PHM - NYSE

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

Great, thank you Abbie. We appreciate everyone joining today’s call to discuss PulteGroup’s third quarter operating and financial results. As detailed in this morning’s earnings release, PulteGroup delivered another quarter of strong earnings as we continue to capitalize on our competitive strengths and balanced approach to the business. Joining me on today’s call to discuss our Q3 results are Ryan Marshall, President and CEO; Bob O’Shaughnessy, Executive Vice President and CFO, and Jim Ossowski, Senior Vice President, Finance. A copy of our earnings release and this morning’s presentation slides has been posted to our corporate website at pultegroup.com. We’ll post an audio replay of this call later today. We want to inform everyone that today’s discussion includes forward-looking statements about the company’s expected future performance. Actual results could differ materially from those suggested by our comments. The most significant risk factors that could affect future results are summarized as part of today’s earnings release and within the accompanying presentation slides. These risk factors and other key information are detailed in our SEC filings, including our annual and quarterly reports. Now let me turn the call over to Ryan. Ryan?

As you would anticipate, given our 43% increase in net new orders, we saw strong demand throughout the quarter. Q3 displayed more typical seasonality than we have experienced in the three years since COVID as absorption pace eased as we moved through the quarter. Demand has been a little choppier in the first few weeks of October with more volatility in the day-to-day sales numbers. I’m sure for some buyers, higher rates have pushed affordability just that much further away, while others may be worried about their jobs. For other buyers, global unrest may simply have them thinking of other things. We are fortunate to have an experienced operating team that will make adjustments if and when needed. On a year-over-year basis, for the first nine months of 2023, we have increased net income by $156 million and increased earnings by share by 17%. Over the same period, we’ve increased our cash position by approximately $1.6 billion while dropping our net debt to capital ratio effectively to zero. Based on guidance that we’ve given, we look forward to delivering exceptional full year results for 2023. From population growth and demographics to supply dynamics and the tremendous opportunity for wealth creation through home ownership, we are bullish on long term housing demand. Over the near term, however, we fully appreciate the affordability challenges being created by higher mortgage rates and the potential impacts from an economic slowdown the Federal Reserve is hoping to bring about. As such, we remain disciplined in how we operate our business particularly as it relates to investing in land, the pace of production, the allocation of capital, and the quality of homes and experience we deliver to our customers. We have a clear and successful operating model against which we have been executing for over a decade, so decision making throughout the organization is consistent and actions are implemented quickly. This strong organizational foundation along with tremendous financial strength has PulteGroup well positioned for ongoing success. In closing, I want to thank the entire team at PulteGroup for their tremendous efforts in delivering for our home buyers, our shareholders, and each other. I am so proud of what you accomplish every day. Let me turn the call back to Jim so we can begin Q&A.

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

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

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

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

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

Yes Carl, happy to talk on October. As I mentioned in the prepared remarks, we’ve seen sales in October, while good, they’ve been a little bit choppier than--you know, the day-to-day kind of numbers have been a little choppier. I think the biggest thing that I’d want you to hear is that similar to what we saw in the third quarter, we actually have seen a return to what we would consider seasonal type sign-up trends that we experienced pre-COVID, and we’ve seen that continue into October. On an absorption rate, the numbers that we’re seeing on absorptions per community are pretty similar to what we saw in 2018 and 2019 pre-COVID levels, which were pretty healthy, so all things considered, we feel pretty good about the continued ongoing desire for home ownership. It’s not lost on any of you out there listening, rates matter, and there has been a lot of rate movement over the last 30 days, and so I think the consumer, all things considered, has handled that really well.

Great, I appreciate the color. Thanks, fellows.

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

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

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

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

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

Got it, thanks Ryan. Good luck, guys.

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

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

Right - no, appreciate that, Bob. I guess secondly, maybe bigger picture conceptually, you talked about earlier in the call questions around your higher gross margin versus your peer group. When you think about the 6% today versus 2% a year ago, and I don’t know if that 6%, I want to say it’s a little bit above your longer term average maybe around 3%, how does that square with the level of gross margins you’re generating today, and if you think about over the next couple years, we’ve heard different things from different builders about maybe increasing hurdle rates from underwriting about--you know, just thinking about higher cost land perhaps might flow through over the next couple years. You know, if incentive levels stay where they are, would that suggest kind of a moderation a little bit from the current level of gross margins, or how should we think conceptually about the next couple of years directionally for this metric?

