PulteGroup, Inc. (NYSE:PHM) Q4 2022 Earnings Call Transcript

PulteGroup, Inc. (NYSE:PHM) Q4 2022 Earnings Call Transcript January 31, 2023

Operator: Good morning. My name is Devin, and I’ll be your conference operator today. At this time, I’d like to welcome everyone to the PulteGroup, Inc. Q4 2022 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. Thank you for your patience. Mr. Jim Zeumer, you may begin the conference.

Jim Zeumer: Great. Good morning, Devin. Good morning and thank you, Devin. Look forward to discussing PulteGroup’s outstanding fourth quarter earnings for the period ended December 31, 2022. I’m Joined on today’s call by Ryan Marshall, President and CEO; Bob O’Shaughnessy, Executive Vice President and CFO; and Jim Ossowski, Senior VP, Finance. A copy of our earnings release and this morning’s presentation slides have been posted to our corporate Website at pultegroup.com. We will post an audio replay of this call later today. Please note, that consistent with this morning’s earnings release, we will be discussing our reported fourth quarter numbers as well as our financial results adjusted to exclude the benefit of certain insurance reserve adjustments and JV income as well as the write-off of deposits and pre-acquisition spend and a tax charge recorded in the period.

A reconciliation of our adjusted results to our reported financials is included in this morning’s release and within today’s webcast slides. We encourage you to review these tables to assist in your analysis of our business performance. And finally, I want to alert everyone that today’s presentation includes forward-looking statements about the company’s expected future performance. Actual results could differ materially from those suggested by our comments made today. The most significant risk factors that could affect future results are summarized as part of today’s earnings release within the accompanying presentation slides. These risk factors and other key information are detailed in our SEC filings, including our annual and quarterly reports.

Now let me turn the call over to Ryan Marshall. Ryan?

Ryan Marshall: Thanks, Jim, and good morning. We ended 2022 on a high note as we closed almost 8,900 homes and delivered all-time fourth quarter records with homebuilding revenues of $5.1 billion and earnings of $3.85 per share. These results, in turn, helped PulteGroup finish the year with over $1 billion in cash and a net debt-to-capital ratio below10%. Bob will detail the rest of our Q4 results in a few minutes. Driven by the company’s exceptional fourth quarter performance, PulteGroup delivered another year of great financial results. For 2022, our home sale revenues increased 18% over the prior year to $15.8 billion, our reported pre-tax earnings increased by 37% to $3.4 billion and our reported earnings increased 48% to $11.01 per share.

These results provided us the flexibility to invest $4.5 billion into the business, while returning over$1.2 billion to shareholders, dividends and share repurchases. Let me just pause right here and thank our entire organization for their efforts in delivering such a great operating and financial results under some challenging market conditions. We are truly fortunate to have such an outstanding team. In assessing our 2022 financial results, we fully appreciate that gains in volume, pricing, gross margin and earnings reflect the stronger demand environment that existed earlier in 2022. As we all know, the Federal Reserve decision to hike rate 7x in 2022 and its fight against inflation is successfully slowing the economy, including housing.

For the full year, national new and existing home sales across the country fell 16% and 18%, respectively from 2021. Consistent with the trend of these national numbers, our 2022 net new orders were down roughly 27% from 2021. The softer demand we’ve experienced as a result of consumers priced out of the market by higher prices and higher mortgage rates, along with those individuals who have moved to the sidelines given market uncertainties and risks. Despite the higher rate environment dominating the national conversation, we saw buyer demand improve as the fourth quarter progressed and can confirm this strength continued through the month of January. We will have to see how things progress from here, but I think this improvement attests to the ongoing desire for homeownership that exists in this country.

Net signups both in absolute number and absorption pace increased as we move through each month of the fourth quarter and through the month of January. While seasonal trends have been distorted over the past few years, monthly sales moving higher as the fourth quarter progressed is atypical. In short, we’re encouraged by the recent improvement in our new home sales. Based on feedback from our sales offices, buyers have been responding to the decline in mortgage rates. Consistent with this idea, I would add that rate buydowns remain among the top incentives for our customers. Along with the decline in mortgage rates, actions we’ve taken to help improve overall affordability appear to be gaining traction. In alignment with our strategy to find price and turn our assets, we continue to implement programs that enable consumers to buy homes in today’s higher rate environment.

