts falling, roughly 25% in December from a year ago, our cost to develop a residential lot continued to decline. Materials like Concrete, Cement and Transformers are still challenging to secure. However, our teams are relentless problem solvers and they continue to navigate this environment exceptionally well. We will continue to be proactive and work with our trade partners to develop cost — control development costs. We evaluate each project and the surrounding market conditions as we determine the appropriate pricing and sales pace to maximize returns.

We remain focused on developing lots for homes at affordable price points demonstrated by our average sale price of roughly $90,000. Over the past 12 months, our inventory balance has grown only 5%. Despite elongated development timelines, and inflationary pressures further demonstrating discipline and strategic inventory management. Jim?

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Jim Allen: 7% of our first quarter deliveries were sold to customers other than D.R. Horton, compared to 11% in the prior year quarter. In the trailing 12-months 16% of our deliveries were sold to other customers and we continue to target selling 30% of our lots to customers other than D.R. Horton over the intermediate term. Additionally, Forestar’s lots sold to D.R. Horton continue to grow as a percentage of D.R. Horton starts year-over-year and sequentially. Approximately one out of every five homes that D.R. Horton starts is on a lot developed by Forestar. Our mutually stated goal is for one out of every three homes that D.R. Horton sells to be built on a lot developed by us. Katie?

Katie Smith: Forestar’s underwriting criteria for new development projects including minimum 15% pre-tax return on average inventory and a return of the initial cash investment within 36-months. During the first quarter, we invested $237 million in land and land development, a reduction of 38%, compared to the prior year quarter. $205 million was for land development and $32 million was for land. As land prices continue to increase across most of our footprint during 18-months, we proactively started to reduce our land investment in anticipation of the slower housing market and primarily focus on the phase development of land that we already own. We are working with land sellers to extend closing dates and in certain cases we have opted to terminate contracts.

Our unique operating model allows us to adjust the pace of development based on market conditions and we remain intensely focused on managing our development in phases as we strive to deliver finished blocks at a pace that matches market demand consistent with our emphasis on capital efficiency. Mark?

Mark Walker: Forestar’s loss position as of December 31 was 82,300 lots, of which 61,500 lots are owned and 20,800 are controlled through purchase contracts. Our lot position decreased by 7,800 lots or 9% sequentially and by 21,000 lots or 20% year-over-year. We incurred $2.4 million of option deposits and due diligence write-offs in the quarter. At quarter end, we had 7,600 finished lots on hand. The majority of our owned lots were placed under contract to purchase from land sellers prior to 2021, resulting in an attractive cost basis and we had no inventory impairments during the quarter. We are continuing to target a three to four-year owned inventory of land and lots. 30% of our owned lots are under contract to sell, representing approximately $1.5 billion of future revenue.

These contracts of $148 million of hard earnest money deposits associated with them. Another 29% of our owned lots are subject to a right of first offer to D.R. Horton based off executive purchase and sale agreements. Jim?

Jim Allen: We are maintaining a strong balance sheet with significant liquidity and modest leverage and we plan to maintain our disciplined approach when investing capital to enhance the long-term value of Forestar. We ended the quarter with over $580 million of liquidity, including approximately $215 million of unrestricted cash and $365 million of available capacity on our revolving credit facility after the reduction for outstanding letters of credit. Total debt at December 31 was $706 million with no senior note maturities until fiscal 2026. Our net debt to capital ratio at December 31 was 28.7%, down from 33.9% in the prior year period. We ended the year with $1.2 billion of stockholders’ equity and our book value per share increased to $24.50, up 15% from a year ago.

Forestar’s capital structure is one of our biggest competitive advantages. Most traditional land developers are encumbered by project level financing, which makes it more difficult to react to the market, while also adding complexity and administrative costs. Our strong liquidity and corporate level financing enable us to operate effectively through changing economic conditions and positions us to be strategic when attractive opportunities present themselves. We have significant flexibility to navigate the upcoming year. Katie?

Katie Smith: Consistent with our last earnings call and as a result of the current market certainties, we are not providing guidance for fiscal 2023 at this time. We will reevaluate providing annual guidance when we have sufficient visibility into market conditions. We have been very strategic and disciplined and we are well positioned to adapt quickly to the short-term challenges that are before us and the housing industry. Dan, I will hand it back to you for closing remarks.

