Hovnanian Enterprises Q3 2024 Earnings Call Transcript

Quartr
Provided by Quartr
August 22, 2024

There are 7 speakers on the call.

Operator

Good morning, and thank you for joining us today for the Hovnanian Enterprises Fiscal 20 24 Third Quarter Earnings Conference Call. An archive of the webcast will be available after the completion of the call and run for 12 months. This conference is being recorded for rebroadcast and all participants are currently in a listen only mode. Management will make some opening remarks about the Q3 results and then open the line for questions. The company will also be webcasting a slide presentation along with the opening comments from management.

Operator

The slides are available on the Investors page of the company's website at www.khov.com. Those listeners who would like to follow along should now log on to the website. I would like to turn the call over to Jeff O'Keefe, Vice President, Investor Relations. Jeff, please go ahead.

Speaker 1

Thank you, Liz, and thank you all for participating in this morning's call to review the results for our Q3. All statements in this conference call that are not historical facts should be considered as forward looking statements within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Such statements involve known and unknown risks, uncertainties and other factors that may cause actual results, performance or achievements of the company to be materially different from any future results, performance or achievements expressed or implied by the forward looking statements. Such forward looking statements include, but are not limited to, statements related to the company's goals and expectations with respect to its financial results for future financial periods. Although we believe that our plans, intentions and expectations reflected and are suggested by such forward looking statements are reasonable, we can give no assurance that such plans, intentions or expectations will be achieved.

Speaker 1

By their nature, forward looking statements speak only as of the date they are made, are not guarantees of future performance or results and are subject to risks, uncertainties and assumptions that are difficult to predict or quantify. Therefore, actual results could differ materially and adversely from those forward looking statements as a result of a variety of factors. Such risks, uncertainties and other factors are described in detail in the section entitled Risk Factors and Management's Discussion and Analysis, particularly the portion of MD and A entitled Safe Harbor Statement in our Annual Report on Form 10 ks for the fiscal year ended October 31, 2023, and subsequent filings with the Securities and Exchange Commission. Except as otherwise required by applicable security laws, we undertake no obligation to publicly update or revise any forward looking statements whether as a result of new information, future events, changed circumstances or any other reason. Joining me today are Ara Hovnanian, Chairman, President and CEO Brad O'Connor, CFO and Treasurer and David Mitreson, Vice President and Corporate Controller.

Speaker 1

I'll now turn the call over to Ara.

Speaker 2

Thanks, Jeff. I'm going to review our Q3 results and I'll also comment on the current housing environment. Brad, our CFO, will follow me with more details, and of course, we'll open up for question and answers afterwards. Let me begin on Slide 5. Here, we show our Q3 guidance compared to our actual results.

Speaker 2

Starting on the top of the slide, revenues were $723,000,000 which was right at the midpoint of our guidance. Our adjusted gross margin was 22.1% for the quarter, which was also within the guidance we gave. Our SG and A ratio was 12.4%. This was just above the high end of the guidance we gave. If you ignore the $2,200,000 impact from the incremental Phantom stock expense, which is solely due to stock price increases, our SG and A would have been 12.1%, which is slightly above the top end of the range we gave.

Speaker 2

One of the reasons our SG and A is running a little high is that we're gearing up for significant community count growth and we have to make new hires well in advance of those communities. In addition, there are other expenses related to preparing for community count growth. Another contributor to higher than usual SG and A is an increase in our advertising spend. Adjusted EBITDA was $131,000,000 for the quarter, which is significantly above the high end of the range that we gave. Finally, our adjusted pre tax income was $100,000,000 which is also significantly better than the high end of the range that we gave.

Speaker 2

We're obviously pleased that our profitability exceeded our guidance for the quarter. Slide 6, here we show our results compared to last year's Q3. Starting in the upper left hand quadrant of the slide, you can see that due to an increase in deliveries, a higher average sales price and the land sale in Phoenix, our total revenues increased 11% to $723,000,000 In the upper right hand portion of the slide, you can see that our gross margin decreased year over year to 22.1%. On a sequential basis, we also decreased slightly from 22.6% to 22.1% in the Q2 of 2024. Our results for the quarter were within the range of guidance that we gave.

Speaker 2

We recognized in advance that there was a risk of seeing a year over year decrease in gross margin given the previous movements in mortgage rates and more specifically the cost to buy down those rates. The good news is that with the more recent declines in mortgage rates, the cost to offer mortgage rate buy downs in the future may decrease for us in the future. Moving to the bottom left hand portion of the slide, you can see that our adjusted EBITDA increased 20% to $131,000,000 in this year's Q3. Finally, in the bottom right hand portion of the slide, adjusted pre tax profit increased 34% to $100,000,000 I know new orders have been a focus of many analysts that follow homebuilders, so I'm going to discuss contracts in much greater detail this time. Turning to Slide 7.

