Steve Davis - EVP and COO
Brent Anderson - VP, IR
Meritage Homes Corp (MTH) Deutsche Bank Leveraged Finance Conference October 2, 2013 4:30 PM ET
Good afternoon. I am Steve Davis Chief Operating Officer for Meritage Homes. Before I start this presentation, I would direct everyone to our cautionary language on slide two, and ask that you review them before making any investment decisions.
You may already be familiar with Meritage Homes. For those who aren't, Meritage is the 9th largest home builder in the U.S. and we're a top five builder of single family homes in many of our markets. We sell primarily to move-up buyers with an average sales price of $350,000 in the second quarter this year. We employ a build to order model, meaning we sign a sales contract before we build most of the time rather than building a lot of spec homes which helps reduce our inventory and risk.
At June 30th we had 165 actively selling communities in 14 markets across six states. In August we added Nashville, Tennessee through the acquisition of Phillip Builders, expanding our presence to 15 markets across seven states. Our West region is our largest representing about 55% of our home closing revenue in the first half of 2013, Texas is our second largest region at 27% and we are rapidly growing our east region which represents about 17% of our closing revenue year-to-date.
After the addition of Nashville we now bill in 12 of the top 20 U.S. markets for home building activity in 2012. Those markets grew building permits by an average of 36% in 2012 over 2011. We've been in most of those markets for many years and chose them because of the absolute price and the long term growth potential. These markets have afforded us a very good balance as Texas markets were some that best weathered the downturn of the housing cycle, while California, Colorado, and Florida have been some of the most resilient markets to rebound, surprisingly quickly as the housing market has improved.
Our West regions consisting of California, Colorado and Arizona have been the principle driver of our growth since the beginning of 2012. California is land constrained and has been our highest growth market over the last six quarters. They made up 19% of our trailing 12 months orders through the middle of 2013, up from 12% of our 2011 orders. We have more than doubled our numbers of lots controlled in California over the last 12 months.
Phoenix has been one of our strongest housing recovery market and prices have risen considerably over the last year due to shortages of homes for sale. Meritage is the third largest builder in Phoenix with arguably the best land position in the market. Our Colorado division is doing very well. Our back log of orders more than doubled as of June 30, 2013 compared to a year ago and we are taking market share.
Our Central region is made up of the four largest cities in Texas and was our strongest region for much of the five year period prior to 2012. While two other regions have posted stronger growth in the first half of 2013 over 2012, Texas orders have increased at a very respectable 21%. We have very well positioned land and some of those attractive growth corridors of Houston and Austin while DFW and San Antonio are also well positioned for growth as those markets strengthen.
We have been aggressively expanding our east region where we see opportunities for additional growth at reasonable prices. Meritage is the largest single family home builder in Orlando and we have a very good land position in some of the most highly coveted sell markets there. We're expanding into four new markets in the east. We have expanded into four new markets in the east since 2012, including Tampa, Raleigh and Charlotte in North Carolina and most recently Nashville.
Raleigh was the most successful startup in Meritage history, turning to profit in our first full year of operation there, which is very rare for green field operations. We entered the Nashville market with an acquisition of Phillips Builders in September of this year. Nashville is a growing market that is expected to double the number of building permits in the next few years due to strong employment growth across a diversified industry base. Phillips Builders is a third generation home building operation in Nashville with a very good reputation and solid land position from which to grow. There are a move -up builder with an average selling price near $300,000, which fits Meritage's strategic sweet spot. Charlie and Jason Phillips, two of the three brothers who own the business will stay on with Meritage and continue to grow with the operation.
We have been acquiring far more lots than homes we're building and closing over the last six quarters. Preparing for future growth, we rely on a strategic research and operation group to support our divisions with the market research we need to help us evaluate new market opportunities quickly and with confidence.
They determine the value of lots based on current housing data, maximizing our profit potential, while minimizing our risk when acquiring new land positions. We believe this is a strategic advantage for Meritage as we know of no other builder who has the same capabilities in house to respond to the same speed that we can, and speed is important in a highly competitive land market. This group also responsible for advising on the appropriate product configuration that should sell best in each new community.
Since we're nearing a play-off, I would say our batting average is measured by communities hitting their pro forma targets has been much higher than it was before we implemented our new strategic research function with very few strike outs. In the last couple of years, we have been investing most aggressively in our west and east region, where the demand for new homes has been the strongest. Our west region now accounts for nearly half of our total lot supply and our east region has grown to nearly one quarter by total lots as of June 30, 2013.
