Meritage Homes Corporation (NYSE:MTH)
Deutsche Bank 20th Annual Leveraged Finance Conference Call
October 10, 2012 06:40 PM ET
Larry W. Seay - EVP and CFO
Brent Anderson - VP, Investor Relations
Mike Stanchina - Deutsche Bank Securities, Inc
Good afternoon everybody. I’m the team head over the high yield credit in Deutsche Bank. We have Meritage Homes Corporation’s today presenting. They design, build and sell single family homes in Southern and Western U.S. And I would like to quickly call upon Mike Stanchina from DB to quickly comment here. Thank you.
Mike Stanchina - Deutsche Bank Securities, Inc
Welcome everybody today and it’s a great (indiscernible).
Larry W. Seay
Thanks Mike, (indiscernible). I want to thank Tom Bradshaw and Nishu, the other people at Deutsche Bank for hosting us. We appreciate being here.
I’m going to run through the first few slides pretty quickly here as most of you probably are at least somewhat familiar with Meritage, but first of all I want to point you to the forward-looking statement. Please take a read through this. We’re in kind of a quite period after the end of the quarter, so I can’t really talk about the quarter much, but we’ll try to answer your questions you may have.
Very briefly, we’re [a builder, it’s been in] business since 1985, 20 years of existence and we’re the ninth largest publicly traded company in the United States. We really are a top 10 builder in most of our markets and then a lot of them were the top five builder. We added three new markets in the last year, one in Raleigh-Durham, we’ve been operating in for about a year and then more recently we added a Charlotte operation that’s in a process of getting its first sales going in Tampa that started its first sales last quarter.
We’re primarily a move-up builder, building about 65% of our homes as move-up, the balance being a starter in a few Active Adult and luxury homes. We primarily have a build to order model, mean that we don’t build a lot of specs. That number bounced-up during the downturn to about 50%, but its scaling back down currently about 35% of our homes are a spec. Traditionally we built only about 10% or 15% of our homes are spec, so usually a pre-order kind of basis.
We also don’t have a huge long land supply. We like to have about four or five years of land. We’re not a long-term the land speculator. On the other hand, we do like to have enough lots to make sure our pipeline has adequately filled, so we can plan our business.
State of the housing market; obviously if you’ve been talking to home builders, people are pretty happy about what’s been happening in the last year. So the recovery kind of started to show itself more permanently in the spring, February to March. So the recovery we think is sustainable. We think that the pent-up demand that has built up from people deferring household formation is going to help [buoy] the recovery, high affordability not only with house prices being very low, but also interest rates are being as low as they’ve been in decades and all that translating into improved buyer confidence that keep buyers actually in house prices bottom and stabilize and start to go up. So we really think that all of that means that there’s going to be a continued housing recovery over the next few years.
There are few things that are out of control, the election, European issues. But we don’t think these are going to impact the housing market very much. If at all, because of all those other things, because of the affordability in the pent-up demand. We do think that the governments recognize that improving home building market is very important to the overall economic recovery with these set actions on having the quantities using three (indiscernible) that’s focused on long-term more the years and also the Obama administration I think doing things later in anticipation to boost housing. All those are positive and we think it will again be more of a long-term recovery at this point.
Strongest orders we’ve had in years, these – the charts here show our net orders year-over-year, up 49%. Order value up 63% for the quarter, where August was our 10th consecutive month. Prices had been going up, closing the revenue [up]. Most of that price increase over the last quarter that the year-over-year 10% increase was driven by mix as usual we were selling more houses in high priced states of California. We are also selling larger houses, largest was 3,000 which is driving sales prices up. But a portion of that was true price increase maybe somewhere around 2% or 3% was two price increase. So we’re seeing top-line being driven by order growth, but also by real average sales price increase too.
So, we are reporting very good orders. The orders in the second quarter as I said were up 49%, the highest of the group, and we’ve been the highest in the group over the last (indiscernible) three quarters. So we’re pleased with how we’re doing compared to the competition. We also are seeing on the bottom part of the slide, seeing our sales per community increase. So the last quarter – the second quarter we were selling nine houses per community per quarter or three per month. That’s a very good number in the industry and particularly since we’re moving -- we’re selling a move up product that’s higher priced than some other lower priced builders who should have a lower sales or higher sales rate because they’re selling at lower price.
