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Desarrolladora Homex (NYSE:HXM)

Q2 2008 Earnings Call

July 22, 2008 10:00 am ET

 

Executive

 

Carlos J. Moctezuma - Investor Relations Officer

Gerardo de Nicolas - Chief Executive Officer

Alan Castellanos - Vice President of Finance and Planning and Chief Financial Officer

 

Analyst

 

Gordon Lee-UBS

Vanessa Quiroga - Credit Suisse

Esteban Polidura - Merrill Lynch

Dennis [Horician] - Santander

Cecilia Del Castillo- Citigroup

Jaime Nicholson - Credit Suisse

Gonzalo Fernandez - Santander Investments

Claudia Medina - [Venture] Capital Mexico

Kelly [Trenton] - FLW

Sergio Molina - Bull [Tech] Capital Market

Carlos [Furlong] - Merrill Lynch

Jorge Kuri - Morgan Stanley

Ivan Barona – GBM

Daniel J. McGoey -Deutsche Bank

Adrian Huerta - JP Morgan Securities, Inc.

Francisco Chavez - BBVA Bancomer

Operator

 

Welcome to the Desarrolladora Homes Second Quarter 2008 financial result conference call. (Operator Instructions) At this time I would like to turn the conference over to Carlos Moctezuma.

Carlos J. Moctezuma

Good morning and welcome to the second quarter 2008 earnings conference call. Before we start, I would like to remind you that certain statements made during the course of this conference call about future events and financial results, constitute forward-looking statements that are made pursuant to the Safe Harbor Provision of the Private Security Litigation Reform Act of 1995. Forward-looking statements are subject to risks and uncertainties, a discussion of factors that may affect future results are contained in our filings with the Security and Exchange Commission. We do not intend to correct or update any forward-looking statements provided as a result of the information’s further event within ten years in our expectation.

With us in the call today are Gerardo de Nicolas, our Chief Executive Officer and Alan Castellanos, Chief Financial Officer. I would like to now to turn the call over to Gerardo.

Gerardo de Nicolas

Thank you Carlos and good morning everyone and thank you for joining us this morning. This quarter we at Homex have continued to deliver a strong top line growth of 19.5% with a 16.5 % net margin. This continued performance leave us comfort (unintelligible 02:36) that our goals for the intermediate term are achievable. This quarter, our volume of home sold increased 9.3%. The affordable entry level grew 8.8% and the middle income volume sales increased to 14.3%. Infonavit continued as a primary source of financing for our clients. In the second quarter of 2008, 80% of our customers secured their mortgages from Infonavit but the remaining clients used five commercial banks and FOVVISSSTE.

This quarter, we continued our focus on improving our efficiency on our technology, expanding the use of aluminum molds to nine additional branches. In an effort to improve the quality of life for our customers and their buying experience and based on an internal studies of what our clients change the most when they are moving to a Homex home. We have recently have launched a customizations options for all our products.

The Company is the first of its kind in Mexico to offer clients custom options, adding a personal touch to the interiors and exteriors of their home. To these options, home owners will be able to chose from a range of up to 6400 combinations for every home and to increase the value of their homes with the added advantage that they can exercise all their mortgage capacity and the cost of customizing their home will be included in the monthly mortgage payments, without compromising their cash flow. It also allows customers a single contact for support, warranty, and back up which is always provided by the company.

The customization option is available today in 14 affordable entry level branches and in 13 middle income branches. We expect to have customization ready to implement in all our branches by year end. Nine percent of the homes sold in the last week were customized by our client. As we mentioned on the last quarter’s call, Homex have launched our new tourist division, Las Villas de Mexico to cater to the second home market from United Sates, Canadian, European home buyer.

In May, during an event in Cancun we successfully presented the first phase of our project to the main brokers from United States and Canada. They told us they were pleased to know that for the first time in Mexico, a home dealer was offering what the retirees and second home markets look for. Reasonable prices, workable sizes, on-site services, and additional programs which are [Capa] Care and Open Door with full fee toll ownership. Homex started construction of Las Villas de Mexico in Cancun and Cabos during this quarter and we expect to initiate construction in Vallarta during the third quarter.

We are confident that this new divisions successfully will deliver the first home by the end of the first quarter of 2009 as planned. The Mexican housing market remains strong and demand for quality homes continues to grow. Geographic diversification has proven to be a chief trend and a differentiator of Homex. We are actively pursuing opportunities to grow within Mexico.

We have operations in 34 cities in 21 states as of June 30, 2008. During this quarter, we launched operations in Saltillo, the capital city of the state of Coahuila. We continue to consolidate our operations in existing cities and launched three new entry level developments and four new middle income projects while also building more homes in existing community.

