M/I Homes, Inc. (NYSE:MHO) Q3 2023 Earnings Call Transcript

M/I Homes, Inc. (NYSE:MHO) Q3 2023 Earnings Call Transcript October 25, 2023

Operator: Good morning, ladies and gentlemen, and welcome to the M/I Homes, Inc. Third Quarter Earnings Conference Call. At this time, all lines are in listen-only mode. Following a presentation we will conduct a question-and-answer session. [Operator Instructions]. This call is being recorded on Wednesday, October 25th, 2023. I’d now like to turn the conference over to Phil Creek. Please go ahead.

Phillip Creek: Thanks. Thanks for joining us. Joining me on the call today is Bob Schottenstein, our CEO and President; and Derek Klutch, President of our Mortgage Company. First, to address Regulation Fair Disclosure, we encourage you to ask any questions regarding issues that you consider material during this call because we are prohibited from discussing significant non-public items with you directly. And as to forward-looking statements, I want to remind everyone that the cautionary language about forward-looking statements contained in today’s press release also applies to any comments made during this call. Also be advised that the company undertakes no obligation to update any forward-looking statements made during this call. I’ll now turn the call over to Bob.

Aerial view of a newly-constructed residential home in a suburban neighborhood. Editorial photo for a financial news article. 8k. –ar 16:9

Robert Schottenstein: Thanks, Phil. Good morning, and thank you for joining our call to review M/I Homes third quarter results. We had an outstanding quarter, one of the best in company history, highlighted by record revenue, record income, a 50% increase in new contracts, and very strong margins and returns. In addition, we ended the quarter with record shareholders equity and a balance sheet that’s as strong as at any time in our 47-year history. Our third quarter results build upon the very strong results we previously reported in the first and second quarters of this year. We are particularly pleased to report these results, notwithstanding an unprecedented rapid rise in interest rates, continued concerns from all kinds of macroeconomic factors, as well as heightened conflict in the Middle East and across the globe.

We increased our revenues during the quarter by 3% to a record $1 billion, deliveries during the quarter also increased by 3%. Pre-tax income improved by 7% to a record $178 million. Gross margins for the quarter improved to 27%. That’s 10 basis points better than last year and 140 basis points better than our second quarter. We also benefited from the continued improvement in our construction cycle time, 50 days better than a year ago, and we are focused on further improving that in future quarters. Pre-tax income equaled 17% of revenue and our return on equity equaled 23%. As previously noted, new contracts improved by 50% from a year ago, reflecting the strength of our product offerings, our intense focus and success in designing more affordable product, quality of our communities, and our ability to selectively use below-market financing incentives to drive both traffic and sales.

Over 50% of our buyers are first-time buyers, and our Smart Series, which is our most affordable line of homes, continues to be a leading contributor to our strong sales performance. Our Smart Series is particularly attractive to the millennial buyer, and our Smart Series sales comprise roughly 55% of total company sales. During the past several weeks, we have seen additional increases in mortgage rates, with the 30-year rate now hovering at around 8%. This recent rise has somewhat impacted demand. Clearly, we are seeing a bit more consistency from market-to- market and a slight slowdown in activity. As we have in the past, we will respond accordingly by focusing on below-market mortgage rates to incent sales where we believe it to be necessary.

We ended the quarter, with record shareholders’ equity of $2.4 billion, 25% better than a year ago. In addition, we have zero borrowings under our $650 million line-of-credit and a quarter-ending cash balance of $736 million. And our debt-to-capital ratio of 22% positions us with one of the lowest leverage levels in our industry. As noted earlier, our balance sheet is as strong as it has ever been. Now I will provide a few additional comments on our various markets. Our division income contributions in the third quarter were led by Dallas, Orlando, Tampa, Raleigh, Austin, and Columbus. New contracts for the third quarter in the northern region increased by 90%, while new contracts in our southern region increased by 29%. Deliveries in the southern region increased 15% from last year, while deliveries in our northern region decreased by 13%, 65% of all deliveries come out of our southern region, the balance of 35% the northern region.

Our owned and controlled lot position in the southern region decreased by 4% compared to a year ago, and in the northern region increased by 1% compared to a year ago. 35% of our owned and controlled lots are in our northern region, while 65% of our owned and controlled lots are in our southern region. We have an excellent land position. Company-wide, we own approximately 23,000 lots, which is roughly a three-year supply. As I conclude, let me just state again that we are in the best financial condition in our history. We remain on track and are very excited to open a number of new communities yet this year, thus increasing our community count by approximately 15% from last year. We feel very good about our business and are well-positioned to have another year of strong results in 2023.

With that, I’ll turn it over to Phil.