So we’re very pleased with our performance and so we’re not only growing revenue because we’re growing average sales price, but we’re also selling more homes per community which is the easiest way for us to know revenue because you can do that without adding community account. So that’s definitely helping us. Why we think we’re selling more houses is we’ve been very focused on buying land in the A and B better locations in all of our markets. We’re not buying out in the C and D location so they’re premium quality in-fill type low patient.
We are also selling a better home. Well, all of our homes have been redesigned, fulfilled to current phase. A lot of times we’ve made the houses bigger, taken out some of the (indiscernible) that people wanted before the downturn, but don’t want now. So we’re giving people really good value on a price per square foot and we’re also selling our green energy efficiency homes which nearly all of the homes we’re building today have a package of Green features, home installation of high-E or low-E windows, high SEER air conditioners which make our homes more affordable operating typically about 40% less expensive in the typical (indiscernible).
All of this translated into us having higher gross margins on average within most of the people in the industry and that’s another way we’re growing not only top-line, but focusing on growing the bottom-line even more by boosting our gross margins. But we’re at 18.2% for the last 12 months were 18.5% for the last quarter. We’re shooting towards a 20% normalized gross margin. So we have about 1.5% here or two expand margins and to drive more profit to the bottom-line.
We have been increasing prices, but as I said before, but some of that is being eaten up by cost increases and I said the 10% increase we had last quarter about 3% is true price increase and about 1% or 2% of that is been eaten up by cost increase. That’s being caused by as the home building industry re-grows and the suppliers and subcontractors we deal with scale back up, they’re having to hire new labor crews, its taking them a bit to pull people back into the industry that got all the industry in the downturn. So in order to do that, they’re having to pay a little bit higher wages.
Not seeing as much kind of cost push on the material side, and most of that’s commodity driven and because of the -- kind of slower global economy, we’re not seeing a lot of push there. We’re seeing some push in some of the manufactured products like dry board and lumber, but even lumber has -- that has gone down a little bit more recently. So moving on, as -- the other kind of way we’re drawing the bottom line is by leveraging overhead and we have really a lot to pick up here. This chart shows how the leverage worked from the second quarter of last year to the second quarter of this year, how we’re picking up basis points by leveraging sales cost, but more in particularly in leveraging G&A and interest cover.
We think we can pick up and get back to maybe more normalized 7% or 8% pre-tax margin by picking up two or three percentage points on G&A and interest coverage. So when you add that to what we’re picking up on the gross margin line with what we’re making today you can push us back up to that 7% or 8% pre-tax which is kind of our interim target here. So growing the top-line through revenue increases, average sales price increases through selling more houses per community, growing our unit deliveries, leveraging overhead and interest expense. That’s how we get back to making more normalized product.
I’m going to go through our hardest markets right now, 3 or 4 of our hardest market. We’re in Arizona, Phoenix particularly that’s kind of ground zero for a strong recovery, single family permits up 54% year-over-year. Listings down 30%. Listings at the bottom of the downturn were over 50,000 NLS listings, today they’re around 15,000. So the clearing of the excess inventory has happened as portability has gotten better, interest rates remain low and as investors have bought up some of the foreclosure type housing and taken them off the market, fix it up when, rent it out for two or three, four years until prices improve, so this is all helping clear the excess housing and also we’re seeing just the lowering of foreclosures now as prices have stabilized and improving people would held on, are not defaulting on their houses. So pre-foreclosures are down. So the market is starting to stabilize. It hasn’t gone there yet, but it’s starting to get there and you can see from the Green [badger] and the red circles how much first and second quarter are up year-over-year.
Moving on to the next market, California. We are the ninth largest builder in Northern California, eight largest in Southern California. The Northern California market is particularly strong single family permits up year-over-year, listings way down, low inventories, again the same thing is driving Phoenix or driving Northern California, dramatic sales increases almost going up by double or triple in the second quarter. So we look at California and think that that’s another great market for us and are very happy with our performance there.