Yes Mike, our crystal ball at this point, a couple of years out, we’re not there yet. We’re still kind of focused on Q4. We’ve given a guide for that quarter, when we get to kind of the end of Q4, we’ll certainly give a full year guide for the balance of 2024, but maybe the thing I do want to address is the incentive load that we currently have, that is allowing us to offer incentives on the interest rate, that’s been in our margin guide and our results for the entire year. You’re seeing the impact of offering below-market interest rates as an incentive. It’s been in Q2 results, it was in our Q3 results and it’s in our Q4 guide, so no guidance about what margins direction will be beyond Q4 of this year, but that’s all embedded in our--you know, to this point, everything that we’ve been doing, that’s embedded in the results that we’ve delivered and the guide that we’ve given.

Appreciate it.

We will take our next question from Joe Ahlersmeyer from Deutsche Bank. Your line is open.

Hey, good morning everybody. Thanks for taking the questions. I appreciate the data point about the active adult community in Michigan - hopefully snow removal is included in that HOA fee!

In fact it is, Joe.

Good. Look, market conditions, that’s what’s going to determine the margin volume and price into next year. I think it’s an under-appreciated element of your business. Of course, the composition of that can vary, right, within the definition of success, but you are obviously appropriately acknowledging the headwinds here. Maybe if you could just talk instead to the return headwind from this, instead of either the absorption headwind or the gross margin headwind, just how are you thinking about returns on capital, and then similarly returns on inventory if interest rates remain high? You’re basically at net zero debt now. Just how you’re thinking about ROE relative to ROI.

Yes Joe, thanks for the question, and I’ll do my best to give you an answer. For the last decade, maybe even going on 12 years, the way that we’ve operated the business has been with a singular focus on delivering the best possible return on invested capital that we can. Given the capital intensive nature of this business, for us we think that’s the best way to make decisions and to operationalize our platform in a way that delivers high return on assets, high return on equity, whatever metric you want to look at. I think we’ve clearly done that. I highlighted in my prepared remarks that for the trailing 12 months, we delivered return on equity over 30%, and part of that derived from running a good business but also a very thoughtful and disciplined way in allocating capital, which includes things beyond just buying land and building homes. We are paying a dividend, we’ve bought back near 45% of the company over the last 10 to 12 years that we’ve had our share buyback program in place, and we just highlighted this quarter we opportunistically took advantage of the opportunity to buy some debt in, near term debt in that was trading below par. You know, I think maybe the best way I can describe it, Joe, we’re going to continue to focus on buying assets in great spots, turning those in a way that delivers high return on invested capital, and one of the other things that I think can also continue to give us flexibility and return-enhancing leverage is moving our land options to 70%, so. We sit at 53% today, we’ve given you kind of a long term target of 70%. We’ve got things in place and work underway that will help us get there.

Appreciate all those thoughts, Ryan. As a follow-up, just maybe on the comment around matching starts to orders, should we interpret that as roughly 7,000 starts in the fourth quarter, or is that more of a comment on what the fourth quarter orders look like, that’s what your starts might look like?

Yes, fourth quarter starts will be more reflective of order trends that we’re seeing in the fourth quarter. We’re starting more spec than we historically have. We’ve highlighted that we’ve completely moved our first-time business to a spec business, so some of that’s predetermined based on what we saw in the third quarter and what we would anticipate. But we’re just not going to get into kind of a position where we’ve got a build-up of spec inventory that creates pressure to do things that are unnatural on the pricing, but we are going to put some units in the ground to have those ready for Q1. You saw us do that last year, in the back half of last year that set us up for a really strong Q1 of 2023, so. You know, I’d want you to hear balanced approach, inventories going into the ground, we’re going to have it ready for Q1, but we are going to be responsive to some of the headwinds that we’ve acknowledged are out there in this current rate environment.

Sounds good, thanks a lot.

We will take our next question from Stephen Kim with Evercore ISI. Your line is open.