We will continue with our expansion strategy and we will open operations in Villahermosa later this quarter, with an affordable entry level development that will bring a competitive offer to the families in the State of Tabasco. During the quarter, we took measures to grow our liquidity and start planning efficiency. On June 30, 2008, we entered into a new great facility denominated in Mexican Pesos in an amount equivalent to $200 million with Banco Inbursa, one of the leading banks in Mexico.

Derived from the early changes in the Mexican tax law, land must be fully paid to re deduct it from our tax payment. Therefore, a portion of the resources from this new great facility will be used to pay for previously acquired land purchases that will help the Company to grow its tax strategy, and reduce its yearly tax-cut payment. The remaining resources will be used for investment in the recently launched vertical and multi-story constructions and tourist development. Alan will discuss further this new, great facility.

During the quarter, the Company constitutes Homex, India which will look to establish its first pilot project of low-income housing in Northern India later this year. We have signed a land development agreement with our local partner. Homex, India has invested $1.4 million in this project thus far. The pilot project is estimated at $10 million of total investment over the next 12 months at which Homex is expected to invest a total of $4 million. Details on the pilot project such as the extension, price range, will be provided as the branches formally open and the master plan is complete.

Homex have been currently researching into International expansion opportunities particularly in highly populated and under served areas where we believe our replicable business model will be most effective.

I will now turn the call over to Alan to disclose the financial information for the quarter.

Alan Castellanos

Thank you, Gerardo and good morning to all. I will begin today with a brief review of our financials for the second quarter ended on June 30, 2008. As we mentioned last quarter, companies in Mexico no longer follow inflation accounting. So, please note that our second quarter figures are presented without inflation adjustment, while our 2007 numbers are adjusted to December 31, 2007. As a result of this accounting change, the two quarterly periods are now directly comparable.

Total revenues increased 19% to Ps.4.4 billion from Ps.2.7 billion in last year, second quarter. Net income for the quarter increased 67.9% to Ps.722 million from Ps.430 million a year ago. This increase is a result of our higher sales and the last reduction in our net comprehensive financial gross. Earnings per share for the second quarter of 2008 were Ps.2.16 a 68.4% increase over the Ps.1.28 in the comparable quarter of 2007.

As we said, total housing revenues increased 19% over the same period last year as a result, first of all, of higher sales in the affordable entry and middle income market as well as the higher average prices in both segments. Affordable-entry-level revenues increased 20.1% in the second quarter while middle income revenues grew 17.6%. The affordable- entry level segment accounted for 77.1% of our total revenue.

The other aspect of Homex during the first quarter of full homes sold was Ps.324, 000 an important 9.4% increase from the second quarter of 2007. In the affordable-entry level segment, prices increased 10.4%, while middle income prices increased 2.8%. The increase in the lower income market primarily reflects our improved product offering.

EBIDTA was 1 billion and Ps.52 million, an increase of 20.3% from last year’s second quarter. The EBITDA margin increased 15 basis points to 24% in the second quarter and 23.9% a year ago. Our gross margin was 32.4%, a 68 basis point increase from 31.7% a year ago. A margin differential is a result of our efficiencies, particularly now that commodity prices have gone up worldwide.

The expanded use of aluminum mould technology and our negotiation power with supplier had been a large contributor to this result. Selling and Administrative expenses were 11.2% this quarter off from 9.9% in the second quarter of 2007. This course was down from the first quarter of 2008. Increase from 2007 figures is a result of our expansion program including the middle income division and the launch of our tourism division which as Gerardo mentioned; we expect to deliver the first homes sold by the end of the first quarter of 2009.

Our operating income increased 16% from the second quarter of 2007. As we look at our balance sheet during the quarter, we took actions to improve our cost of capital and liquidity in particular. As Gerardo previously discussed, at the end of June we entered into a new credit facility for up to $200 million at a very competitive annual interest rate of TA loss, 1.35%, Helping loss to (13:40 unintelligible) to improve Company’s liquidity by reducing the use of revolving lines to acquire land. This facility evidenced the vitality of the Homex grants in the financial markets as well as the strength of our financial system.

Accounts receivable make up 54.8% of revenues as of June 30, 2008, an increase of 39.4% in the year ago period. This rise is attributed to an increase in vertical and middle income building projects which take longer to build as work are delayed in our internal collection process derived from the shift of customers’ files from SOFOLES to commercial bank. We have been experiencing delays in SOFOLES and decided to move our credit worthy client to a bank. We expect the internal delay to be solved and reach the year end 2008 with accounts receivable ranging 190 days for Homex.

I will turn the call back to Gerardo for some final thoughts.