The cost of these programs which might include rate buydowns, lower lot premiums, or even price reductions can be seen in our higher Q4 incentives. In the fourth quarter, incentives increased to 4.3% of sales price. On a sequential basis, this is up from 2.2% on closings in the third quarter of 2022. Beyond just adjusting incentives in many of our active communities, we have already introduced smaller floor plans to help lower future prices and associated costs. The introduction of smaller floor plans is just part of a comprehensive effort to lower overall construction costs to help offset the pressure on sales price. The obvious question now is will this strengthening of demand continue? Like all of us on this call, I’ve heard strong arguments on both sides.

But the honest answer is that no one really knows. Home Builders are optimist by nature. And I want to believe that the Fed can orchestrate a soft landing, but the risk of a recession is real. We’re currently seeing buyers respond to lower rates, and better pricing. But what happens is fed actions weaken the employment picture is uncertain. With today’s volatile market dynamics, one of our frequent conversations with investors is around how Pulte plans to operate its business over the near-term. Given the long timelines associated with land development and home construction, we need to set a plan, but be prepared to adjust as market dynamics require. At a high-level, I’d like to share how we plan to operate the business for the foreseeable future.

At our core, we remain a build order builder, but our system operates best with a steady volume of production. As such, our plan for the — our plan is for a consistent cadence of new starts. This would include starting spec homes on a pace consistent with spec sales. We’ve shared on prior calls that in the current environment, buyers are showing a preference for homes that have near-term delivery dates. As an example, in the fourth quarter, spec sales represented over 60% of our new orders. Our recent sales show that we are finding the market clearing price using our strategic pricing tools to set price and incentives. Within today’s sales environment, we will be intelligent about the process as we optimize our production machine and turn through our land assets.

As always, our primary focus will be to deliver strong relative returns on invested capital through the cycle. In planning for 2023, we have assumed our current cycle time of 6-plus months will remain the reality for the next several months. Combining our planned starts, with our 18,000 homes currently in production, we expect to have a production universe that will allow us to close approximately 25,000 homes in 2023. We have goals in place to reduce cycle time, and our procurement and construction teams are already realizing success in cutting production days, but a lot of work remains to be done. Buyer demand will ultimately determine what the coming year looks like, but this is our operating plan. We see this as a prudent, balanced approach that checks key strategic boxes, namely; we maintain a level of production in our communities, which is critical when negotiating with local trades and suppliers.

We keep an appropriate level of specs in production while seeking to control finished inventory, and we continue to turn our assets, generate cash and position the business for the next leg of the housing cycle. Given today’s market dynamics, at this time, we will be providing guidance for our first quarter, but not the full year. In sharing our operational approach for 2023, we have hopefully conveyed a thoughtful process and conceptualize the opportunity we see for our business. Let me now turn the call over to Bob for a detailed review of our fourth quarter results.

Bob O’Shaughnessy: Thanks, Ryan, and good morning. PulteGroup completed the year by delivering a strong fourth quarter results, the benefits of which can be seen throughout our financial statements. In my analysis of the company’s operating and financial performance, I will review our reported numbers as well as our financials adjusted for the specific items Jim noted at the start of this call. PulteGroup’s fourth quarter home sale revenues increased 20% over last year to $5.1 billion. Higher revenues for the period were driven by a 3% increase in closings to 8,848 homes in combination with a 17% increase in average sales price to $571,000. The increase in average sales price in the quarter was driven by double-digit gains in pricing across all buyer groups.

