Meritage Homes Corporation (NYSE:MTH) Q1 2024 Earnings Call Transcript

Meritage Homes Corporation (NYSE:MTH) Q1 2024 Earnings Call Transcript April 25, 2024

Meritage Homes Corporation  isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Hello, and welcome to the Meritage Homes First Quarter 2024 Analyst Call. [Operator Instructions] As a reminder, this conference is being recorded. It’s now my pleasure to introduce your host, Emily Tadano, Vice President, Investor Relations and ESG. Please go ahead, Emily.

Emily Tadano: Thank you, operator. Good morning, and welcome to our analyst call to discuss our first quarter 2024 results. We issued the press release yesterday after the market closed. You can find it along with the slides we’ll refer to during this call on our website at investors.meritagehomes.com or by selecting the Investor Relations link at the bottom of our home page. Please refer to Slide 2, cautioning you that our statements during this call as well as in the earnings release and accompanying slides contain forward-looking statements. Those and any other projections represent the current opinions of management, which are subject to change at any time, and we assume no obligation to update them. Any forward-looking statements are inherently uncertain.

Our actual results may be materially different than our expectations due to a wide variety of risk factors, which we have identified and listed on this slide as well as in our earnings release and most recent filings with the Securities and Exchange Commission, specifically our 2023 annual report on Form 10-K. We have also provided a reconciliation of certain non-GAAP financial measures referred to in our earnings release as compared to their closest related GAAP measures. With us today to discuss our results are Steve Hilton, Executive Chairman; Phillippe Lord, CEO; and Hilla Sferruzza, Executive Vice President and CFO of Meritage Homes. We expect today’s call to last about an hour. A replay will be available on our website later today. I’ll now turn it over to Mr. Hilton.

Steve?

Steven Hilton: Thank you, Emily, and welcome to everyone listening in on our call. I will briefly discuss current market trends and our recent accomplishments. Phillippe will cover highlights of our operational performance and how our strategy is driving our success. Hilla will provide a financial overview of the first quarter and our forward-looking guidance for Q2 and full-year 2024. Meritage had a remarkable start to the year. We achieved an average absorption pace of 4.9 sales per month in the first quarter of 2024, which resulted in our highest quarterly sales orders totaling 3,991 homes. During the spring selling season with a healthy supply of move-in ready inventory, we were able to capitalize on strong market conditions generated by the increasing need for housing for millennials and Gen Zs as well as the move-down Baby Boomers who continue to find our limited inventory, limited availability of resale housing supply.

In the first quarter of this year, our record backlog conversion of 138% drove 3,507 home deliveries, which led to home closing revenue of $1.5 billion. Home closing gross margin for the quarter was 25.8%, which combined with SG&A of 10.4%, resulting in diluted EPS of $5.06. As of March 31, 2024, we increased our book value per share 17% year-over-year to $129.98 and generated a return on equity of 18%. Although visibility into what interest rate mortgage rates will do for the remainder of the year remains unclear, we believe that by satisfying homebuyers desire to have quick closing time lines, our available inventory should position us to continue increasing our market share. Now on to Slide 4 for our recent milestones. It’s very timely that during the month that we celebrate Earth Day, we can announce Meritage’s 11th Award as the EPA’s ENERGY STAR Partner of the Year for sustained excellence for continued industry leadership in the production of energy-efficient homes.

Additionally, Meritage was also named in Newsweek’s 2024 America’s Greenest companies list as our commitment to sustainability is recognized even outside of our sector. Also I take pride in sharing that at the end of the first quarter of this year, Meritage received the President’s Volunteer Service Award, a civil award bestowed by the U.S. President and the highest honor available for volunteerism that refers to our partnership with No Child Hungry and the 1,100-plus hours our team members volunteer to package nearly 260,000 meals over the past two years to fight childhood hunger. Lastly, this quarter, we were recognized as one of Forbes’ 2024, most successful mid-cap companies based on sales and earnings growth, return on equity and total stock return for the last five years.

