PulteGroup, Inc. (NYSE:PHM) Q3 2023 Earnings Call Transcript

PulteGroup, Inc. (NYSE:PHM) Q3 2023 Earnings Call Transcript October 24, 2023

PulteGroup, Inc. beats earnings expectations. Reported EPS is $2.91, expectations were $2.78.

Operator: Ladies and gentlemen, good morning. My name is Abbie and I will be your conference operator today. At this time, I would like to welcome everyone to the PulteGroup Incorporated third quarter 2023 earnings conference call. Today’s conference is being recorded and all lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question and answer session. If you would like to ask a question during that time, simply press the star key followed by the number one on your telephone keypad. If you would like to withdraw your question, press star, one a second time. Thank you, and I will now turn the conference over to Mr. Jim Zeumer, Vice President of Investor Relations. Mr. Zeumer, you may begin.

James Zeumer: Great, thank you Abbie. We appreciate everyone joining today’s call to discuss PulteGroup’s third quarter operating and financial results. As detailed in this morning’s earnings release, PulteGroup delivered another quarter of strong earnings as we continue to capitalize on our competitive strengths and balanced approach to the business. Joining me on today’s call to discuss our Q3 results are Ryan Marshall, President and CEO; Bob O’Shaughnessy, Executive Vice President and CFO, and Jim Ossowski, Senior Vice President, Finance. A copy of our earnings release and this morning’s presentation slides has been posted to our corporate website at pultegroup.com. We’ll post an audio replay of this call later today.

We want to inform everyone that today’s discussion includes forward-looking statements about the company’s expected future performance. Actual results could differ materially from those suggested by our comments. The most significant risk factors that could affect future results are summarized as part of today’s earnings release and 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. Ryan?

Ryan Marshall: Thanks Jim and good morning. As we will discuss over the next several minutes, PulteGroup reported another quarter of outstanding and, for a number of key metrics, record financial results. Our financial performance demonstrates once again the importance of PulteGroup’s balanced and differentiated operating model. Leveraging our broad geographic footprint and diversified product offering, we are working to maintain significant market share among all major buyer groups. At the same time, we are successfully executing both large scale spec and build-to-order homebuilding businesses. Our spec business allows us to more cost efficiently serve first-time buyers, while our build-to-order business caters to move-up and active adult buyers looking to personalize their home location and design features.

Specific to our financial results, I am extremely proud of our entire organization for their efforts in delivering third quarter results that include a 43% increase in orders, industry-leading gross margins of 29.5%, record third quarter earnings of $2.90 per share, and a return on equity that exceeded 30%. In the quarter, I would highlight our active adult business as an important contributor to our sign-up growth and our gross margin performance. In an operating environment where rising mortgage rates are creating increasing affordability challenges, 47% of our Del Webb purchasers were cash buyers. This is up from 33% just two years ago. Along with largely being cash buyers, these were customers who can afford the premium lots and upgrades that make active adult our highest margin business.

Just to demonstrate the brand power of the Del Webb name, in June we opened Del Webb Kensington Ridge in Michigan, not a market you might consider a hotspot for retirees. In a community where base home prices range from $370,000 to north of $600,000, we have already sold 114 houses in just over 100 days. We fully appreciate that to some degree, all buyers are impacted by rising rates and macroeconomic concerns, but buyer groups can absolutely behave differently over the course of a housing cycle. For PulteGroup, we believe being diversified across all buyer groups can enhance both growth and stability. Beyond our diversification across buyer groups, PulteGroup’s strong third quarter financial performance also benefited from our ability to offer consumers both spec built and build-to-order homes.

As we have discussed on prior calls over the past 24 months, we have transitioned our first-time buyer communities to a spec build model to better serve these customers. Looking at our first time business, spec building allows us to maintain a more consistent cadence of starts in those communities, which drives construction efficiencies and is important in working with our trades. More directly to our quarter, having additional inventory available was important given 49% of our sales in the period were spec sales. I would note that 49% spec sales in the quarter is down from 58% in Q1 of this year. I think the decrease in the relative percentage of spec sales in the quarter reflects two interesting dynamics. On one hand, the affordability challenges caused by higher interest rates are pushing some buyers, particularly first-time buyers, to the sidelines for now.

