Here's 7 Ways D.R. Horton Sets The Tone Of Spring Selling Season

Earnings calls are not the real world. This applies doubly so in homebuilding, where D.R. Horton – for all of its heft as the nation's No. 1 enterprise among its Fortune 500 peers, and the most prolific in the nation – does mid-to-high single digits in market share.

What D.R. Horton does, and adjusts to, and senses, and signals to the market, on the other hand, can hardly be overstated for impact. This is true always, in good times or bad, but especially when they're bad.

Horton constitutionally and its team members culturally hit numbers. Part of that comes of knowing customers so well that they not only recognize what they'll pay for a home they value, but also, down to the nail and the square foot of dirt how much those inputs should cost.

The other part – in a business where market share and operational efficiencies go hand in hand – means always aggressively taking share, of homebuyers, of renters, of vendor contracts, of land deals, etc.

This way, when the whole pie shrinks, you see homebuilders like the D.R. Horton team with a slice close to the same size it had before the pie shrank.

D.R. Horton's report to Wall Street investment research analysts this morning on its fiscal Q1 2023 earnings, comprising a three-month period that ended Dec. 31, 2022, attests to operational excellence with a fillip of hopeful tidings.

The operational excellence came through in a bottom line earnings "beat" – topping investor EPS consensus for the quarter $2.76 vs. $2.28 -- against a backdrop the industry hopes might be the worst-of-the-worst impacts of Federal Reserve strategies to choke off inflation by driving up borrowing costs.

Wolfe Research led its first look commentary on the financial front with a hat-tip to the operational outperformance in what was an ugly patch of business conditions:

Net, EPS of $2.76 beat our $2.21 estimate by +25%. Interestingly, GM of 23.9% came in +60 bps above our estimate and toward the high-end of guide, and the company sold ~1K SF/MF Rental units at a 33.6% Pre-Tax Margin, which is a positive surprise given the challenging 4Q operating environment.

The fillip of good news related to commentary from the field that includes 109 U.S. markets in 33 states. Namely, in the wake of easing mortgage rates in the past month or so, both new orders and cancellations have trended favorably during the first several weeks of the month of January.

The question other homebuilders are left asking might be this:

Has the pie stopped shrinking? Or is the D.R. Horton slice of the pie getting bigger?

We'll excerpt here a sampling of strategic and tactical comments from the D.R. Horton strategic leadership, as they offered high level perspective and answered a baker's dozen analysts' questions focused on the future of the company, homebuilding itself, and the economy.

No single "take-away" captures the essence of D.R. Horton's preparation, optionality, and resolve than president and CEO David Auld's declaration that the firm is on course to hit its numbers come what may.

As we enter into the spring selling season, we're seeing some seasonality that we're happy with as the market starts to lead and we'll continue to adjust to drive the absorptions by community.

Here's a selection of seven "meat and potatoes" topic areas – from the Seeking Alpha transcript [gated] of the earnings call -- that may impact both the housing market and rivals as each jockeys for its share of a demand market at risk of decline by an estimated 30% or more in 2023.

On Reason For Optimism

David Auld, President & CEO

We feel very good about our inventory position. And you know, through the through the last three, four quarters we limited sales to better align inventory cost demand and our ability to deliver. We are now positioned more in what I would consider a normalized inventory position and again, feel very good about our position and where we're heading into this quarter."

Jessica Hansen, VP, Investor Relations

We do expect to see normal seasonality in terms of the move from Q1 to Q2 sales. And so what we saw in terms of the increased sales activity in the first few weeks of January was a positive early indicator. It is still too early to ultimately say what's going to happen this spring, but it gave us the confidence to say that we could see normal seasonality, which typically would be about 50% up from Q1 to Q2 in terms of net sales orders. We also did see a slight improvement, it’s only a few weeks, which doesn't make a quarter, but we've seen a slight improvement in our cancellation rate in January as well, which also helps give us the confidence to say an increased level of net sales orders in Q2 versus Q1."

Pricing

Bill Wheat, Executive VP & Chief Financial Officer

Our net sales order price this quarter is around 367,000, I believe. And, of course, we peaked last year, a little over 400,000. So you're already looking at roughly a 10% decline in our net sales orders.

And as then we look at our margin guide going forward, we're taking recent pricing into effect. We're hopeful that if we see some normal seasonality and normal demand during the spring that further significant pricing reductions would not be necessary, but we're going to assess that week-to-week and month-to-month as we go through the spring. But our gross margin guide takes into account recent pricing along with the cost trends that we've already been discussing.

David Auld, President & CEO

We do, as an ordinary course use mortgage rate buy-downs and many of those are for the life of the loan. That's been a program we've had in quite place for quite some time. The costs do vary from time to time, depending on market conditions and timing of when you tie up those positions. But that's something that we try to make sure that we have in the toolbox for our salespeople is to be able to offer an attractive mortgage rates to buyers who come in.

It's going to vary community-by-community and over time as to what the most attractive incentive is, and we try to put a lot of tools in our division operators' hands to make the best decisions about what's going to motivate and drive their realtor and buyer traffic in their communities and excite our sales agents with a reason to call and a reason to drive some traffic this week.

So, it might be a little bit of a pricing adjustment on a few homes. It might be the rate buy-down, some mortgage financing incentives have been very popular, very heavily utilized. And it might be that supply chain is working back out that we're back to a washer-dryer Wednesdays. I mean there's plenty of incentives out there that we're going to use to drive a pace to hit a return we need to hit at every given neighborhood."

