Taylor Morrison Home Corporation (NYSE:TMHC) Q3 2023 Earnings Call Transcript

Taylor Morrison Home Corporation (NYSE:TMHC) Q3 2023 Earnings Call Transcript October 25, 2023

Taylor Morrison Home Corporation beats earnings expectations. Reported EPS is $1.57, expectations were $1.52.

Operator: Good morning. And welcome to Taylor Morrison’s Third Quarter 2023 Earnings Conference Call. Currently, all participants are in a listen-only mode. Later we will conduct a question-and-answer session, and instructions will be given at that time. As a reminder, this conference call is being recorded. I would now like to introduce Mackenzie Aron, Vice President of Investor Relations. Please go ahead.

Mackenzie Aron: Thank you, and good morning, everyone. We appreciate you joining us today. Before we begin, let me remind you that this call, including the question-and-answer session, will include forward-looking statements. These statements are subject to the Safe Harbor statement for forward-looking information that you can review in our earnings release on the Investor Relations portion of our website at taylormorrison.com. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include but are not limited to those factors identified in the release and in our filings with the SEC and we do not undertake any obligation to update our forward-looking statements.

In addition, we will refer to certain non-GAAP financial measures on the call, which are reconciled to GAAP figures in the release. Now, I will turn the call over to our Chairman and Chief Executive Officer, Sheryl Palmer.

A worker hammering a nail into the frame of a single-family home under construction. Editorial photo for a financial news article. 8k. –ar 16:9

Sheryl Palmer: Thank you, Mackenzie, and good morning, everyone. Joining me is Curt VanHyfte, our Chief Financial Officer; and Erik Heuser, our Chief Corporate Operations Officer. I will briefly cover this quarter’s performance and then discuss the strategy behind our balanced operating model, which we believe is critical to our success in the current housing environment. After, Erik will discuss our healthy land portfolio and investment strategy, while Curt will review our financial results and guidance metrics. In the third quarter, our team once again achieved strong results, including the delivery of over 2,600 homes at a better-than-expected adjusted home closings gross margin of 23.9%. At the same time, we flexed each of our capital allocation priorities to increase our land investment, retire debt outstanding and repurchase our shares, all while ending the quarter with a significant liquidity position of $1.6 billion.

In total, this drove a 21% year-over-year increase in our book value per share to a new high of nearly $47. Our core performance was healthy with margins and returns remaining well above our historic norms given the meaningful enhancements to our operating model over the last several years that we believe will continue to drive enhanced long-term performance. However, at the same time, it is important to recognize that this quarter reflected the temporary impact of last year’s slower starts and sales activity, and compared to record profitability achieved this time last year. We also acknowledge that the rapid reacceleration in interest rates in September has once again injected some hesitation into the market and drove a moderation in sales momentum that has continued into October alongside typical seasonal slowing.

As I will spend some time discussing the strength of our diversified consumer strategy and balanced product portfolio better equips our homebuilding and financial services teams to effectively manage these headwinds. As a result, I am pleased that despite the challenges we are once again raising our full year guidance for home closings and adjusted home closings gross margin as Curt will discuss. The resiliency of our business is a function of our diversification across buyer groups, emphasis on high quality community locations and return-focused investment strategy that has been years in the making. Our portfolio meets buyer demand across entry-level, move-up and resort lifestyle consumers, with the necessary local and national scale to compete effectively.

By Consumer Group, our third quarter net sales orders were comprised of our move-up category at 43%, our entry-level segment at 35% and resort lifestyle at 22%. With different needs and preferences among these consumer sets, this approach allows us to operate both a spec and to-be-built operating model with our spec business largely serving our entry-level and first move-up buyers, while our to-be-built homes are most prevalent in our second move-up and resort lifestyle communities. Approximately 55% of our third quarter sales were for our spec homes, while the other 45% were to-be-built orders, similar to recent quarters. This balanced community-driven approach provides several important advantages. Our spec protection offers cost-efficient consistency and repeatability that drives affordable just-in-time offerings for our entry-level buyers, while our to-be-built business generates outsized high margin revenue when buyers pay a premium to personalize their home on their desired lot.