In fact Florida and Carolina have combined for the largest increase in lots during our second quarter. We invested almost $0.5 billion in 2012 on lots and land development and have planned to invest another $600 million to $700 million in acquisition and development in 2013. We're using land banking to do some acquisition and development off balance sheet and we have recently quote option contracts with land bankers for approximately $100 million of additional lots, using their capital for incremental growth opportunities, while managing a strong balance sheet.
And based on our current lot supply in pipeline, we expect to grow our community comp by 15% to 20% at 2013 and can match that growth next year. Another strategy that sets Meritage apart is our energy efficiency of our home, which sets us apart from both used homes and other new homes. Meritage was the first national high production builder to build 100% of their homes to Energy Star specifications which is our minimal standards. Our average home consumes approximately 6% less energy as new home built to current codes.
In 2012 we built the first U.S. EPA triple certified home for air, water and energy efficiency, which is now available in all our communities nationally. We have won dozens of awards from all kinds of industry groups and government agencies. Greater energy efficiency translates to lower operating costs. For the home owners it can increase both the affordability and resale value of our homes. That can help us sell more homes, command premium price or both in some cases.
Meritage is truly setting the industry standard for energy efficient homes. We spend a great deal of money and effort to educate the public and home builders to advance the industry towards building more energy efficient homes, which we have proven we can achieve, cost effectively.
This cut away illustration is just one of the two that we use with a list of standard features that make our homes perform better and live better. These features work together as a system to make the home more comfortable, quieter and safer, as well as being more energy efficient. I invite you to visit our website to learn more about homes can and should be built today.
At this point I will turn it over to Brent for the rest of our presentation
The housing market recovery began last year and has rebounded much more quickly than we expected it would. Demand increased with an improving economy, job growth and consumer confidence and the shortage of homes available for sale drove demand in new homes and price appreciation higher which created a wealth effect and even greater confidence unleashing more pent up demand, a virtuous cycle.
We believe that the housing recovery has a lot of room to run though, not as steeply as it did last year and not without some pauses along the way, like we've experienced recently, but the underlying drivers of demand, job growth, household formations and confidence, combined with high affordability and low supplies of inventory available for sale are strong arguments for continued growth.
Flip to Slide 14 for those of you that are online. In 2012 we increased our net orders for homes by 41% year-over-year from 2011. We closed 30% more homes and we grew our backlog by 53% in units. As you can see, our average sales prices also increased by 23% in the second quarter of 2013 over ’12.
We grew our total order value by 49% in the second quarter year-over-year as a result of increasing our community count, orders per community, unit sales and average sales prices. You can see some seasonality in these quarterly results as the third and fourth quarters are normally slower sales than the first half of the year but we’ve had nine consecutive quarters of year-over-year growth through the second quarter of 2013. That kind of growth is great but it also comes with some challenges.
Turning to Slide 15, with the rapid increase in home sales last year, suppliers and sub-contractors ran into labor shortages in some areas which drove input costs higher for both us and other builders. Fortunately home price appreciation exceeded our input cost inflation. So we more than covered the rising direct cost of production. Costs are still increasing but at a much slower pace, thanks in part to the suppliers and sub-contractors catching up to the demand and in part to our own purchasing department. We believe we’ve done a better job of managing our direct cost this year but should help us to maintain and further improve our gross margins.
Turning to Slide 16, you can clearly see the earnings leverage in our model. Year-to-date through the second quarter of this year, we have leveraged 58% revenue growth that generated 81% increase in home closing gross profit due to a 270 basis point increase in our gross margin. We think our home margins can go a little higher. Sales and marketing costs dropped 130 basis points on the increased revenues. G&A expenses dropped another bps and our total SG&A can come down a little bit further.
Interest expense dropped to 160 basis points, which was also a nominal reduction of $4 million, mainly due to capitalizing the greater portion of our interest incurred on a larger base of assets under development. The net result was 740 basis point improvement in pretax earnings for the first half of 2013 compared to 2012. While the year-over-year comparisons will get more difficult as we move forward, we expect to continue to leverage top line growth for much greater earnings growth.
Turning to Slide 17, Meritage has performed well relative to the group of 13 or 15 public home builders. We were one of the first home builders to return to profitability after the downturn and we achieved greater revenue growth in the early stages of the recovery.
Meritage has been in the top third of all public home builders from many operating metrics, the second quarter of 2013 was no exception. We produced the second highest growth in average sales price, third highest return on average equity and inventory turnover, fourth highest operating margin and the second lowest cancellation rate on orders. We believe we have the right amount of land to support continued growth while not too much that it would burden our balance sheet and increase our risk.