Yes, okay. That was really helpful. Appreciate all the nuances there. My second question relates to getting back to sort of the seasonality. It sounds like you’ve acknowledged that seasonality is sort of coming back into the business. In the fourth quarter, it’s a little weird, right, because the housing market kind of generally slows, particularly in the last six weeks of the year, and I’m curious as to your posture as you assess the buyers. Are you anticipating--do you generally think that there’s relatively more inelasticity on the part of the buyer, or relatively less elasticity might be a better way of saying it, so that it causes you maybe not to push so aggressively on incentives to try to keep up sales momentum in the last six weeks of the year, kind of like pushing on a string. Is that a reasonable way to be thinking about how you’re likely to approach the market over the next six weeks--I’m sorry, in the last six weeks of the year? Then lastly, regarding risk, you had talked about wanting to evaluate all of your land actions in terms of risk adjusted returns, but you’re also running at a super low net debt to cap, and I’m curious if you move to lower risk through increased incentive--you know, increased land banking, would it be reasonable to think you’ll also carry increased leverage than you currently are today?

Yes Stephen, we are at a very--we’re at a lower leverage rate than what we’ve historically run at. I think that really more than anything, it’s a testament to the strength of the business. We’ve been operating really well and we have been generating a lot of cash. We’ve really been touching kind of all the critical parts of our capital allocation philosophy. We’ve invested a lot of money into land and land development, we’ve been paying our dividend, we’ve bought back the highest single quarter spend in shares this year in the third quarter at $300 million, and we bought back some debt, and with that, we still grew the cash balance, so I think it really demonstrates how strong the business is operating. In terms of your question on pricing and discounts and elasticity or inelasticity, we’re going to continue to price and set incentives at a level that we think is appropriate for the market. We’re going to be responsive, we’re not going to be margin proud. At the same time, I think we’ve got a good understanding of what value is, and you shouldn’t expect to see kind of the national year-end blowout, red tag kind of screaming baby sale from us - I don’t think that helps the consumer. But I think you’re seeing us put the appropriate incentive load such that we’re turning the asset, we’re turning the inventory, we’re making sure that we’re getting a minimum of two sales per active community, which is kind of the level that I think you need to be at in production homebuilding to deliver the types of return on assets, return on inventory, return on invested capital that we want.

Perfect, appreciate that. Thanks guys.

We will take our next question from Ken

Good morning everybody.

Morning Ken.

Right, you were talking returns, right? You’re a return-based company, even though the street and you guys focus a lot on margins. To the extent the first-time buyer, more spec, finished lots so you get better terms, you guys mentioned finished lots, I believe for the first time, so what is the impact of the finished lots? Are you closing finished lots? What type of margin impact is that?

Ken, it’s Ryan, I’ll jump in on that. We haven’t sliced the bologna quite that thin, and I won’t attempt to do it on this call. We are a return-focused company. There is no change there. I think we’ve been the purveyors of the message, we don’t focus on margin, it’s a component of the overall operating model. We’re focused on return, and depending on the number of units we sell in a particular community and how quickly you turn the asset, if you do that fast enough, then it can offset and you can allow for lower gross margins. If you’re getting a lot just in time and somebody else is developing it and carrying it, and we can build in the hundred days that we’re talking about, it allows us to run a high returning business at a lower margin. That’s not a new concept, that’s exactly what we do, and it’s exactly what we’ll continue to do.

As a reminder, we ask that you please limit yourself to one question and one follow-up question. We will take our next question from John Lovallo with UBS. Your line is open.

Good morning guys. Thank you for taking my questions. The first one, so rates at 8% today, you guys are buying down to 5.75%. Can you just remind us, last quarter when rates were closer to 7%, what level you were buying down to?

Yes John, we were--I think the lowest we were was 5%, 5.25% at a national level. We had some specific markets that may have been sub-5% at 4.99%, but basically as you’ve seen the headline rate move from 7.5% to 8%, you’ve seen our promotional rate move up by that same 50 basis points.

Okay, and you would anticipate probably taking that same strategy as we move forward, if rates were to move up?

I think generally, that’s a good rule of thumb. I mean, there is--I think practically speaking, there’s a limit to how much money you can throw at the rate relative to what the headline number is.

And then we haven’t given anything for ’24 yet, John, but as we’ve said in the past, you can see the capital that we’ve spent, for the land that we’ve spent this year, a pretty good indicator of what community count will be in the future, or you can use as a proxy for what community count can turn into in the future.