This two-pronged production approach also improves our starts cadence, expands our land investment opportunities and minimizes portfolio risk. Overall spec and to-be-built homes, the strong utilization of our nationally managed Canvas option packages further streamlines our purchasing and construction processes without sacrificing option revenue. In addition to these production advantages, our consumer diversification is strategically critical, especially in the current environment, because each of these groups respond differently to interest rate volatility. On one hand, rate and affordability concerns are least acute for our resort lifestyle and second move-up buyers as they typically have significant financial flexibility. In fact, the vast majority of our 55-plus buyers pay all cash at a rate that is 3 times higher than younger buyers.

Their financial strength is also evident in our sizable third quarter lot premiums and option revenue, which averaged nearly $110,000 in total and can contribute up to a several hundred basis point advantage for to-be-built gross margins compared to our spec margins. This is consistent with the long-term premium commanded by to-be-built sales prior to the pandemic that we expect will persist going forward. On the other hand, our entry-level and first move-up communities benefit from a deep demand pool that we expect will continue to grow in coming years alongside household formation, but with much greater sensitivity to pricing that often requires outsized incentives. Ultimately, both ends of the buyer spectrum are important to our long-term success and we aim to serve each of our targeted Consumer Groups with appropriate product offerings, pricing and incentive tools and an exceptional customer experience.

Let me share a bit more color on the sales front. During the quarter, our net sales orders increased 25% year-over-year, driven by a monthly absorption pace of 2.7 per community, as compared to 2.1 a year ago. This healthy demand allowed us to raise pricing in approximately 60% of our communities. It’s worth sharing that 15% of our third quarter sales originated from online reservations at an outsized 45% conversion rate. By months sales were healthy and consistent in July and August at healthy paces. However, alongside normal slower seasonal patterns, the rapid rise in rates in September drove a moderation in sales momentum that has continued into October, as would be expected with this magnitude of rate volatility. In this current environment, our longstanding strategic prioritization of finance incentives is even more critical to our sales strategy.

As you have heard me discuss before the benefit to our home buyer from finance incentives outweighs that of a price reduction by nearly 4:1 for our typical home. While we will also adjust pricing and other incentives as necessary to maintain appropriate sales paces in each of our communities, this finance first strategy better protects our gross margins, community values and consumer confidence, while also further differentiating our value versus resale homes in today’s inventory constrained market. There are a number of ways we leverage our finance incentives to best serve each borrower. One way is by providing closing cost assistance, which we have typically offered to most borrowers to offset various transaction costs. More recently, over the last several quarters, we have expanded our incentive programs with the purchase of forward commitment below market interest rates.

These rates can be used on spec homes with move-in dates, as well as with to-be-built homes when combined with an extended rate lock for up to one year offering permanent interest rate security. If rates improve during the build cycle, we offer a free float in. And lastly, we can utilize our incentives to provide temporary interest rate buydown, allowing borrowers to ease into home ownership, while still having the confidence that they qualified at the permanent note rate of a below market fixed rate mortgage. These incentives can be combined as needed to optimize our effectiveness and we are highly targeted with how we leverage these tools to meet each borrower’s unique circumstances and based on its community sales strategy. Generally, our entry-level and first move-up communities prefer rate buydowns to aid affordability.

As a result, in the third quarter, while only 18% of our closings utilized a forward commitment and outsized 50% of those were first-time buyers. On the other hand, our second move-up and resort lifestyle buyers, which as I highlighted earlier are much less reliant on financing tend to favor closing cost assistance and other concessions to minimize upfront cash out of pocket. In total, we tend to attract well-qualified consumers even among our first-time homebuyers. To illustrate, in the third quarter among our buyers financed by Taylor Morrison Home Funding, which achieved an all-time capture rate of 88%, credit metrics remained excellent. Borrowers had an average credit score of 753, provided average down payments of 24% and an average household income of nearly $180,000.