Turning to Slide 18, we have a healthy balance sheet to support continued growth and we believe that we’ve done a good job managing our credit statistics. Our balance sheet is actually stronger today than when we entered the downturn. We had $353 million in cash and marketable securities as of June 30th this year. We want to maintain approximately $150 million to $200 million in liquidity at our current size and our net debt to capital ratio is at a comfortable level of 37%, well under the range of 40% to 45% that we would consider reasonable during the growth cycle. We have no debt maturities until 2017. We’ve managed our debt structure by strategically managing the amount of land on our balance sheet. We have approximately five years of lots under control at the end of June and we believe that is an appropriate lot supply.
So we’re confident that the home building market can continue to grow for many years and I’ll touch on just a few reasons for that optimism. If you turn to Slide 20, job growth is one of the most important drivers of demand for new homes and the ratio of new jobs to housing permits is a widely accepted indicator of how well home builders are keeping up with that potential demand.
As you can see in this chart, the ratio of new jobs to permits indicates that employment growth is outpacing new home construction by a significant margin, both nationally and in all of the regions where Meritage builds. As the economy expands and more jobs are created, household formations should increase and with low supplies of homes listed for sale demand for new homes should persist.
On Slide 21, we get a lot of questions about the impact of interest rates increases on new home sales. There is no doubt that it’s had some impact, though it’s difficult to determine how much and we feel that that has probably been felt more at the entry level then with our move up buyers and in areas where affordability is becoming more stretched.
The pace of orders has slowed in recent months. So difficult to say how much of that is result of interest rate increases. We’ve been raising prices pretty aggressively especially in the West, California and Phoenix where demand has been very strong. So we expected some slowing due to those price increases.
In addition, interest rates rose at the end of spring selling season just as we were heading into the seasonally slower summer months. So we would also expect sales to decline from the second quarter’s pace into latter half of the year. However even with high prices and higher rates affordability is still near its peek and we don’t believe that is impeding demand to any significant degree in our areas.
So at times when prices and interest rates are raising, buyers have a number of options to consider. It’s not just a go, no-go decision on buying a home. Some may choose to increase their down payment or adjust a monthly budget for larger mortgage payment. A move-up buyer can typically do that more easily than an entry level buyer. Others may choose to reduce the level of options they select or select a lower priced plan that still meets their needs in order to reduce the total purchase price of the home.
Some may also chose to finance with an arm rather than a fixed rate mortgage. Price can still be a strong motivator, even more than interest rates for many people. Rising prices tend to promote a sense of urgency and we saw the impact of that is sales were running at a torrid pace during the first half of the year in the west region. As we slacked off on price increases this summer, buyers may have felt less of a sense of urgency to rush their decisions and therefore pause before making their purchase.
So moving to Slide 23, the average credit statistics of our buyers have increased over the last year or more as we have moved further up the price scale with more of our communities. Our buyers have an average FICO score of around 740 and 76% are over 700, with just 1% below 620.
They have an averaged loaned value of 85% and 45% of our buyers put more than 20% down on their home. 70% of the buyers that finance are using conventional financing with about 17% FHA and the reminder VA and USDA loans. Those statistics are from our mortgage banker or mortgage broker, which is a joint venture with iMortgage, now LoanDepot.
So to wrap it up, Meritage is the leader in the home building market and we are well positioned to achieve strong earnings growth and continued earnings growth. We have a strong balance sheet, plenty of liquidity to fund that additional growth. We’re planning to grow our community count, not only within our existing markets but also through expansion into new markets. We believe that our gross margins will show additional improvement and that we can continue to leverage our existing overhead to drive earnings growth far greater than our top line and gross profit growth.
With that I’ll open it up to questions.
Question and Answer Session
Sure. So our normal cancelation or cancelation rate that we would comfortable with would be in the 20% to 25% range in normal times. For the last couple of years we’ve been running in the low teens. I think that’s a testament primarily to the strength of the building recovery and the fact that prices are increasing.
So, we’ve got buyers that are serious buyers. They’re not entering with any doubt and as prices move up, they have no interest in canceling the order. We are build order builder rather than a spec builder. So, when we open a community we’ll put up several model homes and then we basically take sales contracts on a lot and a specific plan and then start building only after we have a signed sales contract, rather than building spec homes, finishing those and then trying to sell.
Any other questions? Okay, if nothing else, thanks very much for your time and your interest and we’ll wrap it up. Thank you.
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