At Meritage, we believe that financial achievements must be maintained while maintaining a focus on responsible corporate citizens and we are honored that these accolades continue to illustrate the breadth and depth of our commitment. With that, I’ll now turn it over to Phillippe.

Phillippe Lord: Thank you, Steve. This quarter, we are excited to share our financial results, but I wanted to provide a bit more context behind the numbers. Nearly 50% of our quarterly deliveries were sold and closed intra-quarter, a trend that has been increasing for the last three to four quarters, resulting in a record backlog conversion of 138%. This conversion rate is materially north of our previous long-term target of 80% plus and notably higher than even our fourth quarter 2023 backlog conversion of 110%, helping drive improved ROE over the last several quarters. This success was the intentional result of migrating to a move-in ready strategy across both our entry level and first newer products, allowing us to enter the year with a sufficient supply of homes available for quick close, particularly in advance of the spring selling season.

We were able to both increase prices and offer less financing incentives than we anticipated on those quick move-in closings, meaningfully improving our first quarter 2024 gross margin. With our intra-quarter sales activity representing half of the quarter’s closing volume, our gross margin reflects more current market conditions in real time, and our outperformance validates that our move-in-ready strategy is the right one for Meritage and for our customers. Now turning to Slide 5. Demand remained solid this quarter. Our sales orders of 3,991 homes were up 14% year-over-year. The nationwide sales event conducted in late January and into February was highly successful. We sold our highest quarterly sales order volume, which benefited from an 8% cancellation rate, significantly below our historical average in the mid-teens.

Entry-level homes comprise more than 90% of the total order volume. ASP on orders this quarter of $409,000 was down 5% from prior year, but fairly aligned sequentially from the fourth quarter of 2023. The ASP decrease from 2023 was due to both the larger mix of our closings coming from our Eastern markets and product mix shift, even as we increased pricing in about half of our communities and use fewer rate locks this quarter. The first quarter 2024 average absorption pace of 4.9 per month improved from 4.2 in the prior year and was well above 4 net sales per month due to strength of spring demand. The first quarter 2024 ending community count of 275 was up 2% sequentially from the fourth quarter of 2023 and down 1% compared to prior year. 34 new communities came online this quarter.

We are still on target for more material community growth later in the year, ending 2024 mid to high-single digits higher than where we started with even greater projected growth in 2025. We only control all the lots we need for planned key openings in 2024 as well as most of our 2025 communities. We are now focused on opportunities for quick openings in 2025 as well as longer term growth into 2026 and beyond. Moving to the regional level trends on Slide 6. All of our regions generated a sales pace well above 4.0 net sales per month during the first quarter of 2024. Although we do expect Q1 to be one of our strongest absorption quarter as the overlap of the spring selling season. The Central region combined our Texas market had both the highest regional average absorption pace of 5.2 sales per month and a backlog conversion rate of over 150%.

The economic growth in Texas fuels the positive momentum in the housing market and with over 90% of this region’s average community being entry-level, a steady supply of affordable and move-in ready inventory has been in high demand. The West region had an average absorption pace of 4.8 net sales per month compared to 4.5 last year. Our previously challenged markets in this region regained sales momentum this quarter, primarily in Arizona and Colorado, some of the toughest markets last year. Colorado’s first quarter 2024 sales order volume increased double digits on a year-over-year basis on a reduced community count. The East region experienced the largest year-over-year growth at an average absorption pace of 4.7 net sales per month, up from 3.8 from last year.

As we have been focused on rebalancing our land portfolio over the last couple of years, our effort in East regions are now visible with a 10% year-over-year growth in average communities and double the prior year spec inventory, which positions us well to continue to take market share in the high-growth market parts of this country. Now turning to Slide 7. Our quarterly starts were approximately 4,000 homes in the first quarter of 2024. We were up from about 2,500 in the prior year and are consistent with our quarterly cadence for the last few quarters. In order to ensure we have sufficient loans available for quick move-in, we align our start pace with our expected future sales pace. Further, as we grow community count in the later half of this year, we will start more homes to meet our targeted per-community move-in ready supply across our growing footprint.