On the other hand, more affluent buyers who are less fearful about rates are comfortable contracting for a home where they’ve selected the lot, the floor plan, and the design options. On the construction side, I’m pleased to say that we continued to shorten our production cycle. Just to remind people, pre-COVID our production cycle was approximately 90 work days. At its worst, this number ballooned to 170 days. By the end of the quarter, we had reduced this number to about 140 days. Our teams continue to shave days and weeks off our build cycle and we remain optimistic about our ability to get back below 100 days in 2024. As you would expect, cutting more than a month off of our cycle time has positively impacted our cash flow, which we continue to allocate across our key business priorities.

Through the first nine months of 2023, we have invested $3 billion in our business through land acquisition and development. Over this same period, we have returned over $800 million to shareholders through share repurchases and dividends. In this most recent quarter, we even took advantage of market conditions to retire $65 million of near term debt at prices just below par. PulteGroup has delivered outstanding operating and financial performance in the quarter and throughout the first nine months of the year as we have leveraged our strong competitive position to capitalize on buyer demand. It grows increasingly clear that Federal Reserve actions to raise interest rates are having the desired effect of slowing the economy, although the speed of deceleration has been slower than expected given the unprecedented ramp in rates.

While arguably not the most supportive economic backdrop, new home demand in 2023 has benefited from a robust jobs market and rising wages, financially resilient consumers and a continuing dearth of supply from the existing home market, and finally as higher rates begin to bite, we have responded with adjustments in product, pricing and incentive programs that successfully address consumers’ biggest pain point, affordability. It’s difficult to know if the Fed is done hiking rates for this economic cycle and trying to guess when they will move to cut rates is challenging, so we will remain disciplined in how we manage our business. We’ll focus on serving our customers, supporting our employees, turning our assets and allocating capital appropriately while maintaining a strong and highly flexible capital position.

Now let me turn the call over to Bob for a detailed analysis of our Q3 results. Bob?

Robert O’Shaughnessy: Thanks Ryan. PulteGroup’s third quarter results add to what has been an exceptional year for the company as we have grown revenues and earnings, generating significant cash flow from operations, lowered our debt, and generally strengthened our entire operating platform. Specific to our third quarter, home sale revenues increased 3% over last year to $3.9 billion. Higher revenues for the quarter reflect a 2% increase in our average sales price to $549,000, in combination with a less than 1% increase in closings to 7,076 homes. The 2% gain in average sales price of homes closed in the quarter was driven by increases of 4% and 6% from move-up and active adult buyers respectively, partially offset by a 3% decrease among first-time buyers.

The lower ASP among first-time buyer closings reflects our focus on remaining price competitive as interest rates have moved higher throughout the year. The mix of homes delivered in the third quarter changed just slightly from the prior year as we continue to operate within the range of our stated mix of business. For the quarter, closings among first-time buyers represented 38% of the business, move-up buyers totaled 37%, and active adult buyers represented 25% of the homes closed. In the third quarter of last year, 36% of homes delivered were first-time, 38% were move-up, and 26% were active adult. Net new orders for the third quarter increased 43% over last year to 7.065 homes as we realized year-over-year gains in both units and absorption pace across all buyer groups.

Orders among first-time buyers in the third quarter increased 53% over last year to 2,979 homes. The gain among move-up buyers was even greater as net new orders increased 56% to 2,524 homes, and finally on a comparable community count, we realized a double-digit gain in sales among active adult buyers as net new orders for the quarter increased to 1,562 homes. In the third quarter, we operated from an average of 923 communities, which is up 12% over last year. Adjusting for community count, the monthly absorption pace in the third quarter averaged 2.5 homes, which is up from 2.0 homes per month in the third quarter of last year. As a percentage of beginning backload, our cancellation rate in the third quarter was 9% compared with 8% in the prior year.

To be clear, on a unit basis cancellations in the third quarter were down more than 20% from last year, but the relative size of our backlog in each period results in the cancellation rate staying comparable. Our unit backlog at the end of the quarter was 13,547 homes compared with 17,053 homes at the end of last year’s third quarter. On a dollar basis, the value of our ending backlog was $8.1 billion, down from $10.6 billion in the third quarter of last year. At the end of the third quarter, we had a total of 17,376 homes under construction. This is down 24% from the same period last year as we strategically manage starts and realize the benefits of faster cycle times. Of the homes under construction, 61% were sold and 39% were spec units.

