Tuesday, February 02, 2010

D.R. Horton Conference Call on Housing Market

by Bill McBride on 2/02/2010 01:02:00 PM

A few excerpts from the D.R. Horton conference call (ht Brian). A couple of key points:

  • Their business is heavily dependent on government life support, this includes government mortgage programs (the bulk of their sales) and the housing tax credit.
  • Horton thinks they have "two more challenging years ahead".

    D.R. Horton CEO: Profitability in the second quarter will be challenging as we will not close as many homes in the second quarter as we did in the first quarter [CR Note: their fiscal 2nd quarter is the calendar year 1st quarter].

    We are entering the quarter with 4,136 homes in backlog and we will need to realize a backlog conversion rate over greater than 100% to reach profitability. With the extension and expansion of the home buyer tax credit and with our available housing inventory, a high backlog conversion rate is entirely achievable. But we do not expect to be as profitable as we were this quarter.

    In the third quarter, we expect strong closings since homes must close by June 30th for the extended tax credit [Once again, he is referring to calendar Q2]. The third quarter will probably be our strongest quarter for profits this year. We expect our September quarter will be the most challenging as the tax credit for home sales will have expired. As we move past the selling season, we'll be able to get a better read on core demand and we'll adjust our business accordingly.”

    [CR Note: The question is: what is the core demand? Most of their current sales are first time homebuyers, and homebuyers using government loan programs]

    “90% of our mortgage company's business was captive during the quarter. Our company wide capture rate was approximately 61%. Our average FICO score was 702 and our average combined loan to value was 93%. Our product mix in the quarter was essentially 100% agency eligible with government loans accounting for 63% of our volume.

    Our homes in inventory at the end of the December, totaled 11,500. Of which, 1,100 were models, 7,300 were speculative, and 2,900 of these specs were completed.

    Of the first quarter closings captured by our mortgage company, 66% were to first time buyers who typically purchase spec homes, so we manage our total number of homes in inventory and number of speculative homes to match expected demand. Our unsold completed homes older than six months were 600 homes at December 31st, 2009, down from 800, at September 30th. We are prepared for the spring selling season and for current demand created by the Federal home buyer tax credit with our current spec level.

    We will continue to manage our spec levels very closely as we move closer to the April 30th sales contract deadline for the home buyer tax credit.

    Analyst: When you talk about fourth quarter being potentially your most difficult quarter and you just talked about that on margin, is that the expectation that you might have to lower prices after the expiration of the tax credit and do you actually think that 4Q volumes to be lower than say 2Q, which could be pretty rare?

    Horton: Actually we do believe that fourth quarter volumes will be less than the second quarter and the third quarter volumes just simply we believe a number of sales, we don't know exactly how many, but we believe that a number of sales are being driven by the tax credit. So to the extent that that tax credit expires, clearly that will adversely affect our sales in the fourth quarter. Relative to inventory we're focusing on reducing our inventory post March to comply with the expiration of the tax credit. To the extent that there's more volume than we anticipate in the fourth quarter, we can ramp our inventory back up again.

    Analyst: You provided some pretty good color on your expectations for gross margins over the rest of the year. Just wondering if you might also provide a little color on normalized gross margins in a healthy new homes selling environment being kind of anywhere in the 18 to 22% range. The 17% that you've sort of implicitly guided toward is a bit low, just wondering on your view, how high does it get and how long do you think it might take to get there?

    Horton: Well first of all, I think you need to have job growth in the economy, and there's obviously no job growth to speak of today and secondly I think we have to have consumer confidence and thirdly I believe that a number of people in the country are still under water on their mortgages, and I think those three things have to be cleared up before we start to have, to get back to more normalized margins. The way that we are managing our business model here is, is that we certainly think that we've got two more challenging years ahead of us. I don't expect job growth or consumer confidence to change dramatically, so I don't expect 18 to 22% gross margins on a consistent basis for a couple of years.