We had approximately 6,000 spec homes in inventory as of March 31, 2024, up 54% from about 3,900 specs as of March 31, 2023, but only about 100 homes greater than where we started this quarter. This represents 22 specs per community this quarter, which equates to 4.5 month supply specs on the ground, well within our target level of four to six months of supply. At our home closings this quarter, 93% came from previously started inventory, up from 87% in the prior year. 22% of the total specs were completed as of March 31, 2024, as we continue to make progress to our target run rate of carrying one-third move-in ready homes. Our ending backlog as of March 31, 2024, totaled approximately 3,000 homes, down from about 3,900 homes in the prior year as our intra-quarter sales to closing percentage increased.

With our focus on carrying more move-in ready inventory, we would expect our backlog will continue to represent less than one quarter sales as our backlog converged rates start to consistently perform above 100%, improving our returns. With our backlog and specs on the ground totaling over 9,000 homes, we believe we have the optimal level of home supply to deliver on our full-year results. I will now turn it over to Hilla to walk you through our financial results. Hilla?

Hilla Sferruzza: Thank you, Phillippe. Before I cover our financial highlights, I wanted to first address the momentum we’ve gained with our land goals as this has been a key pillar in our growth plan. Our land teams have been successful at sourcing deals despite the competitive land market. And through their efforts, we put nearly 6,300 net new lots under control this quarter. This led to the growth in our total lot count by nearly 10% year-over-year and up sequentially by 3% to approximately 56,400 lots. With these new deals, we are starting to increase our use of off-balance sheet financing, growing our outlook percentage to 31% this quarter from 25% in the first quarter of 2023 and 28% from Q4 of last year. We continue to be focused on accelerating our land acquisitions and looking for off-book opportunities while maintaining a healthy balance sheet.

Now let’s turn to Slide 8 and cover our Q1 financial results in more detail. First quarter 2024 home closing revenue was $1.5 billion, reflecting 21% higher home closing volume year-over-year, that was partially offset by 4% lower ASP due to a shift in product mix. On a sequential basis, ASP closings increased in the first quarter of 2024 with reduced utilization of rate locks and targeted price increases reflected in our intra-quarter sales and closings as the market improved over the last 90 days. Assuming interest rates hold steady or improve, ASP for the rest of the year is expected to be fairly consistent with some reductions from geographic mix and new entry-level communities opening with lower prices will be balanced by reduced financing incentive costs and price increases where the markets can absorb them.

While the utilization of rate locks have slowed from 2022 and 2023, our all-in discounts are still running at an elevated level, and we expect to continue to utilize rate locks and buy-downs to negate concerns around rate volatility. Home closing gross margin increased 340 bps to 25.8% in the first quarter of 2024 compared to 22.4% in the prior year. This improvement was a combination of several factors. First, the reduced utilization of rate lock financing incentives that we’ve discussed. Next, the greater leverage of fixed costs on higher revenue. And finally, improvements in our direct cost as last year’s first quarter marked the highest per square footage direct for us since the start of COVID. These savings were partially offset by higher lot costs.

We want to take a minute and cover the trends we’re seeing in our direct costs. Our team has been leveraging our spec strategy and increasing volume, allowing us to deepen our relationships with our vendors. We are proud of the reductions we achieved to date, and we expect that we will be able to hold the line to keep cost steady and find offsets to the recent lumber increases. On the labor front, capacity has hub fairly steady. Perhaps as multifamily construction has pulled back a bit, creating a stable environment for residential construction at the moment. Our cycle times have settled in at around 140 calendar days over the last three quarters. We remain disciplined in our start cadence and are only selling homes later in the construction process to have the necessary inventory for quick move-in closings.

Our goal is to turn our assets three times a year to get their additional capacity will likely be needed for both trade labor and local government staffing for permitting and inspections. When we review the composition of our gross margin, the only known variable is lot cost since the land acquisition and development dollars have already been spent. Elevated land development costs, the impact of the entire industry over the past three years are now fully flowing through our financials as almost all of our land is now for post-COVID acquisitions. Our current guidance reflects the elevated lot cost, and we do not expect any additional pullback on margins beyond 2024 as go-forward lot costs have a similar land development composition component.