As we have stated previously, we are comfortable putting spec units into production, but we are thoughtful about aligning the pace of starts with the pace of sales to help reduce the risk of putting too much inventory on the ground. Consistent with this measured approach to production, of the 6,700 spec homes currently under construction, fewer than 1,000 were finished. Given our Q3 community count of 923, we continue to carry approximately one finished spec per community, which is in line with our operating targets. Based on the homes we have in production and, as importantly, current sales trends, we expect closings in the fourth quarter to be approximately 8,000 homes. Delivering 8,000 homes in the fourth quarter would put us at 29,000 for the full year, which is down slightly from our previous guide for full-year closings to be 29,500 homes.

The change in our guide reflects the more challenging affordability conditions resulting from higher rates as well as the slight shift in our mix toward build-to-order homes which won’t deliver until 2024. Given the mix of homes we currently expect to deliver in the fourth quarter, we expect our average sales price on closing to be in the range of $540,000 to $550,000 in the period. Our third quarter home sale gross margin of 29.5% continues to lead the industry as we successfully our turned our assets while still achieving high levels of profitability and driving higher returns on investment. PulteGroup’s reported results benefited from strong margin performance across all buyer groups – first time, move-up, and active adult. Further, as we have talked about on prior calls, our diversified product portfolio is allowing us to capture higher gross margins that are typically available within our move-up and active adult communities.

As I would remind everyone, our primary focus is always on driving higher returns on invested capital, but we appreciate margins are an important contributor to achieving such returns. This is why we remain disciplined in where we locate and how we underwrite our communities and how we design and build our houses, and in how we strategically price our homes in the marketplace. Given the ongoing strength of our margins, we continue to get questions regarding relative margin performance among the larger public builders. I want to quickly address the line of thought that our margins benefit from land positions within our older Del Webb legacy communities. The reality is that the margins for these communities are comparable to the rest of our active adult business, but they are [indiscernible] our aggregate numbers.

That being said, I’m pleased to say that we expect to continue delivering high margins as we continue to expect home sale gross margins to be in the range of 29% to 29.5% in the fourth quarter. Given current interest rates, demand and cost dynamics, we would expect to be toward the lower end of this range. SG&A expenses in the third quarter totaled $353 million or 9.1% of home sale of revenues. This compares with prior year SG&A expense of $350 million or 9.2% of home sale revenues. Based on anticipated closing volumes for the fourth quarter, we expect SG&A in the fourth quarter to be approximately 8.8%. In the third quarter, pre-tax income from financial services was $29 million, up from $27.5 million last year. While market conditions remain highly competitive for our financial services operations, the business benefited from a higher capture rate of 84% compared with 77% last year.

The large increase in capture rate relates to the expanded use of rate-based incentives, which are executed through our mortgage operations. Looking at our taxes, consistent with our prior guide, our third quarter tax expense was $209 million or an effective tax rate of 24.6%. For the fourth quarter, we continue to guide to a tax rate of 24.5%. PulteGroup’s bottom line results show net income for the quarter of $639 million or $2.90 per share, which is up from prior year net income of $628 million or $2.69 per share. Given the ongoing financial strength and cash flow generation of our business, we repurchased 3.8 million shares for $300 million in the quarter. This was up from $180 million last year and $250 million in the second quarter of this year.

In the third quarter, we also elected to allocate capital towards paying down a portion of our debt. In total, we retired $65 million of our 2026 and 2027 senior notes through open market transactions at prices slightly below par. Inclusive of these transactions, we’ve lowered our debt-to-capital ratio to 16.5%, which is down 220 basis points from the start of ’23 and down 600 basis points from the third quarter of ’22. Adjusting for the $1.9 billion of cash on our balance sheet at quarter end, our net debt to capital ratio was less than 1%. Beyond buying back our equity and debt in the third quarter, we also invested $1.2 billion in the business through land acquisition and development, which keeps us on track to invest upwards of $4 billion for 2023.