Speaker 2

If you start at the top of the table, you can see that our year to date contracts increased 8% for the 1st 9 months of the year. However, as we break it down by quarter, you can see that it's been choppy. Contracts increased significantly in the Q1 when we were up 43%. In the Q2, contracts were up 9% and in the Q3, contracts declined 13%. However, during the last 5 weeks, which we show at the bottom of this table, trends have improved substantially and our total contracts increased 23% over the same 5 weeks a year ago.

Speaker 2

Even though contracts have been choppy, we feel very good about demand overall and I'll describe in a little more detail contracts in upcoming moments. If you turn to Slide 8, you can see contracts per community for the Q3 decreased year over year to 9.5. There are a couple of things on this slide I want to point out. First of all, 9.5 contracts per community that we achieved this year is close to our Q3 average of 9.9 contracts per community historically. Secondly, last year's 14.2 contracts per community was the 2nd best third quarter of contracts per community over the past 20 years.

Speaker 2

You can also see on the slide in the Q3 of 2020 with the COVID surge, our contracts per community were at 19, an unbelievably high level. But last year's 14.2 is still a very tough comparison. The third point I want to make is that the timing of the increase in our community count in the quarter hurts the calculation of contracts per community. That's because half of the community count increase occurred in July, the last month of our quarter. So you don't get the benefit of a full month of contract from those new communities, much less the benefit during the full quarter.

Speaker 2

Finally, some of our outperformance in last year's Q3 was due to a high level of build for rent contracts. The 23 Q3 was the quarter that had the most build for rent contracts since we began selling to this type of buyer, 259 build for rent contracts, all of them happened to be in the Southeast segment during the quarter. Anecdotally, there seemed to be some hesitancy from homebuyers during the Q3, causing some of the choppiness in sales that I referred to, similar to what other homebuilders have been reporting. It's difficult to pinpoint cause of the choppiness, but economic, mortgage rate and geopolitical uncertainty were likely partially responsible. Furthermore, we had extended disruption from Hurricane Burl across our Texas operations in particular, which is one of our single largest states by deliveries.

Speaker 2

Both our Houston and Dallas offices and many of our associates were without power for the better part of a week during the critical last month of the quarter. This hurt sales and deliveries. As you'll see in a moment, sales have jumped back in a very strong manner in recent weeks. If you turn to Slide 9, we show interest rate trends. The gray line on this slide shows what happened to interest rates last year between July of 2022 August of 2023.

Speaker 2

During this period, whenever rates decline after a little delayed reaction, we eventually saw a pickup in sales. The blue line shows what happened with mortgage rates during this past year between July of 2023 August of 2024. For most of the time shown, they coincidentally followed a very similar pattern of monthly increases and decreases just at slightly higher rates this year. Over the past few weeks, we've seen mortgage rates reduced to lower levels. Whenever mortgage rates come down, there are more potential buyers obviously that can qualify for mortgages.

Speaker 2

For the first time in a while, mortgage rates are actually lower now than they were last year. We've already seen the benefits of the lower rates. If you turn to Slide 10, we show that over the past 5 weeks, contracts have increased 23% compared to the same weeks a year ago. This improved trend suggests that homebuyers have already reacted positively to the recent decreasing mortgage rate environment. In addition, web traffic continues to be very strong.

Speaker 2

As a matter of fact, the last 4 weeks were better than the same weeks going all the way back to 2019 with the exception of the COVID surge in August of 2020. In the last week, however, we actually matched the robust website visit levels that we hit in that peak time in August 2020. That leading indicator makes me particularly optimistic about future demand. On Slide 11, we give even more granularity and show the trend of monthly contracts per community compared to the same months a year ago. Here you can see the impact of build for rent on contracts in the month of June this year compared to last year.

Speaker 2

Even though sales were lower in this year's Q3, we believe that many of the fundamentals that led to our prior outperformance remain intact, such as the low supply of existing homes for sale, a slightly weakening, but still good jobs market, the overall health of the economy and positive demographic trends. Again, we have seen the sales trend change to very positive comparisons over the last 5 weeks. Turning to Slide 12, we show our contracts per community as of the 12 months ended on June 30, 2024. In that way, we can compare our results to our peers that report contracts per community on our calendar quarter ends. At 42 contracts per community, our trailing 12 month sales pace per community is the 4th highest among the public homebuilders that reported for this time period.

