PulteGroup Inc (PHM) — Q4 2022 Earnings Call Transcript

Great. Good morning, Devin. Good morning, and thank you, Devin. I 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. 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 certain items. 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. 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 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?

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 helped PulteGroup finish the year with over $1 billion in cash and a net debt-to-capital ratio below 10%. 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 through dividends and share repurchases. I want to thank our entire organization for their efforts in delivering such 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 the gains in volume, pricing, gross margin, and earnings reflect the stronger demand environment that existed earlier in the year. As we all know, the Federal Reserve's decision to hike rates seven times in 2022 is 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 is due to consumers being priced out of the market by higher prices and higher mortgage rates, along with individuals who have moved to the sidelines due to 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 into January. We'll have to see how things progress from here, but I think this improvement shows the ongoing desire for homeownership that exists in this country. Net sign-ups, both in absolute numbers and absorption pace, increased as we moved through each month of the fourth quarter and into 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'd 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 purchase 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. 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 introduced smaller floor plans to help lower future prices and associated costs. The introduction of smaller floor plans is part of a comprehensive effort to lower overall construction costs to help offset the pressure on sales price. The obvious question now is whether this strengthening of demand will continue? Like many on this call, I've heard strong arguments on both sides. But the honest answer is that no one really knows. Homebuilders are optimistic by nature. And I want to believe that the Fed can orchestrate a soft landing, but the risk of recession is real. We're seeing buyers respond to lower rates and better pricing. But how Fed actions might 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-to-order builder, but our system operates best with a steady volume of production. Our plan is for a consistent cadence of new starts, including 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 prices and incentives. Within today's sales environment, we will be intelligent about our process as we optimize our production machine and turn through our land assets. 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 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: we maintain production in our communities, which is critical when negotiating with local trades and suppliers; we keep an appropriate level of specs in production while managing 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 dynamics, we will be providing guidance for our first quarter but not the full year. In sharing our operational approach for 2023, we hope to convey a thoughtful process around 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.

Thanks, Ryan, and good morning. PulteGroup completed the year by delivering strong fourth quarter results, the benefits of which can be seen throughout our financial statements. In my analysis, 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 average sales price increase was driven by double-digit gains in pricing across all buyer groups. Our closings for the quarter came in above our Q4 guidance as we benefited from higher spec sales that closed in the quarter and a faster-than-anticipated recovery in our Florida operations following 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 to 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 community mix 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 fourth quarter, we recorded net new orders of 3,964 homes, down 41% from the same period last year. The decline in orders reflects ongoing softness in buyer demand caused by a significant increase in interest rates in 2022, along 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 to 4% in the fourth quarter last year. In the four 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, 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 Q1 of '23 to be flat sequentially at approximately 850 communities. For the remainder of '23, we expect quarterly community counts 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. 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 valued at $7.7 billion. This compares to the prior year backlog of 18,003 homes with a value of $9.9 billion. Our objective is to keep inventory turning, which requires that we start an appropriate number of homes. In the fourth quarter, we started approximately 4,000 homes, 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 slightly exceeds our target of having specs comprise approximately 35% of our work in process, but given buyer preferences for quicker closes, we are comfortable having a few more homes in production. Based on our production pipeline, we 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 and $575,000. At the midpoint, this would be an increase of 12% over the first quarter of '22. We reported fourth quarter 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 but is 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 a fall in lumber prices in the back half of '22. Savings from ongoing renegotiation of labor and material contracts will be realized in future quarters. 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 $23 million from insurance-related reserve adjustments. We expect SG&A expense in Q1 to range from 10.5% to 11% compared with 10.7% last year. Even with lower closing volumes, we are in a position to realize overhead leverage comparable to '22. Reported fourth quarter pre-tax income from our financial services operations was $24 million, down from $55 million last year. The decline in pre-tax income reflects both lower profitability per loan and an overall decrease in loan origination volumes as the 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. This resulted in a pre-tax charge of $31 million for the write-off of related pre-acquisition costs and deposits, 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, representing an effective tax rate of 24.2%. 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%. 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 the 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, 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 the 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 $1.1 billion at an average cost of $44.48 per share. 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 in cash and a net debt-to-capital ratio of 9.6%. On a gross basis, our debt-to-capital ratio was 18.7%, down from 21.3% last year. Now let me turn the call back to Ryan for some final comments.

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 pushed 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, it's that we have what can be viewed as a favorable supply dynamic. Recent figures from the National Association of Realtors 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 we’ve set up our business accordingly. We head into 2023 with enough units in production to meet demand and with production plans that will allow us to continue turning assets. At the same time, we don't have an excess of spec homes in the system that could cause undue 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. Finally, we are in an exceptional financial position with plenty of liquidity, no debt maturities for three 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’ll close by 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.

Thanks, Ryan. We are now prepared to open the call for questions so we can get through as many 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.

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

Yes, it's interesting. The impact varies geographically, and while I don't want to get too technical about the mix, performance differs based on location. We are expecting stronger results in areas with higher sales activity. The Southeast and Florida are performing well, while markets out West face more challenges. Overall, it's significant where we are operating. Interestingly, our Q4 margin guidance was exceeded, partly influenced by geographic mix. We've discussed increasing volume from Florida, which contributes positively to our margin performance.

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 give us an idea of how broad-based that demand was? Was it limited to certain markets? Or was it across your footprint?