Almost two-thirds of our investment in the third quarter was for the development of our existing land assets. Inclusive of our Q3 spend, we ended the quarter with approximately 223,000 lots under control, of which 53% are held via option. We continue to systematically rebuild the optionality of our land pipeline after having walked away from selective land positions in the back half of 2022. As part of this rebuilding process and consistent with our stated strategy of getting more land light, we are expanding our use of different land banking structures. To date, we have completed land banking transactions for approximately 5,000 lots. Going forward, we will look to use such land banking facilities in order to create optionality in situations where the underlying seller requires a bulk sale.

It’s a disciplined process as we work to balance land costs, returns and risk, but we are gaining momentum in our efforts. We are also getting more questions on our land pipeline, so let me add that about one-third of the lots we have under control are developed and we continue to develop most of the lots that we acquire. As a large homebuilder, assuming you’re confident in the third party’s ability to consistently deliver developed lots on time, the decision to purchase finished lots versus raw dirt comes down to return. Finished lots cost more but can turn faster, whereas the lower cost of undeveloped lots can drive higher margins, but the land is on balance sheet for a little longer. In all of our land transactions, we assess how best to drive higher risk-adjusted returns and to find opportunities and deals for finished and/or undeveloped lots.

Now let me turn the call back to Ryan.

Ryan Marshall: As you would anticipate, given our 43% increase in net new orders, we saw strong demand throughout the quarter. Q3 displayed more typical seasonality than we have experienced in the three years since COVID as absorption pace eased as we moved through the quarter. Demand has been a little choppier in the first few weeks of October with more volatility in the day-to-day sales numbers. I’m sure for some buyers, higher rates have pushed affordability just that much further away, while others may be worried about their jobs. For other buyers, global unrest may simply have them thinking of other things. We are fortunate to have an experienced operating team that will make adjustments if and when needed. On a year-over-year basis, for the first nine months of 2023, we have increased net income by $156 million and increased earnings by share by 17%.

Over the same period, we’ve increased our cash position by approximately $1.6 billion while dropping our net debt to capital ratio effectively to zero. Based on guidance that we’ve given, we look forward to delivering exceptional full year results for 2023. From population growth and demographics to supply dynamics and the tremendous opportunity for wealth creation through home ownership, we are bullish on long term housing demand. Over the near term, however, we fully appreciate the affordability challenges being created by higher mortgage rates and the potential impacts from an economic slowdown the Federal Reserve is hoping to bring about. As such, we remain disciplined in how we operate our business particularly as it relates to investing in land, the pace of production, the allocation of capital, and the quality of homes and experience we deliver to our customers.

We have a clear and successful operating model against which we have been executing for over a decade, so decision making throughout the organization is consistent and actions are implemented quickly. This strong organizational foundation along with tremendous financial strength has PulteGroup well positioned for ongoing success. In closing, I want to thank the entire team at PulteGroup for their tremendous efforts in delivering for our home buyers, our shareholders, and each other. I am so proud of what you accomplish every day. Let me turn the call back to Jim so we can begin Q&A.

James Zeumer: Thanks Ryan. We’re now prepared to open the call for questions. So we can get to as many questions as possible during the remaining time of this call, we ask that you limit yourself to one question and one follow-up. Abbie, we’re ready to open for Q&A.

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Q&A Session

Operator: Thank you. [Operator instructions] We will take our first question from Carl Reichardt with BTIG. Your line is open.

Carl Reichardt : Thanks, good morning guys. I wanted to first just ask about the cycle time numbers – you talked about 140, trying to get down below 100 next year, so that’s more than a month off. What specifically, Ryan, needs to happen for those numbers to go down? Where are the best and most obvious lever points?

Ryan Marshall: Yes Carl, so a lot of the work has already been done and what we’re seeing is some of the homes that are delivering now, and maybe better said, the homes that are starting now are on cycle times that will yield that overall cycle time of below 100 days, so it’s really about getting the older stuff that’s been in the pipeline, that’s got longer cycle times, that as those numbers close out, I think we’ll see our overall cycle times come in line with that target of 100 days.

Carl Reichardt: Right, thanks Ryan. Then you mentioned the choppiness in October, and I wonder if you could expand a little on that and talk a little bit, maybe about performance among the three segments in the month so far or particular markets, and then also from a cancellation perspective, if that’s beginning to sort of impact you in October too. Thanks.