Speaker 2

On Slide 13, you can see that our year over year growth in contracts per community for that same period was also the 4th highest among our peers. What we're trying to illustrate on these last two slides is even though sales in this most recent quarter were choppy, we are still selling an above average number of homes compared to our peers. On the top of Slide 14, you can see that for a sizable percentage of our deliveries, homebuyers continue to utilize mortgage rate buy downs. The percentage of customers that used buy downs this year was 71% in the 3rd quarter compared to 73% in the 2nd quarter and 79% in the 1st quarter. The bottom of the slide gives more granularity.

Speaker 2

We show monthly trends over the same period. Since the beginning of the year, the buy down usage in our deliveries has averaged 74%, which seems to indicate homebuyers have been consistently relying on mortgage rate buy downs to combat affordability at the current mortgage rate levels. Given the relatively high mortgage rate environment, we assume buydowns will remain at similar levels going forward. We are budgeting the cost of buy downs to remain constant. However, the cost of buy downs may decrease with the decline in mortgage rates that we've seen recently.

Speaker 2

In order to meet homebuyers' desires to use mortgage rate buy downs, elevated levels of quick move in homes or QMIs as we call them, remain part of our new operating philosophy in the last few years. On Slide 15, we show that we had 8 QMIs per community at the end of the Q3. It remains at a high level, but we are very comfortable with that level. Furthermore, due to the increase in community count in the quarter, it's not surprising to see that our finished QMIs increased to 192 finished homes. On a per community basis, that puts us at 1.5 finished QMIs per community.

Speaker 2

That's up slightly from 1.3 finished QMIs per community at the end of the second quarter, but it's lower than 1.9 finished QMIs at the end of our Q1. Our goal with QMIs is obviously to sell them before completion. In the Q3 of 2024, QMI sales were about 67% of our total sales, a slight increase from 65% in the Q2 of 2024. Historically, that percentage was about 40%. So obviously, demand for these homes is still high.

Speaker 2

We will continue to manage our QMIs at a community level. We track our start schedule per community with our current sales pace per community to make sure we don't get too far ahead of ourselves. If you move to Slide 16, you can see that even with the choppiness in the third quarter sales, we are still able to raise net prices in 33% of our communities. Despite the choppiness, the current level of demand should support the growth that we hope to achieve over the next several years. I'll now turn it over to Brad O'Connor, our Chief Financial Officer.

Speaker 3

Thank you, Ara. Before I get to the next slide, I want to comment on the other income line on our income statement. During the Q3 of 2024, we assumed control of 1 of our unconsolidated joint ventures after our partner received their final cash distribution, but before the communities were finished. Under GAAP, we were required to consolidate the joint venture at fair value. Based on the exceptionally strong performance of these communities, we recorded a $46,000,000 gain in the other income and expense line upon consolidation.

Speaker 3

Even after this stepped up value, we now have a high performing wholly owned community that is projected to achieve an IRR in excess of 20% and provide significant profits for the next few years. Similarly, in the Q3 of 2023, we recorded a $19,000,000 gain in the other income and expense line upon consolidation of a different joint venture. This could happen again in future reporting periods when final cash distributions to the partners are made on existing and future new joint ventures. Now getting back to the slides. On Slide 17, you can see that we ended the quarter with a total of 146 open for sale communities, a 20% increase from last year.

Speaker 3

126 of those communities were wholly owned. During the Q3, we opened 22 new wholly owned communities sold out of 10 wholly owned communities, transitioned 6 communities from a joint venture to wholly owned and contributed 1 community to a joint venture. We also opened 4 new unconsolidated joint venture communities and closed 2 unconsolidated joint venture meetings during the quarter. The total community count of 146 was also up 11% or 14 communities sequentially from the end of the Q2 of fiscal 2024. As Eira mentioned, half of those 14 community openings took place in the month of July.

Speaker 3

The financial benefits of these new communities will begin in subsequent quarters. Even with the robust growth in community count this quarter, we still experienced delays in opening new communities, primarily due to utility hookups throughout the country. We expect community count to continue to grow further in the Q4 and in fiscal 2025, Predicting community count can be challenging given a variety of factors. The leading indicator for further community count growth is shown on Slide 18. We ended the quarter with 39,516 controlled lots, which equates to a 7.7 year supply of controlled lots.