Phillip Creek: Thanks, Bob. Our new contracts were up 62% in July, up 14% in August, and up 85% in September, and our cancellation rate for the third quarter was 10%. 55% of our third quarter sales were first-time buyers, and 52% were inventory homes. Our community count was 204 at the end of the third quarter, compared to 178 a year ago. The breakdown by region is 101 in the northern region and 103 in the southern region. During the quarter, we opened 22 new communities while closing 13. We currently estimate ending 2023 with about 225 communities, a 15% increase from year-end 2022. We delivered 2,096 homes in the third quarter, delivering 60% of our backlog. And as of September 30th, we had 4,600 homes in the field versus 5,800 homes in the field a year ago.

Our average closing price for the quarter was $481,000, a 1% decrease when compared to last year’s record third quarter average closing price of $487,000. Backlog average sale price is $510,000, down from $533,000 a year ago. Our third quarter gross margin was 26.9%, up 10 basis points year-over-year, and up 140 basis points from our second quarter. Our construction costs were flat in the third quarter, and we benefited from improved building cycle times. Our third quarter SG&A expenses were 10.5% of revenue, compared to 10.3% a year ago. Our third quarter expenses increased 5% versus a year ago, due primarily to higher third-party broker costs and expenses related to our higher community count. Interest income, net of interest expense for the quarter was $5.8 million.

Our interest incurred was $9.4 million. We are pleased with our returns for the quarter. Our pre-tax income was 17%, and our return on equity was 23%. During the quarter, we generated $185 million of EBITDA, compared to $179 million in last year’s third quarter. Our effective tax rate was 22% for the third quarter, compared to 21% in last year’s third quarter. Our earnings per diluted share for the quarter increased to a record $4.82 per share from $4.67 per share last year, up 3%. And our book value per share is now $87, a $16 per share increase from a year ago. Now, Derek will address our mortgage company results.

Derek Klutch: Thanks, Phil. Our mortgage and title operations achieved pre-tax income of $9.9 million, a 25% increase from $7.9 million in 2022’s third quarter. Revenue increased 17% from last year to $23.6 million due to higher margins on loans sold, a higher average loan amount, and an increase in loans originated. The average loan-to-value on our first mortgages for the third quarter was 82%, which is the same as last year. 72% of the loans closed in the quarter were conventional, and 28% FHA or VA, compared to 79% and 21% respectively for 2022’s third quarter. Our average mortgage amount increased to $394,000 in 2023’s third quarter, compared to $385,000 last year. Loans originated increased to 1,469 loans, which was up 16% from last year, while the volume of loans sold increased by 13%.

Our borrower profile remains solid, with an average down payment of almost 18%, and an average credit score of 748, compared to 745 in 2022’s third quarter. Finally, our mortgage operation captured 86% of our business in the third quarter, which was up from 76% last year. Now, I’ll turn the call back over to Phil.

Phillip Creek: Thanks, Derek. For the balance sheet, we ended the third quarter with a cash balance of $736 million and no borrowings under our unsecured revolving credit facility. We have one of the lowest debt levels of the public home builders and are well-positioned with our maturities. Our bank line matures in late 2026, and our public debt matures in 2028 and 2030, and has interest rates below 5%. Our unsold land investment at 9/30/2023 is $1.3 billion, compared to $1.2 billion a year ago, and at 9/30/2023, we had $718 million of raw land and land under development, and $608 million of finished unsold lots. During the third quarter, we spent $106 million on land purchases and $151 million on land development, for a total of $257 million.

In year-to-date, our land spent totaled $600 million. At 9/30/2023, we owned 23,000 lots and controlled 45,000 lots. At the end of the quarter, we had 414 completed inventory homes and 2,021 total inventory homes. And of the total inventory, 914 are in the northern region and 1,107 is in the southern region. And at 9/30/2022, we had 200 completed inventory homes and 1,855 total inventory homes. We spent $25 million in the third quarter repurchasing our stock, and $53 million remaining under our current board authorization. This completes our presentation. We’ll now open the call for any questions or comments.

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Q&A Session

Operator: Thank you. Ladies and gentlemen, we will now begin the question and answer session. [Operator Instructions] Our first question comes from the line of Jesse Lederman at Zelman & Associates. Please go ahead.

Jesse Lederman: Hi. Congrats on the strong quarter, and thanks for taking my questions.

Robert Schottenstein: Thanks, Jesse.

Jesse Lederman: Can you just walk us through the sequential improvement to gross margin? I remember last quarter you noted that your backlog gross margin was relatively flat compared to what you were delivering, and you noted your construction costs were about flat. So, can you just walk us through, what drove the sequential increase to margin?