Gerardo de Nicolas

Thank you, Alan. We remain confident that Homex will have another successful year. Our focus will remain on strengthening our position in key markets in México. Expanding and creating further operational efficiencies and maintaining our commitment to our shareholders. We believe that the mortgage market environment in Mexico is changing, particularly in the middle income and the higher segments as a result of the current global economic situation. Nevertheless, we also believe that Homex will continue strong performance over the balance of the year leveraging on the stability to achieve [Inaudible15:31] of mortgage providers and take advantage from different market opportunities.

As for guidance we are reiterating our 16% to 18% revenue growth projected for the year and our targeted EBIDTA margin of 24% to 25%. We appreciate your continued support and thank you for your time today. We are now ready to take any questions you may have.

Question-and-Answer Session

Operator

(Operator Instruction) We will take our first question from Gordon Lee with UBS.

Gordon Lee - UBS

Hi. Good morning gentlemen, just a couple of quick questions. First, on the balance sheet, I was wondering if you could elaborate a little further on the increase in account receivable days. I know you mentioned in the press release but it has to do a little bit with the mix of financing and also with the mix between vertical and horizontal but I guess my question is whether this new mix is something that we should expect going forward and therefore that this level of receivable days should be the normalized level in the future or is there were something in this quarter which was unique and as a result receivable days should set back the way they were going forward.

And the second question that I had was just on the international expansion. I saw that you obviously confirmed the investment in India and I think that this is the second one after the investment in Egypt and I was wondering if you have an estimate, not of what you have invested so far, but what you expect your commitment to be, say, 2 or 3 years down the road, once this investments have matured a bit. Thank you.

Alan Castellanos

Thank you, Gordon and talking about the receivables. The way we have this time, our balance sheet by the end of the year is around 190 days. It is basically because we are moving to a more foreseeable product mix but also larger homes are more vertical product. In this particular quarter, there was an addition thing that happened that has to do with moving some credit worthy customers to commercial banks and also, Gerardo mentioned the customization of homes also take a little bit more time for the customer to decide as a kind of problems that we have. Gerardo?

Gerardo de Nicolas

Hi, Gordon. In terms of the international expansion, as of today, we have an authorized budget of $10 million by the board. We are expecting to invest $4 million in this project in India during the next 12 months and we have invested a little bit more than $1 million in the Egypt venture and as of today that is the budget that we have, authorized by the board, $10 million.

Gordon Lee – UBS

Okay. That is very clear. If I could just have one follow-up on the balance sheet, so, Alan at 190 days, given that you ended last year I think at below 170 days but that does mean that free cash flow for the year will likely be negative as a result of the change? The next year I know that once the (19:16) normalizes you will be back to free cash flow positive, I would imagine, but this year given this year, I would imagine this can be difficult to be free cash flow positive for the year. Is that correct?

Allan Castellanos

Yes. That is correct Gordon

Gordon Lee – UBS

Okay. Thank you very much.

Allan Castellanos

Thank you very much.

Operator

Okay. We will take our next question from Vanessa Quiroga with Credit Suisse.

Vanessa Quiroga - Credit Suisse

Thank you and good morning. My question is regarding your new land strategy. If you would give us more color going forward. Will we keep that at five years on balance sheet? My second question would be with regards to your tourism division, is there any new guidance or an updated guidance that you would like to provide as, for example percentage of revenues expected to be contributed by the tourism division in 2009 and margins? Thank you.

Gerardo de Nicolas

Hi, Vanessa. In terms of the land strategy because of the changes in the tax regulation we believe that we can change the work strategy in terms of land. We can reduce our land inventory in some cities mainly in the small cities and mid-size cities more in the big cities and we believe and we feel comfortable to reduce our land inventory in terms of just the future sales and that will help us on the tax strategy of the company. We feel comfortable that we can keep our growth reducing the land inventory in some cities. In terms of the tourism division we have had an extraordinary response from our customers, mainly in Cabo or Cancun and we are starting Vallarta in the next quarter, in the third quarter. At this time we do not have guidance in terms of the revenue participation over the tourism division for 2009 and that number will be given to the market in the fourth quarter of this year.

Vanessa Quiroga - Credit Suisse

Okay, just a follow-up on the land strategy. I thought your strategy before was to keep balance at 31/2 years of future production and now you said it was 5 years in the press release. So, just wondering if you will maintain it at 5 years?

Allan Catellanos

There was a unique opportunity because of the change in the tax system to have an investment in land, in the balance sheet by the end of this year and we took it and as Gerardo said now, we are changing that strategy in order to be more tax efficient which means that in some of the middle and the small cities where we want to reduce the inventory but the reason that we that move option land, to buy land by the end of last year was to take advantage of the last year of the tax credit.