Speaker 3

Our lot count increased 7% sequentially and 34% year over year. If you include lots from our unconsolidated joint ventures, we now control 40 2,580 lots. We added 4,800 lots in 57 communities during the Q3. Our land teams are actively engaging with land sellers and negotiating for new land parcels that meet our underwriting standards. Our land and land development spend increased 28% year over year to $216,000,000 in the Q3 of fiscal 2024.

Speaker 3

This brings the latest 4 quarter average to $224,000,000 a quarter. That is 4 quarters in a row with higher than typical levels of land and land development spend. Our corporate land committee counter continues to be busy, which is an indication that our lot count should continue to increase over time, but not always in a straight line. We are using current home prices, including the current level of mortgage rate buy downs, current construction costs and current sales pace to underwrite to a 20% plus internal rate of return. Our underwriting standards automatically self adjust to any changes in market conditions.

Speaker 3

We are finding many opportunities in our markets and are very focused on growing our top and bottom lines for the long term. The growth in lots control precedes growth in community count, which precedes growth in deliveries. On Slide 19, we show the percentage of our lots controlled via option increased from 46% in the Q3 of fiscal 2015 to 82% in the Q3 of fiscal 2024. This is the highest percentage of option lots we have ever had. This increase is intentional and has been a consistent focus of our land light high inventory turnover land strategy.

Speaker 3

We are pleased with the progress we have made. Turning now to Slide 20. You see that we continue to have one of the higher percentages of land controlled via option compared to our peers and we are significantly above median. On Slide 21, compared to our peers, we are tied for the 2nd highest inventory turnover rate. High inventory turns are a key component of our overall strategy.

Speaker 3

We believe we have opportunities to continue to increase our use of land options and to further improve our turns on inventory in future periods. Another way to improve our inventory turns is by shortening our construction cycle times. We made good progress in reducing our cycle times from 190 days at the peak during COVID to 160 days in the last half of twenty twenty three. Our cycle times remained around 160 days for this 1st 2 quarters of twenty twenty four, but during the Q3 of 'twenty four, we were able to shorten the average cycle time by another 10 days to about 150 days. We still have some work ahead of us to get back to pre pandemic cycle times of about 4 months or 120 days, but we are making substantial progress.

Speaker 3

Returning to our normal cycle time should significantly boost our ROI and ROE. Turning to Slide 22. Even after spending $216,000,000 in land and land development, $32,000,000 on debt reduction and $11,000,000 to repurchase stock, we still ended the Q3 with $250,000,000 of liquidity just above the high end of our targeted liquidity range. We are much closer to our goal of being fully invested, which reduces the interest burden of any excess cash and puts all of our capital to work. Turning now to Slide 23.

Speaker 3

This slide shows our maturity ladder as of July 31, 2024. This is reflective of the exchange we did at the beginning of Q3, which lowered the face value of our debt by $75,000,000 reduced our annual cash interest by $4,600,000 and our annual interest expense by approximately 8,500,000 This was the most recent example of the steps we have taken to improve our maturity ladder over the past several years. We are still committed to further strengthening our balance sheet. Turning to Slide 24. We show the progress we have made to date to grow our equity and reduce our debt.

Speaker 3

Starting on the upper left hand part of the slide, we show the growth in equity over the past few years as well as the year end projected equity assuming the midpoint of our guidance. And on the upper right hand portion, you can see the progress we've made in reducing our debt, including the redemptions we made in fiscal 2023 2024 and the most recent debt reductions in the exchange. We reduced our debt by $669,000,000 since the beginning of fiscal 2020. On the bottom of the slide, you can see that our net debt to net cap at the end of the 3rd quarter was 55.9%, which is a significant improvement from our 146.1% at the beginning of fiscal 2020. Using the midpoint of our guidance and assuming we have cash at the same level we finished last year, we expect to end the year with net debt to net cap of 42%.

Speaker 3

We still have more work to do to achieve our goal of a mid-thirty percent level. We are comfortable that we have a path to achieve our target soon. We've made considerable progress, which is evident by the credit rating upgrades we received from both S and P Global and Moody's during our Q3 of 2024. Our balance sheet has improved significantly over the last 5 years, and we expect to continue to make noteworthy progress moving forward. Given our remaining $258,000,000 of deferred tax assets, we will not have to pay federal income taxes on approximately $900,000,000 of future pretax earnings.