Colorado is another great market. We’ve done a great job taking advantage of this market; we’re the eight largest builder there. Not quite as dramatic, we’re seeing single family permits up 28%, listings down 23%. Again, good year-over-year increases, not quite as dramatic as Phoenix, [Arizona and California] but another good market for us and we see an opportunity in this market as other builders, other public builders have pulled out in the market. There’s less public builder competition here. So we think we can continue to grow our position and become a more dominant builder in Colorado.
Florida, we’re the fourth largest builder in Orlando. Prices up almost 10% there, again permits up 41%, listings down. Similar story across all these markets that were very hardly hit during the downturn are now bouncing back off of a very low base. Again year-over-year our comparison’s for the first two quarter is very positive. And then an expansion market as I said we were expanding into North Carolina, we’re very pleased with that. These orders are coming from our Raleigh division. I don’t have year-over-year comparisons, but again the single family permits are up year-over-year, listings are generally down somewhat. So we’re very pleased with this market.
We didn’t have Texas here. Texas is doing well for us, but on the other hand it did not have the big fall off during the downturn. It did not have a big housing recession, sure it was hit more by the economic slowdown, but it didn’t have a huge housing depression. It didn’t take a lot of write-off there, didn’t have the big fall off. So we’re not having a big bounce back off of lower bottom. It’s doing well, but percentage increases aren’t nearly as large in Texas as that market is recovering but it’s not recovering on such a low base.
With that, I am going to turn the presentation back over to Brent and have him up kind of talk through a few more slides and wrap up for us and then we’ll take questions.
Okay, Larry. So we got a lot of questions about land supply, land availability; so I am going to address some of those. Meritage had a strategy historically of using options to grow and keep our debt at a manageable level. Use of lower land supply to be able to still grow the business top-line, bottom-line but put the risk of land ownership on someone else’s balance sheet. That helped to protect us during the downturn by not being settled with too much land, too much debt to – that was used to acquire that land. And consequently we don’t have a lot of legacy lots today.
So other builders that may have longer land supply in terms total years of supply of land, rather that land is in legacy communities and it’s at a cost basis that doesn’t really allow them to bring it back online and turn decent margins with it. So they could bring it back, but it would be detrimental to their margins. So they’re out there looking for land and acquiring new land positions just like we are.
We’ve got 17,500 lots today as you can see that we’ve been growing our lot supply since 2009. We were one of the first ones back into the market started acquiring new lots and land positions while most of the other builders were still sitting on the sideline. So that has allowed us to position ourselves very well within the markets. We’ve probably got the best land position of any builder in the Phoenix area. We’ve got a great land position in Florida. We’ve repositioned within our markets in Texas. California we have got great land position. So options are still desirable, but they just haven’t been economical if even available. The land bankers that were in business that provided those options during the upside of the cycle basically disappeared during the downturn. Now they’re just starting to come back into the market.
So this kind of shows that we’ve repositioned during the downturn of course. Texas represented a much larger percentage of our closings and therefore that’s where our land supply was concentrated. As we’ve re-grown some of those other markets that were harder hit like Arizona, California, Florida, we’ve also re-grown our land supplies in those areas so that today we have a much more balanced land position that will lead to much more balanced deliveries in the future. So the availability of land, we get that question all the time. How constraint is the land supply?
Finished lots in A & B locations at reasonable prices are very constrained. If they’re available at all they’re – its scarce and in very limited markets or submarkets. So what we’ve done is kind of shifted gears earlier again than mostly other builders. We started acquiring undeveloped lots and finishing those because we can acquire the undeveloped land and develop it for lower total all in cost than what may comparable finished lot price would be today. So about 75% or so of our lots that we’ve been acquiring are undeveloped lots within the last year or two. And we are acquiring lots in as Larry said and I mentioned only A & B submarkets. Now how do we define A & B submarkets?
Well during the worst of the downturn, we were -- we got a lot better at how we go about purchasing new land position. We use a much more empirical, strategic research, an analysis process today. We gather data on not only the demographics of a community but the supply and number of listings and trend of listings and foreclosures, what's happening with prices, what's happening with actual sales, the trends of sales, number of days on market. We put all that stuff into a huge database that we then use proprietary tool set to run analysis against and generate basically graded A, B, C, D submarkets and then we send our division land people out to look for lots only in those markets that we grade as A & B and stay away from C & D submarkets.