Vanessa Quiroga - Credit Suisse

Okay. Thank you.

Operator

We will take our next question from Esteban Polidura with Merrill Lynch

Esteban Polidura - Merrill Lynch

Thank you. Good morning, Gerardo, Allan and Carlos, two question if I may. First, you were mentioning that you have been experiencing or seeing some problems with the SOFOLES. I do not know if you can elaborate a bit more on this subject. And second, I was wondering, what is the percentage of homes that you are currently building using aluminum moulds and what is what is you target in terms of aluminum mould utilization for ‘08 and ’09?

Gerardo de Nicolas

Hi, Esteban. In terms of the liaison collection, we believe that we can have a faster process with commercial banks and that is why we decided to invite our customers to do the processing of their mortgages with commercial banks. We have been in the last months having the commercial banks taking stronger steps to take market share. The impressive growth Hipotecaria Nacional and the great program signed by Banamex with INFONAVIT are examples of this. The strongest investments that the commercial banks are taking and we want to follow that trend with them and to offer a faster response to our customers. In terms of the mould, today we have the moulds being utilized in 18 branches for affordable- entry level and in 13 branches of middle income but in terms of the volume of homes, those 35% of the homes are built with aluminum moulds. The idea is that at the end of the second quarter of 2009 close to 85% to 90% of the homes will be built with aluminum mould.

Esteban Polidura - Merrill Lynch

It is perfect. Thank you.

Operator

We will take our next question from [Dennis Horacion] with [Santander]

Dennis

Good morning gentlemen and thanks for the call. Two questions, one, do you see new $200 million dollar credit facility. Will that make unnecessary potential $200 million bond issued at the Company discussed in the press and then I discussed with IR recently and to the momentum for average price increases in the mid-level division seem to be slowing down. Is that a trend that we may see going forward? Is affordability getting to be an issue there, as it is, to many other geographic areas around the world? Are we seeing an end to an increase in the average prices in at least the mid-level and perhaps eventually in the affordable-entry level. Thanks so much.

Gerardo de Nicolas

The $200 million facility that we signed with this bank is in substitution of the bond that was spread in the press and we are not going to do an additional bond.

Allan Catellanos

 

Because of the average price of the middle income segment, we have taken advantage of the great progress on the co-financing program and the way that it is working in Mexico, we believe that today is a mature product. That there is a way for people earning 10 minimum wage and more then we are concentrating on that segment. As you may know our price range for middle income goes from Ps.600, 000 up to Ps.2.3 million. But we are concentrating mainly on the range from Ps.600,000 up to Ps.1.4 million and that is where the co-financing is the best mortgage available for those customers and we believe that the right segment to stay and we will open new project on that price range in the future on the middle income segment.

Dennis

But in terms of the year-over-year gross rates slowing down in the average price in that segment is that a trend that we are likely to see going forward or do you think you could reignite momentum or is it possible that that could decelerate even in two negative territories? Could you ever add a bit a color on the average price trends?

Gerardo de Nicolas

 

In terms of the range price trend, we believe that the price will be increasing around inflation. We are not foreseeing reduction on the average price on middle income but we believe that we will be growing close to inflation – close to 5% to 6% per year.

Dennis

Thanks very much.

Operator

I will take our next question from Rodrigo for the network [Inaudible] with Citi.

Cecilia del Castillo- Citigroup

Good morning. This is Cecilia Del Castillo. How are you? I have a couple of follow up questions. One is regarding the co-financing that you were mentioning. When we look at the mortgage financial breakdown that you provide, how much, would you say is coming from the financing and the second question would be also related to the breakdown and the type of gross construction. What percentage of sales do you expect vertical houses will represent in 2008? My third question would be regarding the international expansion. I am just wondering if you can share with us the stake that Homex have in the JV in India. And where would you be recording these results when it happens in the results?

Alan Castellanos

Hi Cecilia, in terms of the co-financing, as of today, is close to 14% of the affordable-entry level homes and it is close to 18% on the middle income home that were acquired with the co-financing mortgage. In terms of the vertical construction, we are starting some projects in some cities mainly in the State of Mexico, some in Culiacan that maybe you have seen. At this time it is close to 5% of our revenues and we believe that in the next year will be 5% to 10%; will be coming from vertical construction. And your third question about the JV. The JV is with the land owner. And Homex owns 80% of the JV and JV will be accounted when we start recognizing revenues.

Gerardo de Nicolas

As any other project

Alan Castellanos

As any project and we have our minority interest from the local partner.

Cecilia Del Castillo- Citigroup

Okay. Thank you. That is very clear.