Photo by Vita Vilcina on Unsplash

Our closings for the quarter came in above our Q4 guide as we benefited from higher spec sales that closed in the quarter and a faster-than-anticipated recovery in our Florida operations following the impact of Hurricane Ian. The mix of closings in the fourth quarter was 36% first-time buyers, 39% move-up buyers and 25% active adult. This compares with last year’s closings, which were comprised of 33% first time, 42% move-up and 25% active adult. The increase in first-time closings is consistent with changes in our mix of communities and the greater availability of spec homes in our first-time buyer neighborhoods. Our spec strategy emphasizes production within our Centex brand as almost 60% of spec units are in communities targeting first-time buyers.

In the quarter, we recorded net new orders of 3,964 homes, which is a decrease of 41% from the same period last year. The decline in orders for the period reflects the ongoing softness in buyer demand caused by the significant increase in interest rates realized in ’22 in combination with higher cancellations experienced in the period. As a percentage of sign-ups, the cancellation rate in the fourth quarter was 32% compared with 11% last year. Cancellations as a percentage of backlog at the beginning of the quarter totaled 11% in the fourth quarter this year compared with 4% in the fourth quarter last year. I would note that in the 4 years prior to the pandemic, quarterly cancellations as a percentage of beginning period backlog averaged 10%, so Q4 cancellations in relation to backlog were in line with historic norms.

In the fourth quarter, our average community count was 850, which is up 8% from an average of 785 last year. Community count growth reflects new community openings as well as the slower closeout of certain neighborhoods. Based on planned community openings and closings, we expect our average community count in the first quarter of ’23 to be flat sequentially or approximately 850 communities. For the remainder of ’23, we expect quarterly community count to be up 5% to 10% over the comparable prior year quarter. By buyer group, fourth quarter orders to first-time buyers decreased 28% to 1,574, while move-up demand was lower by 56% to 1,241 homes and active adult declined 36% to 1,149 homes. As has been widely discussed, housing demand remains under pressure as higher interest rates and years of price appreciation have stretched affordability for buyers.

We ended the quarter with a backlog of 12,169 homes with a value of $7.7 billion. This compares to the prior year backlog of 18,003 homes with a value of $9.9 billion. As Ryan discussed, our objective is to keep turning — keep inventory turning, which requires that we start an appropriate number of homes. In the fourth quarter, we started approximately 4,000 homes, which is down 50% from the fourth quarter of last year, and, on a sequential basis, down about 40% from the third quarter. We ended the fourth quarter with a total of 18,103 homes in production, of which 10% were finished. Of our total homes under construction, 43% were spec. This is slightly above our target of having specs comprised approximately 35% of our work in process, but given buyer preference for a quicker close, we are comfortable having a few more homes in production.

Based on our production pipeline, we currently expect to deliver between 5,400 and 5,700 homes in the first quarter of the year. As Ryan indicated, for the full year, we will have the production potential to close approximately 25,000 homes. These production numbers assume a continuation of current construction cycle times. Given the price of homes in backlog, the mix of homes we expect to close and the anticipated level of spec closings in Q1, we expect the average sales price for Q1 closings to be between $565,000 to $575,000. At the midpoint, this would be an increase of 12% over the first quarter of ’22. In the period, we reported gross margins of 28.8%, which remain near historic highs for the company. This represents an increase of 200 basis points over the comparable prior year period, although down sequentially from the 30.1% gross margin we delivered in the third quarter.

Looking ahead, we expect to deliver another strong quarter with Q1 gross margins of 27%, which includes the benefit of lower lumber costs due to the fall in lumber prices in the back half of ’22. Any savings from ongoing renegotiation of labor and material contracts will be realized in future quarters, and we will have to see how much of this work benefits our ’23 versus our ’24 closings. Our reported fourth quarter SG&A expense of $351 million, or 6.9% of home sale revenues, includes a net pre-tax benefit of $65 million from adjustments to insurance-related reserves recorded in the period. Exclusive of this benefit, our adjusted SG&A expense was $415 million or 8.2% of home sale revenues. In Q4 of last year, our reported SG&A expense of $344 million or 8.2% of home sale revenues included a net pre-tax benefit of $23million from insurance-related reserve adjustments .