Over the past four to six quarters, our long-term gross margin target has been at least 22%. Structurally, we believe our target has changed as we continue to dial in our relationships with national vendors and further streamline our operations. The goal of these efforts is to improve cycle times and reduce costs. We’ve been operating under extreme environments for the past several years, highly favorable and then very challenging. As the markets are stabilizing, we are gaining a clear understanding of our capabilities in a normalized environment and expect to share our higher internal targets with you over the next several quarters. Turning to SG&A. SG&A was 10.4% of home closing revenue in the first quarter of 2024, which was fairly in line with 10.2% for the first quarter of 2023.

Higher commissions this quarter offset the incremental leverage achieved on higher home closing revenue. We are still comfortable with our full-year SG&A goal of 10% or under and expect quarterly SG&A to improve throughout the year. Given our anticipated volume growth over the next few years, our longer term SG&A target is 9.5%. In the first quarter of 2024, the financial services loss of approximately $700,000 included $5.8 million in write-offs related to rate lock unwind costs. This compares to financial services profit of $2.9 million in the first quarter of 2023 that had $1.9 million in similar write-offs. We anticipate potentially incurring another $7 million of rate lock underlying costs in the second quarter, which is included in our guidance.

Excluding these charges, the profitability of our financial services is held in line with our historical averages. The first quarter’s effective income tax rate was 20.5% this year, essentially flat to prior year, with both periods benefiting from energy tax credits on qualifying homes under the Inflation Reduction Act. Overall, higher home closing revenue and gross profit with flat SG&A leverage and tax rate led to a 43% year-over-year increase in first quarter 2024 diluted EPS to $5.06 from $3.54 in 2023. Before we move to the balance sheet, I wanted to cover our Q1 2024 customers’ credit metrics. As expected, our buyer profile remained relatively consistent with our historical averages, with FICO scores near 740 and DTIs around 41 or 42.

LTVs were still in the mid-80s and about 80% of our buyers in Q1 received some sort of financing incentives consistent with our mortgage company capture rate. Now turning to Slide 9. Our balance sheet, returns and liquidity management are a core focus for us. We have nothing drawn under our credit facility, cash of $905 million and net debt to cap of 2% at March 31, 2024. Our net debt to cap ceiling target is in the mid-20s, leveraging our improving backlog conversion. We also generated $82 million in operating cash flow for the first quarter of 2024. Our overarching capital spend philosophy looks to generate long-term shareholder value expansion through both growth in the business and returning capital to shareholders. Since early 2023, we have been accelerating our investment in organic growth.

This quarter, we spent $430 million on land acquisition and development, which was up 39% from prior year. We expect our go-forward trend for full-year 2024 and beyond to total $2 billion to $2.5 billion of land spend. Given confidence in our business model and our ability to deliver strong and stable financial performance during the first quarter of 2024, we meaningfully enhanced our shareholder returns directive as well. In February, we instituted a formal programmatic share repurchase plan with a minimum buyback commitment of $15 million in each quarter to provide consistency and predictability to our share repurchase activity. During the first quarter of 2024, we went beyond the systematic $15 million commitment and opportunistically bought back an additional $41 million.

We repurchased over 360,000 shares or 1% of common stock outstanding at December 31, 2023, for $56 million this quarter. $129 million remain available under our authorization program. One year after initiating our dividend policy, we nearly tripled our quarterly cash dividend to $0.75 per share this quarter or $0.27 per share, providing another avenue for us to improve our ROE. This resulted in total spend of about $27 million in dividends in the first quarter this year. And rounding out our capital plan for the year, we are also evaluating near-term opportunities to address the senior debt that’s coming due in early 2025. On to Slide 10. In the first quarter of 2024, we were able to find and secure land deals that meet our underwriting standards in the majority of our markets meaningfully putting more lots under control than home starts.