Operator

I will take our next question from Jaime Nicholson with Credit Suisse

Jaime Nicholson - Credit Suisse

 

Hi. Thanks for the call. I am just wondering if you can provide us with an update on your discussions with the rating agencies. I noticed that Moody’s had some positive outlook this past September. Are there any metrics they are looking for you to achieve before possibly giving you an upgrade or can you give us any color on what your recent discussions there have been? Thank you.

Gerardo de Nicolas

We are starting our annual review with the rating agencies. We believe that as in the past we have been following a conservative financial structure. With the addition of the credit facility, we are making sure that the liquidity and the growth rate of the company for the finals; we are a very comfortable of easier prospect with the rating agency.

Alan Castellanos

And we believe with our diversification strategy, in terms of geography and products, we can provide comfort to the credit rating agencies to talk about the improvement on our ratings in the medium term.

Jaime Nicholson - Credit Suisse

Okay. Great. Thanks so much for the call.

Alan Castellanos

Alright.

Gerardo de Nicolas

Thank you.

Operator

I will take our next question from Gonzalo Fernandez with Santander.

Gonzalo Fernandez – Santander

Yes. Hi. Good morning everyone, just expanding on the working capital issue. In the past you have been able to offset the delinquency in receivables with an increase in the accounts payable. Are you expecting that you can be able to do this? Can you provide an estimate of your inventory turnover and payables turnover for the year end? And from the credit facility – I understand you used $800 million. Are you planning to use the total $200 million until the end of the year? Sorry, you used Ps.800 million.

Gerardo de Nicolas

 

Hi, Gonzalo. First, I want to start with the credit facility. We used Ps800 million and here we are trying to – we are going to use, during this quarter the additional Ps.1.2 billion. Basically the proceeds are the ones that we have spoken about. In terms of our working capital management strategy it remains the same. I mean, we are going to work with our supplier base in order to compensate some of this increase in the receivables with the accounts payables and we have been successful doing in the past. However, I must say that because of the new product mix, we do expect around 190 days of receivables by the end of this year.

Gonzalo Fernandez

And Allan both inventory turnover and payables toward turnover. Do you have any expectations for the end of the year or should remain at the levels we have in June?

Alan Castellanos

 

With June it should be more or less at the levels

Gerardo de Nicolas

 

(Inaudible 34:25)

Gonzalo Fernandez

Okay. Thank you very much.

Operator

This is operator. Your line is open. Please check your mute button.

Once again, we will move on to Kelly Trenton (ph) with FLW

Kelly Trenton

Good morning. I have a follow up question about the Company’s plan for international expansion. What are the plans for Brazil? It is known that you have a Joint Venture in the country, the Homex Brazil for developing the local market. Can you give us an idea of when you are planning to start off developing there?

Alan Castellanos

 

Thank you, Kelly. As of today we do not have plans to start any operation in Brazil and we have seen and we have taken a great opportunity in Egypt and India and we will show you the result of these two initiatives in the next quarter. As I said in Brazil, we are waiting for the appropriate conditions to start transferring the Homex models to that great country.

Kelly Trenton

What about the Joint Venture, the Homex, Brazil? What is the situation of that?

Alan Castellanos

 

We are in the process of starting that JV and we are working on that process. And it is a very slow process and as a consequence of that we are not starting any operation in Brazil.

Kelly Trenton

So, the contract of thirty years you have there is not – you are not planning to continue it. Is that okay?

Alan Castellanos

 

As I have said when we do something in Brazil, we will give the information to the market.

Kelly Trenton

Okay. Thank you.

Operator

I will take our next question from Claudia Medina with Venture (ph) Capital Mexico.

Claudia Medina

Hello. Good morning to everyone and congratulations for the good results.

I want to elaborate a bit more in the expansion. I know, it might be too sensitive now but I was wondering of perhaps you could give us some colors or guidance as to the expected revenue from that new endeavor. Please.

Alan Castellanos

Yes, Claudia. As we have said more than one year ago, the board approved a budget of $10 million as part of our research and development initiative to learn from the experiences in other countries and to analyze the opportunities of transferring some portions of the Homex business models to those countries. As we have mentioned, it is a real small portion of our efforts and we will continue on that size for the future. We have just, as I have said this Indian JV is just a pilot project. A portion of this $10 million-budget in this project will represent close to 1% of our revenues in 2009 only.

Claudia Medina

Thank you very much.

Operator

I will take our next question from Sergio Molina with Bull Tech [ph] Capital Market.