Exclusive of that benefit, our adjusted SG&A expense was $367 million or 8.7% of home sale revenues. With the pullback in overall housing demand, we’ve worked hard to ensure our overheads are properly aligned with today’s tougher operating conditions. As such, we expect SG&A expense in Q1 to be in the range of 10.5%to 11% compared with 10.7% last year. In other words, even with lower closing volumes, we are in a position to realize overhead leverage that is comparable to ’22. Reported fourth quarter pre-tax income from our financial services operations was $24 million, down from $55million last year. The decline in pre-tax income reflects both lower profitability per loan and an overall decrease in loan origination volumes as mortgage capture rate declined by 10 percentage points to 75%.

In the fourth quarter, we walked away from 21,000 option lots and an associated $900 million in future land acquisition spend. As a result of these actions, we incurred a pre-tax charge of $31 million for the write-off of related pre-acquisition costs and deposits. This charge was offset by a pretax gain of $49 million in JV income associated with the sale of commercial property completed in the quarter. Our reported tax expense for the fourth quarter was $282 million, which represents an effective tax rate of24.2%. Our Q4 taxes included a $12 million charge associated with deferred tax valuation allowance adjustments recorded in the period. We expect our tax rate in the first quarter and for the full year in ’23 to be 25%. On the bottom line, our reported net income for the fourth quarter was $882 million or $3.85 per share.

On an adjusted basis, the company’s net income was $832 million or $3.63 per share. These results compared with prior year reported net income of $663 million or $2.61 per share, and adjusted net income of $637 million or$2.51 per share. Moving past the income statement, we invested $1.1 billion in land acquisition and development in the fourth quarter, with almost 65% of this spend for development of existing land assets. For the full year, we invested a total of $4.5 billion in land, including $1.9 billion of acquisition and $2.6 billion of development spend. Given recent decisions to exit certain option land positions, we ended the year with 211,000 lots under control, which is down 8% from last year and down 13% from the recent Q2 peak of 243,000 lots.

With the decision to drop option lot deals over the past two quarters, owned lots currently represent 52% of lots under control. As we’ve discussed on prior earnings calls, given the slowdown in overall housing activity, we plan to dramatically lower our land spend in 2023. At this time, we expect our total land investment to be approximately$3.3 billion, with an estimated 65% of these dollars going toward development of owned land positions. Along with investing in the business, we continue to allocate capital back to our shareholders. In the fourth quarter, we repurchased 2.4 million common shares at a cost of $100 million for an average price of $41.81 per share. PulteGroup continues to maintain one of the most active share repurchase programs in the industry, having repurchased 24.2 million shares of common stock in 2022, or almost 10% of our shares outstanding, for $1.1billion at an average cost of $44.48 per share.

In 2022, we returned over $1.2 billion to shareholders through share repurchases and dividends. After allocating capital to the business and our shareholders, we ended the quarter with $1.1 billion of cash and a net debt to capital ratio of 9.6%. On a gross basis, our debt to capital ratio was 18.7%, which is down from 21.3% last year. Now let me turn the call back to Ryan for some final comments.

Ryan Marshall: Thanks, Bob. For all the financial success that we realized in 2022, I can tell you it was a hard year to navigate. When the year started out, we had almost unlimited demand, but supply chain disruptions resulted in countless bottlenecks and extended build cycles. As the year progressed and rising interest rates push more and more consumers to the sidelines, we initiated a series of operational changes as we quickly adapted to the more competitive market conditions. If there is a silver lining in today’s challenging demand environment, I think we have what can be viewed as favorable supply — as a favorable supply dynamic. Recent figures from the National Association of Relators show the inventory of existing homes for sale at 970,000, or only 2.9 months of supply.

Existing homes are our industry’s biggest source of competition, so such limited supply is certainly advantageous. As we sit here today, I’m incrementally more optimistic about the year ahead, but as the expression goes, hope for the best, but prepare for the worst. I think what we’ve done — well, I think that we’ve done that in terms of how we’ve setup our business. We head into 2023 with enough units in production to meet demand and with production plans will allow us to continue turning assets. At the same time, we don’t have an excess of spec homes in the system that will cause incremental self-inflicted pressures. We are in a strong competitive position within the markets that we serve. We are typically among the biggest builders in our markets, and our ability to serve all price points provides opportunities with land sellers and municipalities.