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 highlighted in the last answer, we continue to see great performance out of the Texas markets. And probably one of the more encouraging signs we've seen is that we started to see our Western markets, Phoenix, Las Vegas, Southern California, Northern California, come back to life. So it's a broad-based improvement across the footprint.

Great. Thanks a lot, guys.

Thanks, John.

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 the low point for the year given the kind of sequential improvement in demand that you've seen?

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. As I mentioned in my comments, that's the extent of what we are going to provide at this point.

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.

Well, Truman, as we've discussed 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 where affordability matters. So we do have communities that are more in the growth rings and 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 it depends on the community situation that is, as much as anything, from a margin standpoint, dependent on the structure of the land deal. And like you've heard from us, we don't underwrite the gross margin, we really focus on underwriting to return. But we've seen relative strength and improvement in kind of sales across the board that’s not just geographically speaking, but community by community as well.

Perfect. Thank you all for the time.

Thanks, Truman.

Hey, guys. Good morning. Nice execution, and thanks for the time here. Ryan, just on the margin, I know you're not guiding beyond Q1, but I'm just curious if you could talk through a little bit. When I compare you to some of your larger competitors, your margins right now are outperforming by a pretty wide level—400, 500 basis points. Could you talk a little bit about whether that’s a timing issue or if there's something you're doing that is resulting in that outperformance, in your opinion?

Yes, Alan, thanks for the question. I think, for those that have followed us, I think you are aware that we've implemented several important changes in how we operate our business, which has driven higher returns over the housing cycle, and certainly, higher margins have been part of that. Those initiatives have touched everything from our home and community design to how we price and sell homes, with the quality of the dirt that we're buying being key. I think you're seeing that pay off. I think you're certainly seeing that pay off. We've highlighted on this call, in my prepared remarks, how we plan to run the business in this tougher operating environment. It's essential to turn inventory to achieve good flow-through and to find a market-clearing price. While we believe our operating model is strong and beneficial, we won't be immune to some market pressures. We think we're an efficient homebuilder and will continue to be disciplined in pricing decisions.

Great. I appreciate all the thoughts there. Second question on the cost side. Can you share your current thinking on the lumber costs rising 40% year-to-date? Does that change your outlook on managing costs—and are you still able to renegotiate for lower costs?

It's going to be tricky. We've talked a lot about affordability being the biggest challenge we've experienced over the last several quarters. And affordability is going to continue as a theme through 2023, not just in housing but in all consumer spending. Consumers are feeling that affordability pinch, and that’s why we've worked hard to find prices that help address some of that. We've seen positive reception from our trade partners as there's a slowdown in new starts and permits pulled. We've collaboratively discussed consumer feedback with them. Meanwhile, labor costs seem likely to be more rigid despite lumber prices being more fluid, so we’ll focus on efficiencies.

If the lumber price continues to increase, how might that timeline impact your margins?

Yes. Our lumber load was down about $10,000 from deliveries. Q1 will have that benefit in it. Lumber pricing typically impacts our income statement two or three quarters later with commodity fluctuations, so it’s an important aspect we’ll keep monitoring as the year goes on.

Thanks. Good morning, everyone. I wanted to circle back to the gross margins in the fourth quarter and the first quarter guide. Your historical gap of gross margins was historically around 200 to 250 basis points; now it is more than double. Are there any factors contributing to that gap? Are you seeing short-term actions or unusual items helping your gross margins?

There's nothing unusual happening in our margins for the fourth quarter. We're not projecting unusual events for Q1 other than what we’re closing.

Correct. There is no unusual circumstance; we’re focused on price competitiveness.

I appreciate that. One last quick question regarding lumber costs. You mentioned being impacted by price increases. When would that potentially be a challenge to your margins, say second half of the year?

Yes.

Thanks. Good morning, everybody. Regarding the closing mix you mentioned—36% first-time buyers, 39% move-up, and 25% active adult. Is your expectation for '23 on the 25,000-unit guide to differ significantly from that mix?

I wouldn't call it a large shift. Our spec inventory is largely in our first-time communities, so that's where the activity is today.

On active adult, how has that business trended over the last few months given that customer is more likely to pay cash?

The active adult segment has been able to sell their homes, arguably at pretty good prices, but they might be more patient compared to the first-time buyer. So overall, we feel good about the active adult space.

Good morning. When we look at net order ASP, down 5% quarter-over-quarter. Can you break that out between incentives-based price reductions and any mix shifts that you saw?

Anthony, we haven't provided that, so we are not going to break it out at this point. However, it’s fluid. Discounts sometimes roll into base pricing. On average, we’ve been buying land for 3 to 4 years in addition to development timelines. Therefore, pre-pandemic land will begin moving through the system now. Regarding impairment risk, we do impairment reviews quarterly and will adjust as necessary based on individual community performance.

Good morning, thanks for taking my questions. Can you clarify the increase in customer incentives, and what's your current incentive load on orders?

Incentive load increased to 4.3%, which is almost double. However, embedded price changes are happening as well.

Can you provide details on sales progress month-by-month in January?

We don't provide month-to-month details, but we’re optimistic and have seen strength.

Thanks for your comments regarding the market. What share of prospective buyers are being rejected for mortgage applications?

We haven’t seen a significant number of individuals unable to qualify. Overall, trends remain fairly consistent. In terms of starts, we're capable of ramping to the previous peak if market conditions permit. However, we must manage demand appropriately.

It’s challenging to predict lot counts, as it depends on market demand and negotiations.

Thank you for your time today. We are available for any questions you may have throughout the day. We look forward to speaking with you on our next call.