This strength extends to our backlog where customers are secured with average deposits of more than $62,000 or about 9% per home, providing critical financial commitment that minimizes cancellation risk. In addition, our financial services team has thorough pre-qualification standards and is diligent in locking in our backlog buyer’s interest rate to further reduce risk and provide confidence during the build cycle. Equipped with all of these compelling programs, we are well positioned to navigate the headwinds from today’s higher interest rates and macro uncertainty. To wrap up, let me once again reiterate that our strategy will remain focused on serving our buyers with appropriate product offerings, pricing and incentives, and an exceptional customer experience.

We are focused on capitalizing on the benefits of both spec and to-be-built projection driven by the needs of our targeted Consumer Groups. Together, the exceptional quality of our buyers, the location of our communities and ability to use powerful finance incentives to overcome interest rate headwinds enables our business to be resilient. Our experienced and dedicated team members are focused on continuing to drive smart, accretive growth and we will remain nimble in our operating decisions as we move into the new year, supported by significant liquidity and a healthy committed backlog. With that, let me turn the call to Erik.

Erik Heuser: Thanks, Sheryl, and good morning. Our land investment approach is focused on achieving capital efficient accretive growth in markets that are well-positioned to benefit from long-term demand drivers and meet the needs and preferences of our well-balanced consumer sets. At quarter end, we owned and controlled approximately 74,000 homebuilding lots. This represented 6.1 years of total supply. With 42% of these lots controlled via options and other off-balance sheet structures, our supply of owned lots was 3.5 years. When underwriting new deals we evaluate duration risk and long-term return potential to determine the optimal financing vehicle for each asset, weighing the capital efficiency of off-balance sheet financing with the cost of that optionality.

With a strong balance sheet and multiple financing tools available, we will continue to balance our owned and controlled lot inventory within our targeted ranges. In the third quarter, we invested $320 million in homebuilding land acquisition and $232 million in development for a total of $552 million. Year-to-date, our total land investment has been approximately $1.3 billion, leaving us on track to invest around $1.8 billion for the full year, as compared to $1.6 billion in 2022. Looking ahead, we expect to further increase our land investment in 2024 with an initial projection of total spend of approximately $2 billion based on our robust deal pipeline. For new lot acquisitions, we are primarily focused on providing home closings for 2027 and beyond, as we are either fully subscribed or on track for the next three years.

This provides us with significant flexibility on the land acquisition front. On the development side, our priority is continuing to convert our attractive existing land portfolio into new community openings to support future growth. In addition to this growth, we are equally focused on the efficiency of our new communities. As we have shared previously, we have increased the average size of our underwritten communities by approximately 50% in recent years, allowing us to magnify our scale with a like level of resources. As an illustration of this pivot and impact, we can share that in Houston, for example, we have reduced our outlet count by half since 2018, while driving greater autonomy through self-developed larger communities, as well as paces that are significantly higher.

Ultimately, we are driving for greater overhead leverage and returns here in Houston and across the business. And this is just one example of strategic shifts across our portfolio that are supporting our long-term annualized sales pace goal in the low 3 range. With that, I will turn the call to Curt.

Curt VanHyfte: Thanks, Erik, and good morning, everyone. In the third quarter, our adjusted net income was $180 million or $1.62 per diluted share. Including an inventory impairment and charge related to our early debt redemption, our reported net income was $171 million or $1.54 per diluted share. During the quarter, we delivered 2,639 home closings at an average closing price of $611,000, which produced total homebuilding revenue of $1.6 billion. This was down from $2 billion a year ago. Cycle times for homes closed improved meaningfully in the third quarter with a nearly eight-week sequential reduction driven by clearing of older backlog homes and improvement in many of our trade categories. This faster-than-expected normalization in most markets helped to offset hurricane related closing delays in Florida.