Pace

David Auld, President & CEO

We saw the starts kind of align with our sales pace in the quarter, and I think we're going to look to try to maintain that relationship through this time of the year as we're seeing good sales demand in the early spring selling season, we'll be replacing those homes with new starts to continue having inventory in the shelf available to sell.

We are certainly seeing more homes selling later in the construction process, certainty of delivery date, certainty of mortgage rate and payment are big important factors for our buyers. And we're also focusing very heavily on recovering our housing inventory turnover metrics and getting more efficient with those inventory dollars. Got to get our returns back up on our housing inventory."

As we see marginal improvement in our inventory turns and home construction times, you're starting to see and you see that in our numbers, a larger percentage of our inventory homes on the completed side, which allows us to meet the market, which quite frankly is available to us today, which is shorter-term close. And so we're seeing more homes sell and close in the quarter, getting back more towards historical norms, and we expect to see that on a go-forward basis with the maturity of the home inventory that we have."

We have a pretty aggressive definition of what's completed, it's when it gets into the final flooring stage. So typically, from a home hitting that completion milestone for us, normal conditions, it's probably going to take between two weeks to four weeks for that home actually to be moving ready and more likely to the four-week side of that.

So if we look at how many houses we have out there that are aging in the buckets, we have about 190 houses that have been passed our completion date by more than six months or more. So we still feel very comfortable about the freshness of that spec inventory, and this is the exact right time of the year to have that inventory, especially with the backdrop of very low existing home sale inventory available in the marketplace.

Jessica Hansen, VP, Investor Relations

And so as with everything, our starts are managed community by community, market by market by our local operators to focus on not piling up excess completed homes that have been sitting there for an extended period of time."

Expansion: Secondary, Tertiary Markets

Paul Romanosky, Executive VP & Co-Chief Operating Officer

We've seen these newer markets and secondary markets performing well for us due to limited competition in those markets. We certainly saw a strong push to all the secondary markets with a pandemic moving people making them more mobile that we've been happy with the progression in the secondary markets and glad that we entered them."

David Auld, President & CEO

Even before the pandemic, we did very well in the small markets. And ultimately, it comes back to SG&A and control and the ability to deliver houses incrementally add a competitive advantage to what anybody else out there is able to do. So, that that's been a part of our program and I think you're going to see continue to be a part of our program."

On Bringing Down Construction Costs

Michael Murray, Executive VP & Co-Chief Operating Officer

We've been really successful working with a lot of our trade partners in lowering our cost. And we've gotten a little bit of tailwind from certainly from the lumber price reductions that have occurred, but it just takes a while for those cost changes on the front end to actually show up in the closing, especially with the more recently prolonged build times.

So, it's just a function of the calendar working those new cost structures through the pipeline. So, the deliveries we see in 2003 were largely, first half of the year especially started in fiscal 2022 in a different cost environment."

David Auld, President & CEO

We're probably taking a conservative stance in looking at the fact that seasonally in a normal seasonal environment, we do see lumber cost increase through the spring -- and if we do -- are seeing some normalized demand coming back with the spring selling season, seasonality, would expect that to drive lumber prices higher, which would offset some of the efforts we've made on like-for-like cost reductions. We have been able to get new product starts out, new home starts out that are more reflected to today's environment, smaller homes, more affordable homes that should help -- but in terms of a like-for-like cost benefit increase, it's going to take a little while for that product to move through the system in a material way."

Jessica Hansen, VP, Investor Relations

Typically lumber prices go up as we move throughout the spring. So although we're seeing a benefit from lumber today, if typical seasonality holds, lumber would actually be a headwind against the cost reductions that we are seeing on those new home starts that Mike just alluded to."

Land

Mike Murray, Executive VP & Co-Chief Operating Officer

During the quarter, our homebuilding segment incurred $4.8 million of inventory impairments and wrote off $19.4 million of option deposits and due diligence costs related to land and lot purchase contracts."

David Auld, President & CEO

We have worked hard for the lot position that we have and the relationships that we've built and with those developer relationships, we're continuing to -- it's still hard to get a lot on the graph. And so our lot count as a percentage of owned and total numbers, we expect to continue to increase -- and some of that will depend on what we see with the spring selling season and through the rest of fiscal 2023. But we don't expect that to go down and we expect to see potentially our owned lot supply as a percent increase marginally through this market.

Jessica Hansen, VP, Investor Relations

And as a reference, again, our owned lots finished percentage is only 32%, which is roughly 43,000 lots. So, we're by no means oversupplied from a finished lot perspective, which is what we're trying to continue to position ourselves forward community-by-community."

Bill Wheat, Executive VP & Chief Financial Officer

Land is typically one of the stickier parts of the process. And as David and Paul both mentioned earlier in the call, it is increasingly difficult to get a lot entitled and on the ground. And so that is something that has held up pretty well. But anecdotally, there are situations where we're able to make some progress on the land residual with some of our land sellers. But not broad trends yet, for sure."

Water Rights

David Auld, President & CEO

There has been a lot in the press on water and water is and will continue to be a headwind throughout the West, not just in Arizona. And certainly, our acquisition and integration of Vidler has helped our positioning and that's really some benefit to the short-term, but mostly a long-term strategic decision on our part, knowing that we're going to head these -- facing these headwinds for the foreseeable future. I don't think there's been a significant change on a local basis. It's still difficult to get lots on the ground to get entitlements through the process and to get those permits. It has been for a while, and that continues. So, we feel good about our position -- the lot positions we have in the Phoenix market and we've got a great team on board there that continues to navigate through that environment.