Robert Schottenstein: I think it’s a number of things. Clearly, we’ve had some benefit from the flattening of hard costs, the items that you mentioned. But I think it’s — as much as anything, the continued increase in the mix of more affordable product, which we call our Smart Series, which typically carries higher margins than the other — the more move-up product that we sell. We have really focused, it began several years ago. I’m glad we did. Sometimes you focus on things that don’t work out as well as others. But several years ago, we really began to focus on designing even more affordable product that we could sell under our Smart Series umbrella. Some of it’s attached. The number of attached communities that we currently have in the market right now is roughly 50% more than it was a year ago.

A year ago, we had about 20 communities across our various markets selling attached product. Today, it’s close to 30. In addition, more narrow single family. This product offering has been very successful for us, and is selling not only at good pace but at better margins, lower cycle time, when you put all this into the mix. And one other factor; we’ve opened up a number of new communities this year. Our new communities are quite candidly performing even better than we, not all, but many, even better than we anticipated. So it’s not one thing, its many things. We, at the beginning of the year, did not believe our margins would be as strong as they are. Mainly because at the beginning of the year, business conditions were much more challenging in terms of demand than they have been thus far this year.

But we’re very pleased with our margins. It’s possible there could be a little bit more pressure on them going forward for the reasons that I mentioned with doing more to incent below-market financing. But look, we’re going to do what we need to. We’re really proud of our results. We want to continue to maintain our momentum. We think the underlying demographics in our industry, as you pointed out, as much as anyone has, frankly, are very strong, with household formations, millennial home ownership rates increasing incredibly low levels of inventory of existing homes. We know things are by no means perfect. We know there’s still inflation. We know rates are in an unsteady state. But we’re bullish on the homebuilding industry, and we’re bullish on M/I Homes.

Phillip Creek: And Jesse, just as a specific for you, as Bob mentioned, we have opened 56 new stores this year, and we’ve been very pleased with the way they’ve performed.

Jesse Lederman: That’s helpful. Thanks. Could you give maybe – you noted that your orders were up 85% at September, which I look back to your comments from last year, and you were down 35% a year ago. So, a lot of that’s comp-driven also. But maybe if you could talk about demand trends in September, and maybe if you could comment on October as well, that’d be helpful, along with maybe some pricing action that you may need to take to keep sales strong with rates continuing to rise?

Robert Schottenstein: Yes. First of all, the last six months of last year was rough, as you recall. I think throughout the better part of the last six-month – well, throughout the last six months of last year, I think we averaged maybe 380 or 390 sales a month, which is not good. So, going into this year, we knew at some point we were going to have some pretty low comps, if you will. Interestingly, our sales since January and through September have averaged in the high sixes, low sevens, 100 a month. It wasn’t that September was such a blowaway month. It’s just we had a particularly low comp from a year ago. Sales throughout the quarter were pretty steady month to month to month, although September was probably a little better in some ways aided by new community openings.

I think things have slowed a little bit in October, as I mentioned. It’s a little bit market-to-market. Some markets are – the demand is a little stronger than others. But clearly, there’s inconsistencies, choppiness, whatever words you want to use. We’ve been essentially using below-market mortgage rates to incent sales for quite some time. When the par rate was 7.5, we knew we had to get it below that. Now that the par rate’s hovering around 8, we know that to get sales, we’ve got to continue to incent. We may have to do a little bit more. We’re going to continue to watch. We’re also entering into a normally seasonally slow time as we get here into November. We don’t want to overreact. But we’re going to do what’s necessary. There could be a little bit of pressure on margins.

I don’t want to spook people, but that’s just the reality. I think that our results have stood tall for the last year-plus, and I suspect that they will continue to for the next several quarters and beyond.

Phillip Creek: Also, Jesse, we’re trying to balance things. I talked about as far as houses in the field. We have 4,600 homes in the field today versus 5,800 a year ago. So, we do have fewer houses in the field. We did slow our business down, especially the last couple of quarters of last year. We do have 400 completed specs kind of versus 200. So, again, we’re trying to be very mindful of all those things. Slashing prices and those type things is not the way we operate in general. We try to run a very conservative business. It’s hard to get these subdivisions approved and land development houses built. So, we’re trying to balance all those things off, but…

Robert Schottenstein: Every subdivision is a little different. What I’m particularly inspired by, is the number of communities that we have. In the last week, I’ve been out driving communities in Houston, Orlando, and Columbus. I spent quite a bit of time in the field in all three within the last week. And the number of communities that we have, we’re still seeing very strong activity. It’s not all of them, but there’s certainly a healthy number of them that are still running at that three, four, five, in some cases six sales a month. And the demand is there. Obviously, the demand slows as rates go up, but I still think that there’s strong desire for home ownership across a number of sectors, particularly millennials and right behind them, the Gen Zers [ph]