Sergio Molina - Bull Tech [ph] Capital Market

 

Hi good morning everyone. I just have a couple of questions, one regarding the Homex India JV. I just want to know if there were any main reasons why joining India and not Brazil where you have good relationship with the Afisa [ph] and can take advantage of this. And the second one is regarding for raw material cost. What are your expectations for cement and steel prices you have for the remaining year?

Gerardo de Nicolas

 

In terms of the Indian JV, we have analyzed India as part of this initiative of analyzing countries with population equal or higher than Mexico and with similar conditions in terms of mortgage availability and we understand the opportunities in Brazil but the Indian initiatives has been working fast and we hope that we can do something in Brazil in the future. In terms of the raw material cost, we have seen some increases in terms of cement of around 10% during the year and in terms of the steel around 20% during the year. We have been able to increase our gross margins even with these increases in the prices of the raw materials and we believe that the pressure in the future will be lower than in the last two quarters. And we feel comfortable of being able to increase our gross margin even with these pressures in the future.

Sergio Molina - Bull Tech [ph] Capital Market

Okay. Thank you.

Gerardo de Nicolas

 

Thank you

Operator

Thank you. I will get our next question from Carlos [Furlong] with Merrill Lynch

Carlos [Furlong] - Merrill Lynch

 

Thank you, gentlemen and congratulations on the results. A follow-up question on the cost side on cement and steel, I don’t know if you answered this already. The contracts that you do, as for what period of time and could you tell us if you are currently negotiating this two or prices are already set for the remainder of the year. Thank you.

Alan Castellanos

 

Thank you very much and as I have said we have seen some pressure in terms of steel. We have annual contract and we are negotiating the renewal of that contract in terms of steel and in terms of cement we do not have an annual contract but we are working with most of the suppliers of cement in Mexico to find the best offer in each city. To reduce our cost and we have seen more competition due to the entrance of new participants in the cement industry in Mexico. And that is why we feel comfortable that the pressure to increase prices will be lower in the future.

Carlos [Furlong] - Merrill Lynch

 

Alright, thank you.

Alan Castellanos

 

Thank you, Carlos.

Operator

I will take our next question from Jorge Kuri with Morgan Stanley.

Jorge Kuri - Morgan Stanley

 

Hi. Thank you. Good morning. For the second half of the year, the mix between volumes and prices should be more or less what? If I look at the first half you have grown units 9%, prices 7% to achieve kind of like 16% revenue growth. What is your expectation for the second half of the year?

Alan Castellanos

Hi, Jorge. We believe that we will continue with these trends of increasing both volume and prices at this level in both the affordable-entry level and middle income and we are going to start to show some revenues from the tourist division mainly in the fourth quarter of this year.

Jorge Kuri - Morgan Stanley

The price increases that you have seen had to do with the change in the mix rather than from outright increases in list prices for your product. Correct?

Alan Castellanos

Correct Jorge. It is not a price increase in chain homes …

Jorge Kuri - Morgan Stanley

Yes.

Alan Castellanos

… it is a price increase because as I have said at the beginning, we are taking a higher percentage of co-financing mortgages on the affordable-entry level. As of today it is close to 14% and maybe last year was less than 5%.

Jorge Kuri - Morgan Stanley

Okay. And so how much can that grow – I mean how high can that number be? I am just trying to understand, a bit longer term, what the potential for price increases and the result of mix change?

Alan Castellanos

We believe that we will be able to grow a little bit more than inflation rate. We are doing it in terms of prices and one thing that I want to invite you to consider is that this customization program will help us to increase prices because the customers are utilizing in full their mortgage capacity in INFONAVIT with the same monthly deduction. We will be able to sell the homes at a higher price without affecting the monthly payment of the customers and that will give us support to increase the prices in the future.

Jorge Kuri - Morgan Stanley

Okay. And lastly – the second question is, what sort of returns in your capital are you expecting? I know this is very early stage but I am sure that was brought up before you committed the money. What levels of returns in investment capital are you expecting from your investment in India and in Egypt and how does that compare with the returns that you are generating in Mexico today?

Alan Castellanos

Yes. We are asking for the pilot project in India a higher EBITDA margin, taken into consideration the risks of this first project and the return, as you say, we are in an early phase to have the number but it will be very, very important the time that will take us to build the project. We have had great response from the authorities. We have the permits in one week because the government is promoting housing as a way to promote economic development in the region and the challenge is now on building the homes on time to increase the return on that investment capital.

Jorge Kuri - Morgan Stanley

I mean, at this point, what is the thinking of returns of investment capital should be there and how does that compare to the returns of investment capital to generating in Mexico.

Alan Castellanos

As I have said, depending on the time of construction. We can have better returns on this pilot projects. We do not feel comfortable of giving numbers at this time but we will keep you updated on the progress of this pilot projects in the next quarter.