Dan Bartok: Thank you, Katie. Forestar will continue facing difficult comparisons to our fiscal 2022 results as the housing industry adjusts throughout 2023. We have made remarkable progress building Forestar’s platform, which enabled us to maintain strong returns and margins during a challenging quarter. While we cannot control the macroeconomic backdrop or directly influence the demand for housing, we can and will stay focused on strengthening our platform and increasing operational efficiencies to drive future growth. We are closely monitoring each market submarket and project as we strive to balance pace and price to maximize returns. We are the market leader in a highly fragmented and undercapitalized industry and are optimistic about Forestar’s ability to continue to execute well, consolidate market share in any operating environment.

I would like to add on to Jim’s earlier comment about our capital structure being a big competitive advantage, because it is our team that is our biggest advantage. I could not be more proud than to be a part of this team. Their knowledge and experience and the way that they have dealt with the challenges of this past year are truly remarkable. Looking forward, we continue to believe that D.R. Horton and many other homebuilders will shift their focus towards buying finished lots from third-party developers. Instead of self-developing. With our broad geographic footprint, attractive land positions, strong balance sheet, and most importantly, our experienced team. Forestar is well positioned to be the last supplier of choice to homebuilders. We are planning for the long-term and have a track record of solid execution.

We proactively and methodically started to implement our downturn playbook over 18-months ago by adjusting our pace of new land acquisition in preparation for today’s current environment. When appropriate, we will leverage our platform and balance sheet to take advantage of opportunities to build shareholder value. Our flexibility enables us to quickly adjust to meet the needs of our customers. Our team has managed through market cycles before and we are well positioned to navigate these challenging market conditions. John, at this time, we’ll now open up the line for questions.

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Q&A Session

Operator: Thank you. Our first question is from Truman Patterson with Wolfe Research. Please proceed.

Truman Patterson: Hey, good afternoon, everyone and thanks for taking my questions. First, you all been trending close to 20% of Horton starts or orders over the past year? You mentioned your stated goal of supplying about a third of their lot needs. Do you think you all continue to increase that percentage throughout 2023? Or given the current housing backdrop, do you kind of run into a steady state, digest the current environment, see where home and lot prices ultimately settle?

Dan Bartok: Yes. Thanks, Truman. Thanks for the question. It will be an interesting year. I think everybody is looking forward to seeing how it plays out. I don’t expect that our market share within Horton will decrease. I expect that it will increase, but is that going to be going from one out of five homes to one out of four during this year, that would probably be pretty aggressive. But I do expect to continue to see some increase in our market share within Horton.

Truman Patterson: Okay, okay, got you. And then are you all actually seeing any opportunities to buy discounted land or distressed deals? Or is it still just a bit too early? I got the impression on the call that perhaps you’re not ready to deploy capital yet and maybe there’s some further downside?

Dan Bartok: Yes. We’re starting to see opportunities more particularly though in deals that we may have either passed on before or where somebody outbidder’s and now those deals are coming back around when they’ve been dropped. But as far as seeing anything that I would call distressed or severely discounted, I haven’t really seen that yet, but we’re looking hard for them.

Truman Patterson: Got you. Understood. And then one final from me, which markets do you think have the greatest lock constraints and we’ll just say are lease acceptable, the potential impairments in the industry in which markets are maybe more oversupplied and more at risk. I’m asking because right now new home pricing we just made is kind of down about 10% from the peak nationwide?

Dan Bartok: I don’t really see that any market is oversupplied. Again, nothing at all compared to what we saw back in ’07, €˜08 timeframe. So I think it’s still really hard to get lots entitled and they get lots developed. So again, I don’t see anything being oversupplied. I think as far as riskiest markets, I think it’s the ones that ran up the most and are probably going to be a little slower to bounce back. And the ones I would point to would be, I think the ones that you hear on everybody talk about, right, which is Arizona, Denver. And we kind of got out of the Northwest, so we kind of missed some of the stuff that happened up in in Salt Lake and Washington in Boise. But I’d say for us, probably the two that we look at most carefully are Arizona and Colorado.

Truman Patterson: Perfect. Thank you all. Appreciate the time.

Dan Bartok: Great. Thanks, Truman.

Operator: Okay. The next question is coming from Carl Reichardt with BTIG. Please proceed.