Got it, thank you guys.

We will take our next question from Mike Dahl with RBC Capital Markets. Your line is open.

Morning, thanks for taking my questions. Ryan, just to pick up on one of your last responses in terms of the practical limit on how much you can throw at the rate buy-down. I mean, we’ve heard different things from different builders, depending on whether you’re doing fewer buy-downs versus the forward purchase commitments which I think you alluded to earlier, and kind of what is and isn’t considered seller contributions, can you maybe elaborate a little bit more on the details of how you’re executing in the case of going down to 5.75%, how you’re executing that? Is it--like, how much is allocated towards the forward purchase commitment versus the pure points, and do you consider the purchase commitments and the cost of that as part of your seller contributions?

Yes, so I don’t want to give away all of our trade secrets on that, but suffice it to say there are different rules based on who is--depending on which government agency rules you’re using for that mortgage program. For the upfront fees that we’re paying on a forward commitment, because those are done prior to having a home under contract, those fees do not count toward seller contribution; but there are additional incentives that have to be applied to the deal--that do have to be applied to the deal once the home’s under contract, those do certainly count towards the seller contribution, so to get to 5.75%, you’ve got some fees on the front end, you’ve got some fees on the back end. We do look at them in the aggregate, and those are the numbers that you’re hearing Bob talk about.

Okay, that’s helpful. Then my follow-up is if we think about the movement in rates, I don’t know if you’ve looked at it this way, and I’ll ask it in a historical context year-to-date, if you look at your year-to-date orders or closings, maybe let’s focus on closings, have you run an analysis of how many of those buyers just wouldn’t have qualified at today’s rates versus the rates that you were able to get them year-to-date?

No, we haven’t run that analysis, no. I would highlight that no matter the rate that we’re offering, we qualify the buyer on the 30-year, so a lot of the incentives that we’ve been doing have been 30-year fixed rate, so that is the rate we’re qualifying, but in the case that you do a temporary buy-down, the buyer is qualified at what the permanent 30-year rate will be. I think everybody knows that, but I think it’s worth highlighting because we don’t--none of us wants to see the industry back in a situation that we were in, in 2008.

Right.

We’ll take our next question from Alan Ratner of

Hey guys, good morning. Thanks for the info so far. Switching gears a little bit, I guess what I’d like to hear your opinion on is maybe what opportunities could potentially come about from this recent, I guess, softening or choppiness that you’re describing. Your balance sheet is obviously in fantastic shape, so is pretty much the rest of the public industry, but we are hearing anecdotes of AD&C capital tightening up for private operators and land developers, and we’re hearing build-for-rent deals potentially falling out of favor here. Have you started to see any increase in either distressed or opportunities that you feel like you might be able to take advantage of, if these current conditions persist for a handful of quarters?

Yes Alan, I think we’re hearing the same things that you are, particularly on maybe availability of capital or the cost of capital on the land development side. There’s definitely, I think, some strain or tightness in that arena. I think that certainly might continue to create an opportunity the longer that we stay in a high rate environment. I think it’s also a great opportunity for us to take market share. With our mortgage company, the size of our balance sheet, the ability to be active in the capital markets, I think it gives us an opportunity to do things that smaller local builders and maybe private builders can’t, so I think there is certainly a market share opportunity there as well. We’ve made build-to-rent a small piece of our business. We’ve got good relationships with national partners that we’re building some percentage of our annual deliveries for those operators, and I think we’ve talked extensively about that, that it will continue to be an arrow in our operational quiver. Look - I’m really, really confident and pleased with the way we’re operating. The health of the business, the volume that we’re selling in kind of the core operations, and then when you go to the balance sheet, I think we’re set up to do a lot of great things that will continue to set us up for success down the road.

That’s helpful, Ryan. Then I guess other builders have kind of put out an absorption target that they manage their business to, that tends to be maybe more the spec guys, entry level, where volume is certainly more of a consideration. But I’m curious, when you think about your price outlook and your margin profile and where your incentives are currently running at, right now you’re absorption pace is you’re probably going to be in the mid-2s somewhere. Is there a level where, if that pace dips below, that you would get much more aggressive on incentives, discounts, and even adjust base prices again? What would that level look like?