Jorge Kuri - Morgan Stanley

Okay. Thank you very much Al.

Operator

And to the next question from Ivan Barona with GBM

Ivan Barona - GBM

Hi everyone. I was wondering with your land investment during the quarter. And we are looking at a few years in the first quarter of 2008 you have around 69 million square meters in reserve and we expect that you are doubling to in quarter over quarter to 140 million investment being in land. It has not risen that much and neither the accounts payable regarding land acquisition. We consider that this new land with extremely lower price than the other ones or that it lacks infrastructure spending that we shall witness some increase investment for this land?

Gerardo de Nicolas

Hi, Ivan. Most of the land that we acquire is land that we need to provide the infrastructure, as you said. And we will invest in the infrastructure of this new land in the future depending on the inventory level on each bidding and that is part of the land strategy and as Alan said we are taking into consideration the ability to grow because of the land inventory that we are achieving on each branch and the impact on taxes that will be reflected on the return on investment capital.

Ivan Barona - GBM

You mentioned that you will try to reduce your land bank in the medium segment going forward. Nevertheless, do you have any estimate regarding land investment during ’09? How much would we expect for further investment during 2008?

Gerardo de Nicolas

Yes. Ivan, we are, as I have said, we took advantage over the shift in the back loss and by the end of the year we invested a lot of money in land. We are rationalizing that investment this year and in the process of defining the most efficient in tax term strategy. We feel comfortable with the levels of inventory and we are reducing the sphere of growth in the land acquisition for the future.

Ivan Barona - GBM

Alright, so, we should not expect anymore land, well any divestment related to land acquisition during the rest of 2008?

Gerardo de Nicolas

Yes. Any [Inaudible].

Ivan Barona - GBM

Alright, thank very much.

Alan Castellanos

Thank you, Ivan.

Operator

I will take our next question from Dan McGoey with Deutsche Bank

Daniel J. McGoey - Deutsche Bank

Good morning gentlemen. My question was just regarding the pricing. You had a pretty strong average price increase in the affordable segment about 10% and the average price is now about Ps.270, 000. What then can you tell me if that is where a good deal of your affordable housing prices are or the numbers were skewed higher by some sales in the Ps.500, 000 and Ps.600, 000 level and then of you could also comment a little bit on I guess the receivable cycle for I guess what is the traditional INFONAVIT segment, historically that has been slower to get money paid back. Has that been improving this year and is that why you are operating more in that segment?

Gerardo de Nicolas

 

Thanks Dan. The average price increase in the affordable entry level is mainly because of more co-financing on that segment and we are starting to show the impact of the customization in that segment too. In terms of the INFONAVIT collection we have seen so many initiatives from INFONAVIT have been working and been applied as the INFONAVIT Empleado program to speed up the process and the remote capture of files that will be available for more homebuilders during the second half of this year and we believe that as INFONAVIT have shown in the last 8 years with all the initiatives to make the process more efficient. The agreement with Banamex is an example of those efficiencies that can be applied to mortgage processing, as you know, INFONAVIT is the largest mortgage processor in Mexico and they are still finding areas of opportunity to make the process faster.

Daniel J. McGoey - Deutsche Bank

 

Okay. You do not expect to see the saturation in the traditional INFONAVIT price range that maybe we saw a little bit more of, in 2007?

Alan Castellanos

 

Yes Dan. We have seen that situation in some of the file problems of INFONAVIT mainly on the traditional and in some estate. As we have said in the past because of our geographic diversification we have been able to reduce that risk and we are always analyzing those data to change our strategy and our mix to reduce the impact of that saturation of traditional housing in some states mainly at the northern region of Mexico.

Daniel J. McGoey - Deutsche Bank

Okay, understood. Thank you.

Alan Castellanos

 

Thank you, Dan.

Operator

I will take our next question from Adrian Huerta with JP Morgan Securities, Inc.

Adrian Huerta - JP Morgan Securities, Inc.

Hi. Good morning everyone. Hi, Gerardo. Hi, Allan. My question had something to do with your land strategy. We understand well why if what you are looking for is to pay more land easier in cash so you can reduce your cash payments. You will also be lowering your land levels in some of these medium size series. That is question number one. And the second one is, just how much did you invest in land last year? How much do you expect to make this year?

Allan Castellanos

 

Maybe we were not clear but what we need in the first half of this year is to acquire land and to pay for that land and that is why we believe that in the future we are going to acquire less land and as we do the payments on the first half. That is why we believe that we will make less payment during the second half of this year. I do not know if that is clear.

Adrian Huerta - JP Morgan Securities, Inc.