The nearly 6,300 net new lots under control this quarter represent an estimated 43 future communities. We put about 200 net new lots under control in the first quarter of 2023 as we were only starting to ramp up from the pullback in late 2022 that quarter. As of March 31, 2024, we owned or controlled a total of about 56,400 lots, equating to 4.6 year supply of lots in line with our target of four to five-year supply. Our land financing strategy focuses on managing our capital while being mindful of balance sheet metrics and margin goals. We’ve been able to utilize our healthy balance sheet to replenish our land portfolio while minimizing the gross margin impact from option land yields for the past several years. As we mentioned earlier, we have recently been utilizing more option financing for our land purchases.

About 69% of total lot inventory at March 31, 2024, was owned and 31% optioned compared to prior year, where we had a 75% owned inventory and a 25% option lot position. We believe that off-balance sheet financing will allow us to control more land and increase our year supply of lots beyond what we like our balance sheet to absorb. Our intent is to accelerate our growth into 2025 and onward, and we are currently working on some land financing opportunities that we hope to be able to share with you in the next several quarters. Finally, I’ll direct you to Slide 11 for our guidance. Given the robust market conditions and our supply of move-in ready homes, we revised our projections upward for full-year 2024 to the following. Total closings between 14,500 and 15,000 units, home closing revenue of $6 billion to $6.2 billion, home closing gross margin of around 24.5% to 25%, an effective tax rate of about 22.5% and diluted EPS in the range of $19.20 to $20.70.

As for Q2 2024, we are projecting total closings between 3,600 and 3,800 units, home closing revenue of $1.5 billion to $1.6 billion, home closing gross margin of 24.5% to 25%, an effective tax rate of about 22.5% and diluted EPS in the range of $4.70 to $5.30. Both Q2 and full-year guidance assume current market conditions and interest rates. We will continue to refine our guidance as additional clarity around interest rates becomes available later in the year. With that, I’ll turn it back over to Phillippe.

Phillippe Lord: Thank you, Hilla. To summarize on Slide 12. Our first quarter 2024 results demonstrate that our ample spec home supply for quick closings and our focus on pace over price allowed us to plus up and exceed not only our volume targets, but also our gross margin guidance. As we increase our community count in the second half of this year, we believe we are positioned to continue growing our market share. Further, our acceleration on both land spend as well as share repurchases and dividends demonstrates our confidence in our business model. We are committed to balancing growth in the business and returning cash to shareholders in order to continue creating long-term value. With that, I will now turn the call over to the operator for instructions on the Q&A. Operator?

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Q&A Session

Operator: Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question is coming from Stephen Kim from Evercore ISI. Your line is now live.

Stephen Kim: Thanks very much guys. Really impressive results. Thanks for all the guidance and color. Question for you regarding the backlog turnover ratio. This is something that we’ve chatted a lot about over the last year. It sounds like you’re clearly now saying that you’ve arrived at a level at a point now with your business model where you feel comfortable guiding to a turnover ratio at triple digits. I was curious as to whether you think that when – what you see this year in terms of how you’re planning to operate, whether this is a level of backlog turnover ratio that you also think can continue sort of as you progress towards whatever your long-term normalized level is? Is this the new normal? Or do you see 2024 as maybe being a little higher than normal?

Steven Hilton: I would say that it’s pretty much going to be the new normal. As we think about the rest of this year, we’re modeling a similar backlog conversion for the remaining quarters. Some of it is just predicated on cycle time stability, which currently we have. The production capacity is really, really good. So as long as that remains in the same state, this is going to be the new normal for us.

Stephen Kim: Yes. That’s really great. And I assume the same thing could probably be said for absorption rates perhaps per community, but maybe you can update us on that. I know historically, I think you’ve talked about 3 to 4. And then as a follow-on to that, you talked about your gross margin now pretty much for this year, incorporating a fully adjusted land cost. You don’t have that pre-pandemic unusual land effect. So that would seem to suggest that your gross margins have potentially some upside from here. I know you’re going to give us more on that later. But you had talked in the past about how a higher level of volume translates very directly for you into a higher level of profitability, not just on the SG&A, but the gross margin. So I was wondering if you could remind me again about the sensitivity of higher volume to your gross margin as well as updating us on your absorption rate longer term?