Yes Alan, it’s a good question. The thing that I talk about with our operators, and I spend a lot of time in the field in our communities, in our division offices talking about exactly this, the mantra that we have inside the company is a minimum of two sales in every community. Now, certainly we have certain price points in communities that sell way more than two per community, but as a production homebuilder, it’s hard to have an active store that does less than two, you just--you know, you can’t make the returns work to the level of our expectations. Below two per active community, that’s where we start looking at, hey, we are positioned right, do we have the right incentives, do we have the right pricing, do we have the right product, are we going after the right consumer? There’s a number of those levers that we pull, but it nets out to for this quarter, we were 2.5, but that two per community is kind of the level that we look at.

We will take our final question from Truman Patterson with Wolfe Research. Your line is open.

Hey, good morning everyone, and Ryan, the screaming baby sale got me - I think that kid’s probably in high school or college by now.

We’re going to the way-back machine, Truman.

Exactly, exactly. You all--I’m trying to understand, your orders for entry level were performing well in the third quarter - I think you said up, like, 53% year-over-year, but then you mentioned some more cautious commentary about that buyer. I’m just hoping maybe big picture, if you could help us think through the monthly incentives needed for that buyer cohort versus you mentioned active adult, maybe move-up, more affluent, not needing quite as much. I’m just hoping you can help us just kind of understand these bigger trends that you’re seeing near term.

Yes Truman, look, I think we’re really pleased with what our first-time business is doing. We’ve invested in it, and we’ve said our target was to get it to kind of 40% of our business, and we’ve done that. I think you’ve seen not only growth in absorptions but growth in communities, and the business is about where we’d like it to be. On one hand, that buyer doesn’t have a home to sell, they’re not locked into a low interest rate that they’re reluctant to get rid of, so I think that’s the positive with that first-time buyer. In terms of the headwinds, I think it’s obvious - it’s 8% interest rates, and that’s a buyer that’s got a down payment, hopefully, either they’ve saved it or it’s been gifted to them by parents, and then they’re going and getting a 30-year mortgage and they’re working on what they can afford based on their wages. The good news is wages are going up, which is helping affordability, but beyond rate-rate-rate, there’s probably not a bunch more that I could add in terms of the first-time buyer. Maybe just the last thing on the overall rate environment, look, high rates aren’t good for the consumer, they’re not good for housing, they’re not good for the broader economy, but we’re all kind of playing in the same environment and with the quality of the management team that we have and the way that we’re operating this company, I think we’ve proven that we’ve got the tools and the operational flexibility to be successful in any environment. This most recent quarter is a great example of that.

Okay, perfect. Then Ryan, you mentioned adjusting product given the higher rates. I’m hoping you could elaborate on what all that entails for Pulte specifically. Then if I’m reading between the lines, spec sales were about 49% of your overall bucket this quarter - that’s a pretty good run rate that you all expect going forward?

Yes, so in terms of product, Truman, the one great thing about our product portfolio is we offer a lot of flexibility to scale up, scale down. We offer structural options that allow a smaller floor plan with added square footage in the form of loft or additional flex space. We’ve got the ability to take a base floor plan, scale it up or scale it down, and we’re seeing buyers use that flexibility to help address some of the affordability challenges that are out there. In our--the way that we sell options, we see buyers pick the things that they see value in, and we’re also seeing buyers make trade-offs in terms of how they spend those dollars, in terms of cabinets, countertops, upgrades, etc. The last piece of your question, Truman, remind me again?

Your spec strategy, should we kind of assume that it’s pretty much stable from here, that you’re targeting about half the business perhaps as spec?

Yes, roughly. I think that’s a good go-forward run rate. It’s higher than what we experienced pre-COVID - that’s mostly reflective of the size of our first-time business and entirely moving that to spec. We did highlight this quarter, 49% - that’s down from about 60% earlier in the year, so we feel pretty good about that performance in the spec business.

Ladies and gentlemen, that is all the time we have for questions. I will now turn the call back to Mr. Jim

Okay, appreciate everybody’s time today. Sorry we couldn’t get through to all the questions, but we’re certainly available over the remainder of the day for follow-up, and we’ll look forward to speaking with you next quarter.