So we’re at – at the end of June, we were at a 151 communities. Now our target is to be up to about a 165 communities by year-end and up to around 200 communities by the end of 2013. So, the community count growth is one way to grow our top-line, increasing our sales per community is the other cheap way and then as Larry said we’re also increasing prices.
So turning to the balance sheet we’ve got a stronger balance sheet by far today than when we – even when we entered the downturn. We have more liquidity today both in terms of cash on the balance sheet and available credit facility. We pushed out our maturities with $300 million debt offering back in April, so our earliest debt maturities today are 2017. We did an equity offering in May raised actually – excuse me, completed it in July, raised $87 million through that. We raised another $123 million by issuing more (indiscernible) convertible bonds just last month and then added back $125 million credit facility. We’ve done without a credit facility for several years.
So with $415 million of cash and marketable securities on our balance sheet as of June 30th and the additional capital. Our net debt capital ratio on an adjusted pro forma basis is only 35% today, so we feel that we’re very well positioned for growth.
As you can see on this chart that we're actually in the – under the median net debt capital ratio for the industry. As I said, that should allow us to grow and yet mitigate our risk. We’ve got $87 million in deferred tax asset that’s off the balance sheet fully reserved. We expect that we’ll be able to re-book that in the next several quarters and potentially late this year or in 2013. That $87 million deferred tax asset should offset the cash taxes on a roughly $200 million in Federal taxable income. We reversed a portion of it last quarter for Florida.
Just recapping our strategies that have served us very well to-date. Corner stone as I just covered. Strong balance sheet, we're somewhat risk averse and that we don’t want to be settled with too much debt to keep our debt equity, our debt to capital ratio low, manage our land supply at a lower level so that we don’t have to take on all that debt and use options where we can to control land without having it on our balance sheet. We’re dedicating new capital only to A & B submarkets that we’re defining through a very rigorous strategic market research function that’s new within the last three years.
We have totally redesigned our product during the downturn to offer more value to customer, home buyers through better designs at a lower cost and by building much more energy efficient homes. So the operating cost, utility cost on a month-to-month basis is on average today roughly half, 40% to 60% of what it would be in a standard code built home, new home today. And we have the opportunity to grow profitability top-line through unit growth in more communities, more absorptions per community, increase in our gross margin and increase leverage on the G&A and interest expense end of it.
So in summary, we believe that the market conditions that have been improving over the last 9 to 12 months will continue. This market does have [legs]. The increased demand is sustainable and we believe that we are very well positioned to grow within that environment. We’re projecting 4,000 to 4,300 closings for 2012. We haven’t necessarily given guidance yet for 2013, but we’ll update our guidance when we report third quarter results here in a couple of weeks and we expect to be profitable for 2012.
We were one of the first builders back to profitability in 2010. Market softened again after the Federal tax credits expired in 2010 and so 2011 we slipped back into a small loss position. 2012 we’ll be solidly back into a profitable position and we expect to grow that again next year.
So with that, I’ll wrap up and open it up for questions.
A lot of foreclosures in the A & B submarkets, anymore those were the first homes to clear the market and be resold by the banks. So even though we’re still seeing them to a lesser extent, it’s not impacting our positions that much today in the A & B submarket where you’re continuing to see more foreclosures is out in the hinterlands in the C & D submarkets where things are still much softer.
So, a lot of things about real estate are very submarket specific and that is one of them. So I don’t think it will hurt the ability for us to grow our business because there is enough demand from regular home buyers who live in their homes and between investors that the excess supply that was out there has gotten used up and continues to be soft-up by the current demand.
So I don’t see that as being an issue for us going forward if anything, over the next couple of three years it will slide back into a normal foreclosure environment.
Larry W. Seay
It’s a very difficult process. It’s a whole different buying process to purchase of foreclosed homes, to navigate that, that market is a difficult thing for most buyers to do unless you’re an investor and you understand the [working of that].
So we have story after story of buyers that have gone out there thinking that they will get a great deal picking up a foreclosure and bargain basement prices and they just get frustrated and fed-up with looking for, bidding on homes and not getting anything and they end up going back into more of a regular home buying whether its new or used. The other thing is just they have (indiscernible) the inventory is not there today.
Any other questions? Okay, well we appreciate your time. Thank you for coming.
[No Q&A session for this call]
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