While back-end construction schedules remain somewhat extended due to tight labor capacity, we are encouraged by the normalization we have experienced, especially in this year’s new starts. As a result of this improvement, we now expect to deliver approximately 2,950 homes in the fourth quarter. This would drive a full year total of around 11,250 homes, as compared to our prior full year guidance range of approximately 11,000 homes. We continue to expect the average closing price of these deliveries to be around $625,000 for the full year, including approximately $615,000 for the fourth quarter. Our teams are focused on managing starts to align with sales plus targeted inventory levels on a community-by-community basis. At quarter-end, we had about 2,700 spec homes available of which only 280 were finished, with a skew towards our entry-level communities, where first-time buyers prefer quick move-in homes.

We started approximately 2,800 homes during the quarter, equaling 2.9 starts per community per month, which was down from 3.5 in the prior quarter but up from 1.5 a year ago. As a result, we ended the quarter with about 8,100 homes under production. During the quarter, our adjusted home closings gross margin of 23.9% exceeded our guidance due to favorable mix and less incentive cost pressure. Including a $12 million inventory related charge tied to one legacy community in the west facing a scope change due to municipal requirements, our reported home closings gross margin was 23.1%. For the fourth quarter, we expect our home closings gross margin to be around 23%. The sequential moderation reflects an increase in expected incentives on spec homes sold and closed during the quarter due to the recent increase in interest rates.

This would result in a full year adjusted home closings gross margin of around 23.7%, up from our prior guidance of approximately 23.5%. Turning to financial services, our team produced revenue of $40 million at a gross margin of 42.2%, aided by an all-time high capture rate of 88%. This was up from $28 million and 26.5%, respectively, a year ago. As Sheryl noted, our net orders in the quarter increased 25% year-over-year to 2,592 homes, driven by a 26% increase in our monthly absorption pace to 2.7 per community and a flattish ending community count of 325 outlets. As we look ahead, we continue to expect our community count to be between 320 and 325 at year-end. Cancellation rates remain consistent with long-term norms at 11.4% of gross orders versus 15.6% a year ago.

Taking a step back, year-to-date through the end of the quarter, our monthly sales pace averaged 2.9 per community. As we shared last quarter, going forward, we are targeting an annualized absorption rate in the low 3 range as compared to our historical low-to-mid 2s. The increase is a function of the shift in our community mix and geographic footprint as we have positioned our portfolio for higher long-term returns. SG&A as a percentage of home closings revenue was 10.4%. For the year, we are still forecasting an SG&A ratio in the high 9% range. To wrap up, we ended the quarter with a total liquidity position of approximately $1.6 billion. This included $614 million of unrestricted cash and $1.1 billion of available capacity on our revolving credit facilities, which remain undrawn outside normal course letters of credit.

Our homebuilding net debt to capitalization ratio was 18.8%, as compared to 34% a year ago. During the quarter, we redeemed the full $350 million outstanding principal amount of our 5.625% 2024 senior notes. As a result, our next Senior Note maturity is not until 2027, leaving us with a significant runway ahead. Since 2020, we have repaid approximately $1.8 billion of senior debt, driving a significant reduction in our net capitalization from 46.8% in the first quarter of 2020 as we have successfully executed our post-acquisition debt reduction strategy. In total, these payments have reduced our annual interest expense by about $105 million. Due in part to these ongoing efforts to fortify our balance sheet along with strong operating momentum, we are pleased to have recently received an upgraded credit rating from S&P Global to BB+ from BB with a stable outlook.

And lastly, during the quarter, we spent $100 million on share repurchases. Since 2020, we have deployed approximately $865 million to repurchase our shares, reducing our diluted share count by about 33 million or approximately 30%, driving higher earnings per share and returns for our shareholders. At quarter end, we had $176 million remaining on our repurchase authorization. Going forward, we expect to maintain our disciplined and opportunistic capital allocation framework as we evaluate our main priorities of investing for future growth, maintaining strong liquidity and balance sheet health and returning excess capital to shareholders. Now I will turn the call back over to Sheryl.