Speaker 3

This benefit will continue to significantly enhance our cash flow in years to come and will accelerate our growth plans as well as our ability to pay down debt. Our financial guidance for the full year of 2024 assumes no adverse changes in current market conditions, including no further deterioration in our supply chain or material increases in mortgage rates, inflation or cancellation rates. Our guidance assumes continued extended construction cycle times averaging 5 months compared to our pre COVID cycle time for construction of approximately 4 months. It also assumes that we continue to be more reliant on QMI sales, which makes forecasting gross margins more difficult. Our guidance assumes continued use of mortgage rate buy down similar to recent months.

Speaker 3

Further, it excludes any impact to SG and A expense from our phantom stock expense related solely to the stock price movement from the $209.89 stock price at the end of the Q3 of fiscal 2024. Slide 25 shows our increased guidance for all of fiscal 2024. We increased our expectations for total revenues for the full year to be between $2,900,000,000 $3,050,000,000 We tightened the range slightly for expected adjusted gross margin to be in the range of 21.5 percent to 22.5 percent, and we kept the range for SG and A as a percent of total revenue to be between 11% 12%. We are providing guidance on income from joint ventures for the first time. For the year, we expect income from joint ventures to be between $55,000,000 $65,000,000 We increased guidance for adjusted EBITDA, adjusted pretax income, EPS and book value per share.

Speaker 3

Our guidance for adjusted EBITDA increased to a range between $420,000,000 $445,000,000 and our expectations for adjusted pretax income for the full year increased to be between $300,000,000 325,000,000 dollars We now expect our diluted earnings per share for the full year to be in the range of $29.31 At the midpoint of our guidance, we anticipate our common book value per share to increase by about 50% at October 31, 2024 to approximately $109 per share compared to last year's value at year end of $73 per share. Analysts that only focus on price to book missed the point regarding our industry leading returns and rapid growth in book value. Turning to Slide 26, we show that our return on equity was 38.8%, which is the highest over the trailing 12 months compared to our peers. And on Slide 27, we show that compared to our peers that we have one of the highest consolidated EBIT returns on investment at 33.7%. While our ROE was helped by our leverage, our EBIT return on investment is a true measure of pure homebuilding operating performance without regard to leverage and was the highest among our midsized peers.

Speaker 3

Over the last several years, we have consistently had one of the highest EBIT ROIs among our peers. Eventually, investors will recognize our consistent superior returns on capital and significantly improved balance sheet. Given our rapidly growing book value, we think it would be appropriate to consider a variety of metrics, including EBIT return on investment, enterprise value to EBITDA and our price to earnings multiple when establishing a fair value for our stock. We believe when all our fundamental financial metrics are considered, our stock is still a compelling value. On Slide 28, we show our price to book multiple compared to our peers.

Speaker 3

We do compare more favorably on this metric based on the midpoint of our guidance, we expect to end October with a book value of approximately $109 per share. On Slide 29, we show the trailing 12 months price to earnings ratio for us in our peer group based on our price earnings multiple of 6.48 times at yesterday's stock price of $207.60 We are trading at a 36% discount to the homebuilding industry average PE ratio. We recognize that our stock may trade at a discount to the group because of a higher leverage, but our leverage has been shrinking rapidly. On Slide 30, we show that despite our extremely high ROE, there are still 4 peers that have a higher price to book ratio than us. This slide more visually demonstrates how much we are undervalued relative to the other homebuilders when looking at the relationship between ROE and price to book.

Speaker 3

A very similar result exists when looking at ROE to price to earnings. These last few slides further emphasize our point that given our 38.8% return on equity, our top quartile EBIT return on investment combined with our rapidly improving balance sheet, we believe our stock continues to be the most undervalued in the entire universe of public homebuilders. I will now turn it back to Ara for some closing remarks.

Speaker 2

Thanks, Brad. I want to spend a few minutes talking about our joint ventures during this call. We consider joint ventures to be a core part of our operations. Income from our unconsolidated joint ventures has been an important part of our operations for a long time. On Slide 31, we show income from unconsolidated joint ventures for the past 6 fiscal years.

Speaker 2

You can see on the far right hand portion of the slide that income from joint ventures was already 30 $7,000,000 for the 1st 9 months of fiscal 2024 and the midpoint of the guidance we gave is for it to reach $60,000,000 for the full year. Based on the current level of joint venture activity, we believe that our income from joint ventures should continue to be a meaningful portion of our earnings for the next several years. Keep in mind, these bars do not reflect the $19,000,000 gain from consolidation during fiscal '23 or the $46,000,000 gain from consolidation in the Q3 of 'twenty four. These gains from consolidation could occur in the future joint ventures as they've been performing very well. Turning to Slide 32, we give some reasons we engage in joint ventures.