And finally, we are in exceptional financial position with plenty of liquidity, no debt maturities for 3 years and expectations for another year of strong cash flow. There are opportunities to be seized upon even in challenging market conditions. When the time comes, PulteGroup will have the flexibility to take advantage of those opportunities. I will close by again thanking the entire PulteGroup organization for their work this past year to build outstanding homes and to provide an exceptional customer experience. Let me now turn the call back to Jim Zeumer.

Jim Zeumer: Thanks, Ryan. We are now prepared to open the call for questions so we can get through as many questions as possible during the time remaining. We ask that you limit yourself to one question and one follow-up. Devin, if you will open it up for questions, we are all set.

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Q&A Session

Operator: Our first question comes from John Lovallo with UBS.

John Lovallo: Good morning, guys. Thank you for taking my questions. The first one is, can you just give us an idea of the margin on quick move-in homes compared to the company average?

Bob O’Shaughnessy: Yes. It’s interesting. It depends, and I hate to give you the mix, but geographically, it makes a difference. Obviously, we are going to see stronger performance in markets where we are seeing stronger sales activity, I think the Southeast of Florida, specs out West are a little bit more challenged. So it really does matter where. On balance, we’ve seen — interestingly, if you think about our Q4 guide for margins, we outperformed it. Part of that was that geographic mix. We’ve talked about getting more volume out of Florida which is one of our better margin performances, but also because of the relative strength of spec sales, we did a little bit better on those than we anticipated when we gave the guide.

John Lovallo: Got you. Okay. And then it was the commentary on demand getting better through the quarter and into January was interesting and encouraging. Can you just give us an idea of how broad based that demand was? I mean, was it limited to certain markets? Or was it pretty much across your footprint?

Ryan Marshall: John, the improvement really came across the footprint on a relative basis. Speaking geographically, we continue to see strength in Florida and the Southeast. As Bob just highlighted in the last answer, we continue to see great performance out of the Texas markets. And probably one of the more encouraging signs that we’ve seen as we started to see our Western markets, Phoenix, Las Vegas, Southern California, Northern California, we started to see those markets come back to life. So kind of broad based improvement across the footprint.

John Lovallo: Great. Thanks a lot guys.

Jim Zeumer: Thanks, John.

Operator: Our next question comes from Truman Patterson with Wolfe Research.

Truman Patterson: Hey, good morning, guys. Thanks for taking my questions. First question, you have lower lumber costs beginning to flow through the P&L and perhaps some other stick and brick cost savings. We also have likely higher land costs and perhaps some uncertainty around pricing. I’m hoping you can help us think through first quarter gross margins. Do you think it will be likely the low point for the year given the kind of sequential improvement in demand that you’ve seen?

Ryan Marshall: Truman, I think you’ve highlighted the variables that are out there. And at this point in time, we’ve given a guide for Q1. And as I mentioned in my comments, that’s the extent of kind of what we are going to provide at this point.

Truman Patterson: Okay. Got you. Understood on that. And how are tertiary submarkets within metros performing relative to closer end communities maybe in entry-level move-up segments? I’m thinking that the prior remote worker or work-from-home tailwinds might be leveling off here, which might negatively impact the tertiary markets, but at the same time, affordability is a bit squeezed and the tertiary markets provide a better value proposition.

Ryan Marshall: Well, Truman, I think, as we’ve talked about with our land acquisition strategy over the years, we’ve attempted to stay closer into the core, closer to the job market in some of the retail sectors. We certainly have a sizable first time entry-level buyer business and affordability there matters. So we do have communities that are more in the growth rings and on the — in the tertiary areas, but I don’t believe that our land footprint goes out quite as far as maybe some of our competitors. So what I’d tell you is it kind of depends on — it’s a community-by-community situation that is, as much as anything, from a margin standpoint, dependent on the structure of the land deal. And like, I think, you’ve heard from us in a lot of situations, we don’t underwrite the gross margin, we really focus on underwriting to return.