Sheryl Palmer: Thank you, Curt. As we have discussed, the third quarter was healthy despite the headwinds from last year’s slower activity and the interest rate pressure that unfolded during the quarter. As we head into year end, there are many factors at play complicating what is always a high volume push for the industry to deliver homes to customers and ready inventory for the coming spring selling season. The sharp spike in interest rates over the last two months has once again pushed affordability to unsustainable levels for many buyers, especially at the entry-level and is weighing on buyer confidence and urgency even among some with the financial ability to move forward. With uncertainty around the Federal Reserve, a wider-than-normal spread between mortgage and treasury yields and significant headline noise, I expect that these issues will evolve and stabilize when there is greater clarity on the Fed’s timing of any future actions.

Nevertheless, I am confident that our balanced consumer-driven portfolio and experienced dedicated team at Taylor Morrison is well positioned to excel during these market disruptions as is evidenced by our increased guidance for the year. While the near-term outlook is somewhat cloudy, the intermediate to longer term opportunity for housing and Taylor Morrison remains clear. Our country is significantly undersupplied and there is an undeniable need for new construction based on the aging evolution of younger generations to meet the needs of today and tomorrow’s consumers. At the same time, we will be working to solve for the current multi-million rooftop deficiency that exists in our country today. Thank you to all of our team members for another great quarter.

Before we wrap up, I would be remiss not to share that Taylor Morrison was recently awarded two brand new accolades which are a testament to our talented and dedicated team. The first comes from Newsweek 2024’s America’s Greenest Companies where we were included among just 300 U.S. companies recognized for progress in positively changing its sustainability footprint. The second comes from U.S. News & World Report, where we were included on the publication’s inaugural Best Companies to Work For list. With that, let’s open the call to your questions. Operator, please provide our participants with instructions.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question comes from the line of Carl Reichardt with BTIG. Carl, please go ahead. Your line is now open.

Carl Reichardt: Thanks. Good morning, everybody. Sheryl, I wanted to ask…

Sheryl Palmer: Good morning.

Carl Reichardt: …a question about buyer hesitancy. So is your sense that some consumers are hesitant because they are concerned not about the mathematics of home prices, but a fear that home prices might come in? Read headlines, they see a lot of conversation about this topic in the press and I am just curious if that’s something you are hearing from your consumers right now?

Sheryl Palmer: Good morning, Carl. Thanks for the question. That’s not what we are hearing. We are hearing that there’s this overall just, there’s a lot going on right now, there’s a lot of attention around what’s happened to interest rates, the way the media is portraying that, and honestly, the impacts it has on true affordability when you look at the difference of where we were a year or two ago. So I don’t think it’s specifically that they feel that prices are going to drop. I think actually at some level, Carl, it’s the opposite, because inventory is so tight that I don’t think they are expecting that they are going to see — that we are going to see a reduction in pricing overall. Once again, I think, it’s as much around just general affordability for that first-time buyer, and as I said in my prepared remarks, though, it’s a very deep pull.

So we are seeing the traffic, we are seeing demand. It’s just working with customers to get them qualified. And then when you look at the other consumers, I think, they are being appropriately diligent in understanding what choices are and what’s happening. When I look at our October trends, you know, we are still up. I expect we will still be up considerably year-over-year, but to say that it’s the same that we saw, from the kind of early summer when rates were in the mid-6s versus 8, I think, would be unfair.

Carl Reichardt: Okay. Thanks for that. I appreciate that. And then, secondly, I was interested in the SG&A line, and as you look going forward, we have talked before about overall initiatives to improve asset turns at Taylor Morrison and construction times. Can you talk a little bit about the fixed cost side SG&A? How you are feeling about how that’s laying out and what you might see in terms of long-term ability to improve that ratio as you go? Thanks.