Speaker 2

1st and foremost, we're extremely focused on a high return on investment. 1 of the key methods to achieve this high return on investment is our land light strategy. Land light has always been part of our strategy, but we've increased the focus over the last 5 years. An alternate tool to achieve a high return on investment is the use of joint ventures. They allow us to build larger communities with less capital, typically 20% to 25% of the peak capital, particularly for larger, longer life communities.

Speaker 2

If these joint ventures hit certain hurdle rates, we can receive a disproportionate share of the upside performance. This improves both IRR and the net profit dollars we receive. By limiting our capital to 20% to 25%, we can invest in multiple communities with the same amount of capital, diversifying risk and leveraging our fixed costs. We don't always achieve our IRR targets for our communities. When done in a joint venture, our joint venture partners typically share in the downside risk.

Speaker 2

Having said that, as you can see from our results, our joint ventures have been performing very well for our company and for our partners. We're also paid a management fee for our joint ventures, which helps offset some of our overhead costs. We believe these benefits to utilizing joint ventures makes a lot of sense from several perspectives and we'll continue to seek joint venture partners to work with for future communities. On Slide 33, we show some metrics for a recent community that we're considering contributing to a joint venture. As a wholly owned transaction, the peak capital on this community would be $74,000,000 the IRR would be 31% and the Community Life profit would be $82,000,000 As you can see, the under based on this underwriting, it's a very solid community and it would make sense to go forward with this transaction on a wholly owned basis.

Speaker 2

However,

Speaker 3

if we

Speaker 2

were to joint venture this community instead, our peak capital would only be $14,000,000 the IRR would improve to 47% and we'd still get a Community Life profit of $33,000,000 The decrease in profit at first blush seems discouraging. However, if we add 4 other communities like this one, our peak capital for the entire joint venture for all 5 communities would be only $70,000,000 less than 1 wholly owned community in the example. Our Community Life profit for the joint venture would be $165,000,000 more than double that of just one wholly owned community. In addition, we get the benefit of diversifying our risk. I could make an academic argument that we should joint venture all of our communities.

Speaker 2

Now frankly, that wouldn't be feasible, but the point I'm trying to get across is that the returns from these joint ventures are very compelling. Joint ventures will continue to be part of our overall strategy and deliveries for years to come. The majority of our joint ventures are domestic here in the United States like all of our operations. However, yesterday we signed a memorandum of understanding with the Ministry of Housing in Saudi Arabia. This will expand our activities in Saudi and expand our partnership, increasing housing for a growing population of young middle class families.

Speaker 2

Overall, given our recent community count growth and continuing growth in our lot count, we find ourselves on the precipice of substantial growth, which will allow us to continue to deliver top tier industry returns to our shareholders. That concludes our formal comments, and I'm happy to turn it over for Q and A now.

Operator

The company will now answer questions. So that everyone has an opportunity to ask questions, participants will be limited to 3 questions and a follow-up, after which they will have to get back into the queue to ask another question. We will open the call to questions. Our first question will come from the line of Alan Ratner with Zelman and Associates.

Speaker 4

Hey guys, good morning. Nice quarter and thanks for all the detail so far. My first question, maybe this is more for Brad. I'd love to just get a little more color or insight on the JV consolidation since it was such a big driver of the upside in the quarter and also sounds like it might be something that at least repeats on an inconsistent basis going forward. I just want to make sure I understand kind of the moving pieces here.

Speaker 4

So

Speaker 3

you booked a

Speaker 4

big gain this quarter and going forward, I guess the sale of homes will be flowing through your revenue and COGS line and gross margin. The offset, I guess, when I look at your annual JV income running around $60,000,000 pretax, does that mean that that number should come down as like you're not booking the gains from that project going forward and now that's shifting into your wholly owned business?

Speaker 3

Not exactly. I mean you're thinking of it correctly, but the reality is we have other new JVs that have also started, which will provide JV income going forward. So with respect to that specific joint venture, the income that we had recorded over the last year or so for our returns, well, that will go away and now come through wholly owned just like you described. And the one thing to add to that is, it comes through at a higher land value because we had to record the step up on consolidation. So that gain basically adds to the book value that we put on our books.

Speaker 3

And so as we're recognizing those deliveries, they have a higher cost, higher land cost than they did when they were in the joint venture. So just keep that in mind. As I commented, though, it's when you record the fair value, we do it calculating IRR that's still in the 20% range. So it still will provide good profits for us, just not as high as what was being generated in the JV itself. But with that said, because of other JVs that are coming online, as Eero was kind of commenting, we expect JV income to continue in the future like what you've been seeing.