Yes. But will you also have to do large investment in, let us say, in 2009 as well; where you were able to reduce you cash taxes?

Allan Castellanos

 

But we have made those payments in the first half and we will embed in the second half. The payments will be lower than the first – compared with the first half.

Adrian Huerta - JP Morgan Securities, Inc.

But in 2009, Gerardo – I mean my point is, are you going to need to invest more in land every year from your cash flow in order to reduce your cash taxes?

Gerardo de Nicolas

 

The priority that we are following is, in the series where we can reduce our land inventories that are mainly the small and mid size series we are going to reduce our land inventories in both series. We believe that that would help us to increase our return on invested capital.

Alan Catellanos

Taking into consideration the tax flow.

Gerardo de Nicolas

 

Yes.

Adrian Huerta - JP Morgan Securities, Inc.

Okay. Perfect. Thank you very much Gerardo.

Gerardo de Nicolas

 

Thank you, Adrian.

Operator

I will take our next question from Francisco Chavez with BBVA Bancomer

Francisco Chavez - BBVA Bancomer

My question is regarding the SG&A expenses. In the last three quarters we have seen some increases in the SG&A due to your expansion strategy. My question is when do you expect that SG&A expenses will normalize?

Gerardo de Nicolas

Yes, Francisco. Well, the reason for the SG&A increase is because we have been investing heavily in locations and in products that are still not been completely on the revenue side and as a percentage of sales, it has been stable for two quarters. That the peak as a percentage sale was on December 2007 and we expect the normalization of that during next three to four quarters with the normal ratio for this. The main reason is because investment and an expanding of the footprint of the company.

Francisco Chavez - BBVA Bancomer

Thank you.

Operator

A reminder, dial 1 for question. I will take our next question from [Dennis Horacion].

[Dennis Horacion]

Thanks for taking my follow up. I am wondering, given that you have answered to the previous questioner’s inquiry. He said that it is likely under the current working capitals now that you end up free cash flow negative this year as opposed to your guidance for free cash flow neutrality. Could give us a little bit of color there about how much free cash flow negative do you think you are going to be and I presume that will absorb a part of the $200 million credit line. Some of the $200 million credit line will go to fund that negative free cash flow. Thank you.

Gerardo de Nicolas

Yes, Dennis. Well, in the strategy of the company is to privilege growth but we are not giving any free cash flow guidance for the year. If we come up with any investment opportunity, we will go for it and we are not in that arena. We are in the final planning for the last semester of the year. So, we cannot give any detail but we do know that because of our growth rates and our product mix we are now expecting positive free cash flow money.

[Dennis Horacion]

 

And to the funding of the negative free cash flow. Will that come out of the $200 million credit line?

Gerardo de Nicolas

Yes, it will come from that fund.

[Dennis Horacion]

Thank you

Operator

Okay. Our next question comes from Vanessa Quirago with Credit Suisse.

Vanessa Quirago - Credit Suisse

Yes, thank you. This is a follow up on the financing, the shift of customer financing from SOFOLES to banks. Today, so much of your volumes and/or revenues is financed with SOFOLES by your customers and if there is an outlook volume? Thank you.

Gerardo de Nicolas

 

Vanessa, percentage of home financed to our customers by the SOFOLES has been reducing maybe in the last four quarters. It is a small portion if close to maybe less than 10% of the home sold with a mortgage from SOFOLES and we are seeing a bigger share from the banks in the future.

Vanessa Quirago - Credit Suisse

Okay. Thank you. A follow up with regards to the India joint venture, you mentioned that you have an 80% stake on the joint venture but of that $10 million investment expected for the pilot program you expect to contribute 4 million. So, that would be actually $40 million participation. Is it correct to assume that your stake consists of other types of participations and I mean other than financial.

Gerardo de Nicolas

We have, as you said, we have 80% of the joint venture and we are planning to invest $4 million in capital and we are applying the Homex business model, the working capital type of management and that is the planned capital to be invested is $4 million that we will be invested by Homex. In that venture, the total sales of the project will be close to $24 million.

Vanessa Quirago - Credit Suisse

Okay. Thank you.

Operator

We have no further question.

Gerardo de Nicolas

 

Thank you very much for attending the call we will, as always, we will be available for you in the usual numbers. The replay of the conference call will be available for you about 15 minutes through the website and through the call-in numbers that you received with the press release. Thank you for your attention and we will be there for you to attend any further questions that you may have.

Alan Castellanos

 

And thank you very much for celebrating with us our fourth anniversary of Homex as a public company.

Carlos J. Moctezuma

Indeed. Thanks.

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Source: Desarrollador Homex Q2 2008 Earnings Call Transcript

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