Curt VanHyfte: Yeah. Good morning, Carl. How are you?

Carl Reichardt: Good.

Curt VanHyfte: Carl, I can attack that for you a little bit. SG&A, I think, historically, has always been roughly about — the G&A side of it has always roughly been about half of our SG&A in total. So that’s something we look at, a lot of its driven by kind of our fixed costs with our people, office facility, those types of things and we are always looking at ways to kind of monitor and evaluate those costs on a go-forward basis. The bigger question for us is on the kind of the variable side, which is kind of where we are up a little bit year-over-year and that was in large part due to our commissions — our external commissions, while our broker kind of cooperate as consistent over time, it’s just that we are paying a little bit more now today than we were a year ago for every transaction, and then, of course, we had a little bit more from a marketing standpoint relative to adjusting to kind of the conditions of the market today.

Carl Reichardt: That makes sense. Thanks very much. Appreciate it guys.

Sheryl Palmer: Thanks, Carl.

Curt VanHyfte: Thanks, Carl.

Operator: Our next question comes from Paul Przybylski with Wolfe Research. Please go ahead, Paul. Your line is now open.

Paul Przybylski: Thank you. I guess to start off, I mean, I appreciate the demand commentary. I was wondering if you could provide us maybe the monthly cadence of absorptions through the third quarter into October?

Sheryl Palmer: Yeah. Good morning, Paul. July was good. August was even stronger, which is honestly quite unusual when I look kind of historically at the numbers. September was not far off of August, but we definitely saw a tiny pullback in September. So cadence was pretty steady with August being the peak. And as we have moved into October, as I have said, we are still, I think, from a historical perspective, from a seasonal perspective, things are still looking really nice and we are seeing good traffic and sales. It’s just I can feel the difference from what we saw earlier in the summer.

Paul Przybylski: Okay. I guess, as you look at your traffic, any color maybe on the percent of traffic that’s not qualifying versus maybe the second quarter and a year ago?

Sheryl Palmer: That’s an interesting question. I mean, our traffic year-over-year for the quarter was up. I would tell you that our conversions, when I look at like our conversions, for example, on our web, they are higher. When I look at conversions on like our chatbot, they are higher. When I look at our reservations, they are higher. I think what I really want people to take away is, once again, on that first-time buyer pool, it’s deeper, it just takes — it used to take a 5:1 to get a conversion, I would say in today’s environment, it’s 7:8:1. Once again, that’s going to depend on community and market. But we have the tools that are helping our buyers, even in today’s environment kind of withstand the challenges that have been brought by interest rates and pricing, and just kind of the overall inflationary environment. But it just takes a few more, certainly on that first-time buyer.

Paul Przybylski: Okay. Thank you. I appreciate that color.

Sheryl Palmer: Thanks, Paul.

Operator: Our next question comes from the line of Matthew Bouley with Barclays. Matthew, please go ahead. Your line is now open.

Anika Dholakia: Good morning. You have Anika Dholakia on for Matt. Thanks for taking my question. So, first off, wonder if you can provide a little more color on the Buy Build Secure program? Specifically, how are consumers considering this versus other incentives? And then how does this differ from the buydowns you guys are currently offering, and then more specifically, how large of an impact on margins? Thanks.

Sheryl Palmer: Yeah. Thank you for the questions. What I really obviously was trying to get across in our prepared remarks was the power of our incentives and how necessary they are when you compare to 2021 rates of about 3% and what we are seeing in today’s market of 8%. So if I run through the programs quickly for you, without going into too much detail, about 94% of our closings in the quarter had some sort of discount points paid by either the buyer or seller. That number is not really any different than what you would have seen historically, maybe somewhat influenced by the percentage of cash because really everyone that’s got a mortgage, we are helping in some way and on those discount points the average was probably just under about 2.5%.