Speaker 3

The other comment I'll make is the reason you may see this gain phenomena happen going forward is some of our joint ventures, we structure as prep structures so that the partner gets paid out first. And when that happens and the partner is then hits their IRR hurdle and gets paid out, that's when this occurs and it becomes a wholly owned community. In the case where it's a pari pass through JV and the distributions occur over time to both parties and both parties are in the venture until the end and continue to get paid out, you won't see this occur. So more recently, more of our JVs have been done as preferred structures. So that's why you're seeing this last year and this year, and I think you might see it going forward from some of the joint ventures we have in place.

Speaker 3

But we still do some JVs as peripassu. And in those cases, you wouldn't see this happen. So I just want to give that extra clarification.

Speaker 4

Got it. And I appreciate all that added color. And just one more on this topic. So you mentioned the step up in land cost obviously or land basis obviously. Just relative to your the rest of your business, I mean is this going to be dilutive to your margins going forward?

Speaker 4

Obviously, it's only one project or is it kind of written up to a similar margin?

Speaker 3

It would be relatively similar margin to what our other projects are because we used a similar underwriting IRR that we do for our existing projects. It's just that community was actually performing at much higher margins in the JV itself. So now it will be performing at what we're doing kind of wholly on a regular with all other communities. Got you. Okay.

Speaker 3

That's helpful. Thank you

Speaker 4

for the extra time there. Yes. Second question, the gross margin range you tightened, but it still implies a pretty wide range for Q4. And I know you mentioned the uncertainty around spec with that being 2 thirds of your business today. I guess just from a high level, your margins dipped a little bit sequentially.

Speaker 4

You're off of the recent highs. Where do you see the margin profile of the business visavis the Q3 result you just reported with all the moving pieces you've got going on? Incentives seem pretty steady, but elevated. I would imagine land costs are going up. You still have some pricing power in about a third of your communities.

Speaker 4

Is this 22% margin kind of like a decent run rate going forward? Or are there mix considerations or cost considerations that we should think about into the Q4 and into 25% that could directionally move that one way or the other?

Speaker 3

Speaking specifically about the Q4, I think you're pretty much right on that 22% -ish range is where I would think we would be. But that's given the caveats we've talked about, which is similar mortgage rate buy down costs, etcetera. From a construction cost perspective, I think we've been holding pretty stable. In fact, we've had some decreases in areas, including some benefits from lumber, which has helped. Our land costs, as you pointed out, should, as we open new communities and get deliveries from those new communities will probably increase from because they're newer deals.

Speaker 3

So that could put some pressure on margins in 2025. On the other hand, if mortgage rates go down, as I think people might anticipate when the Fed makes their moves, then the cost of buy downs and perhaps the amount of incentives we have to give will change as well, so to potentially offset that. So we're not really giving 25 guidance, but I can answer your Q4 2024 question by saying that we feel that the 22% range you're talking about is pretty reasonable.

Speaker 4

Perfect. And then if I can just squeak in one more here. Ara, the comments on ROE are very much appreciated and understood. You guys are at the highest in the industry. I think one of the things that admittedly we struggle with a little bit and I think it's probably investors do as well given where your valuation is, is

Speaker 5

just

Speaker 4

the fact that your elevated ROE today obviously is somewhat driven by the book value having been depressed over the last few years and it has compressed a year ago you were at 50%, 2 years ago 80%. So I'm not asking you to forecast ROE, but I guess when you think about the business over the next two, business over the next 2, 3 years, the long run industry average has been somewhere around 15%. And we've had several builders say they think they're targeting more of a 20% ROE going forward on a sustainable basis. Is there a way to think about your business over the next 3 to 5 years from an ROE standpoint? Once the book value has accreted and once you're kind of at a normalized run rate of activity that the way you're thinking about the ROE of the business?

Speaker 2

Sure. Well, thanks for the question, Alan. I think it's important to also talk about EBIT ROI because that has nothing to do with our equity or our leverage. It is pure homebuilding performance. And I'm proud to say we're the 2nd highest performer on pure EBIT ROI.

Speaker 2

We outperform almost everybody and we definitely outperform every single one of our midsized peers. So I'd say we're proud it's not a one time thing by the way. We've been doing that for several years now. So I'd say whatever you feel will be the ROE of our peers, once we get to a comparable debt to cap leverage, given our outperformance on EBIT ROI, I'd say we should end up higher than everyone else on an ROE on a long term basis. That's assuming we continue our performance as we've been outperforming over the last few years.