Phillippe Lord: Yes. I’ll take the absorption question, and then I’ll hand it over to Hilla on the margin guidance. We obviously believe we’re going to sell more houses in the front half of the year than the back half of the year just due to seasonal trends. But we are reevaluating our overall absorption targets specifically for our entry-level business. We’ve often said that our target is around 4 to 5 for entry level and somewhere between 3 and 4 for 1 MU. And the affordable part of the market is extremely strong. We’re finding really strong land positions out there to support that affordable price point, and we are evaluating whether we can do better than that 4% to 5%. But stay tuned on that, and I’ll let Hilla talk about the margin guide.

Hilla Sferruzza: Sure. So historically, when we have longer cycle times and lower closing, sales at closing time, they could be up to 100 bps pickup in the fixed component of gross margin between Q1 and Q4 due to the incremental volume. Now that’s a little bit different these days because we’re selling the spring selling homes and closing some of the spring season homes in the same quarter, but increased volume for us, even 400, 500 incremental units in a quarter can have up to 100 bps improvement in our gross margin, not just SG&A leverage.

Stephen Kim: Great. That’s really helpful. Thanks, Hilla. Thanks, Phillippe. Appreciate it.

Phillippe Lord: Thank you.

Operator: Thank you. Next question today is coming from Alan Ratner from Zelman & Associates. Your line is now live.

Alan Ratner: Hey guys, good morning. Congrats on the great quarter. First question, gross margin. So if I look at your full-year guide, I think the biggest adjustment was to the margin range. And if I think back to three months ago when you gave that, I believe, if I’m remembering correctly, obviously, higher land costs flowing through was kind of the main headwind as far as your expectation for some pressure through the year. But I think you probably also had some assumption on incentives embedded within that as well. And clearly, the first quarter came in better than, I guess, you guys were expecting. But when you think about the macro environment today versus back then, rates are higher and continuing to move higher. So what is actually embedded in that guide for the remainder of the year as far as incentives?

Do you expect to kind of continue the improvement you’ve seen in the first quarter? Or are you baking in any potential for having to increase incentives as you get to the back half, softer seasonal time of the year?

Hilla Sferruzza: We’re still in an elevated level of incentives compared to where we were pre-2022. So we’re maintaining that level. There was a decent amount, even with the pullback in improved market conditions in Q1, there was still a decent amount of incentives that are being used. But something that’s really important to consider when you’re selling and closing intra-quarter, even though you’re offering an incentive, you can offer it much less expensively if you’re offering a 45-day interest rate lock, it’s much cheaper than trying to buy a forward commitment. So we’re still planning on using the tools that we have in our toolkit to rate lock buydowns and rate locks just in general, but the cost to those is going to be less expensive because of our ability to sell and close so quickly. So we’re modeling current market conditions, including what we’re seeing in April, which includes the uptick in the guidance that we provided to you.

Phillippe Lord: Yes, I’ll just – I’ll give you an extra question here because people are going to ask you about April. We’re not needing to go out and increase our rate lock costs to acquire the customers for April. That’s included in our guidance. Even in these elevated rate environments, we’re able to move people into our move-in ready inventory at about similar costs than we were in Q1. So it’s all baked into our guidance.

Alan Ratner: Got it. That’s really helpful. Thank you for that added color. Second question, I guess, just pointing to your Slide 10, where you show the lot acquisition activity, which is very helpful to see. So I know this is not a smooth number by any means, but first quarter looks like it was down a little bit from the last couple of quarters in terms of dollars spent on both development and acquisition. It looks like the community, I guess, acquisition was relatively steady, but you’re tracking, I guess, below the $2 billion to $2.5 billion target for land spend year-to-date. So is that just a timing function? Or is there – is it getting harder to find deals to pencil? How should we think about that? Because I know, obviously, your 25 community count growth is somewhat dependent on hitting that target.