Ryan Marshall: Yes Carl, happy to talk on October. As I mentioned in the prepared remarks, we’ve seen sales in October, while good, they’ve been a little bit choppier than–you know, the day-to-day kind of numbers have been a little choppier. I think the biggest thing that I’d want you to hear is that similar to what we saw in the third quarter, we actually have seen a return to what we would consider seasonal type sign-up trends that we experienced pre-COVID, and we’ve seen that continue into October. On an absorption rate, the numbers that we’re seeing on absorptions per community are pretty similar to what we saw in 2018 and 2019 pre-COVID levels, which were pretty healthy, so all things considered, we feel pretty good about the continued ongoing desire for home ownership.

It’s not lost on any of you out there listening, rates matter, and there has been a lot of rate movement over the last 30 days, and so I think the consumer, all things considered, has handled that really well.

Carl Reichardt: Great, I appreciate the color. Thanks, fellows.

Operator: We will take our next question from Matthew Bouley with Barclays. Your line is open.

Matthew Bouley: Hey, good morning guys. Thank you for taking the questions. Just a question around some of the comments you made at the top, Ryan, around addressing affordability and some of the challenges you’re seeing, particularly with the first-time buyer. Any additional elaboration on what you’re doing with incentives and rate buy-downs, and what’s working and not working as we get into September and October, and sort of the margin implications of all that? Thank you.

Ryan Marshall: Yes Matt, thanks for the question. We continue to use the permanent 30-year buy-down as probably our most powerful incentive. Right now, we’ve got national incentives that offer 5.75% on a 30-year fixed, so I think given rates today on the open market would be over 8%, to be able to get a new home in a great location of the quality and design features that we have at 5.75%, I think is pretty powerful. I’ll remind everybody, what we’ve done is we’ve simply redistributed incentives that we’ve historically offered toward cabinets and countertops and things of that nature, we’ve redirected those to interest rate incentives, and I think that’s the–you know, that’s been the most powerful thing for that buyer group.

Matthew Bouley: Got it, okay. That’s really helpful. Then secondly, just one on stick and brick costs – you know, just as you’re addressing these issues and presumably there is margin pressure out of that, and the housing market has evolved here, what are you guys doing around construction costs, labor, sort of ability to push back on all that? How should we think about that over these next few months? Thank you.

Ryan Marshall: Yes, well you know, look – inflation is real, and we’ve previously talked about something in the neighborhood of 8% to 9% year-over-year inflation, which I think is part of the reason we’re in the rate environment that we’re in as the Fed’s trying to get a handle on that. What we’ve seen on our cost to build is on a year-over-year basis, we’re actually flat. Now, that’s a lot of commodity and material and labor increase in a number of categories that’s been offset by lumber save, so headline is we’re flat on a price per square foot to build year-over-year, but it’s a lot of increases in material and labor offset by lumber.

Matthew Bouley: Got it, thanks Ryan. Good luck, guys.

Operator: We will take our next question from Michael Rehaut with JP Morgan. Your line is open.

Michael Rehaut: Thanks. Good morning everyone. Just wanted to kind of take a step back and understand some of the dynamics. You talk about October being choppy, but at the same time it sounds like more in line with seasonality pre-COVID, and you also–you know, the flipside of that is with volume, you’re putting out a gross margin guidance for the fourth quarter maybe a touch down from 3Q. Can you just give us a sense of the level of incentives, if through your own offerings in October or maybe even more broadly in the marketplace, do you feel like incentives have started to come up over the last couple of months because certainly, I guess in the near term, you’re looking for a similar gross margin, and maybe just more broadly how you feel the market is reacting to September and October?

Ryan Marshall: Yes Mike, I’ll take part of that and then I’ll have Bob talk about the incentive load. As demonstrated by our orders in the quarter, we had 43% growth in new orders and it was a number of over 7,000, so I think we’ve clearly demonstrated that we’ve got the ability to sell homes. You’ve heard me talk about not being margin proud, but at the same time, we’re not going to give away price and incentives that we don’t have to, and I think we did exactly that in the third quarter and we’d continue to focus on making sure that we’re turning the asset and we’re getting the number of absorptions that we need in every single community to deliver the best return on invested capital that we can. Look, I think it was a great quarter.

We’re happy with how sign-ups performed in October – you know, you heard me kind of talk about that on the question that Carl asked, so I won’t repeat it. Then Bob, if you can, maybe just talk a little bit about the incentive load.