Speaker 4

Appreciate it. Thank you for the thoughts.

Speaker 3

Okay. Thanks, Alan.

Operator

Our next question will come from the line of Jordan Haimowitz with Philadelphia Financial Management of San Francisco.

Speaker 6

Thanks, guys. Couple of questions. Moody's in their recent note said they would look to upgrade you if debt to capital got below 50%. Your own projection is 42% by the end of this year And unless something goes crazy, it will be in the 30s by next year. So I guess my question is, when does the next discussion with them, when does that play a role?

Speaker 6

Do you think the only negative is they upgraded you somewhere recently, but the debt pay down has been so dramatic that could it happen again soon?

Speaker 3

Yes. Just to be clear, Jordan, that comment they made is a gross debt to cap basis and the 42% is a net debt to net cap. So it takes the cash into play. So we'll be getting close to the 50% to your point by year end, but I just don't want you to be confused by the 42%. And so I would be hopeful that certainly during next fiscal year, we're having another conversation about another upgrade.

Speaker 6

What's the gross number, sorry, on the Napiero?

Speaker 3

We're looking. We didn't prepare it ahead of time. So if we grab it in time, we'll add it. We'll make the comment.

Speaker 6

Fine. To the extent that that occurs, you put out a bunch of debt that originally was hoping to be in the 8% but ends up being in the 10% to 11%. Is there a possibility next year you could call some of that and refinance at a lower level or they're lockouts at that point?

Speaker 3

It's, I would say cost prohibitive. It's possible, but cost prohibitive

Speaker 1

next

Speaker 3

year likely unless rates were dramatically lower that we could save more on the delta in interest. But it's certainly something we're going to be paying attention to, Jordan, because we think we're getting really close to being able to, if not able to do it right now, transition from secured to unsecured, which is something we want to do when we do a more global refinancing in the near future. And so it certainly will be paying attention to the cost to rate trade off over the coming year to year and a half, I'll say. I did get the calculation on the gross debt to cap projection for year end at around 56%. So we still won't be at 50%, but we'll be on our way.

Speaker 6

Okay. And final question is, can you detail any income from the Saudi Venture? When do you think that will start to be an impactful number or any guidance on that in any way?

Speaker 3

I would say it's still a couple of years of web and I can have Eric comment as well. But right now, we're just starting 2 or 3 new communities. We don't have any that are delivering at the moment. So I would say before there's any real meaningful profit, it's probably late fiscal 2025, early 2026.

Speaker 2

Jordan, I'll add a couple of comments to your first question. And that is that because we had higher leverage, our cost of debt is higher than most of our peers. But our performance has been improving so dramatically and our leverage is improving dramatically that once the high prepayment costs happen, I think we'll have a great opportunity to refinance in the future at substantially lower rates that should save us quite a bit of interest compared to what we've been paying. Our ROE has been outstanding even with the high interest, but I think it will get even better as we have an interest more similar to our peers. On top of that, the reason we have a big difference between gross debt to cap and net debt to cap is we don't have a large unsecured revolving line of credit like our peers.

Speaker 2

I suspect that in the near future, we'll be able to achieve that once we refinance the bonds. That will also save substantial dollars because right now we're operating with a big cash cushion that we're paying interest on. That will go away as we transition to regular financing more like our peers and should substantially enhance our performance.

Speaker 6

But that's probably a second half twenty twenty five issue, it sounds like?

Speaker 3

Yes, early twenty twenty six something like that. Yes.

Speaker 6

Okay. Thank you, guys.

Speaker 3

Thank you. Thank you.

Operator

Our next question will come from the line of Alex Barron with Housing Research Center.

Speaker 5

Yes. Thanks, gentlemen. I wanted to ask about the phantom share impact. Is that something that has some termination date or it's just ongoing quarter to quarter?

Speaker 3

There are there's been additional grants. There's another grant in December of this fiscal year with Phantom shares. So there'll be some impact going forward. And obviously, each quarter, we're providing that in the appendix just so you can see what the impact is. This quarter was the $2,200,000 We're just trying to highlight that for everybody.

Speaker 3

But it can be very little if the stock price doesn't change. The good news is in this particular quarter that means the stock price went up significantly and that's why it was a $2,200,000 impact. But it's something that we will have going forward.

Speaker 2

And I'll add, as Brad mentioned, the quarter by quarter impact is in the appendix. It just hasn't been it's there and will continue, but it's just not a substantial number. Couple of meetings.

Speaker 3

The other quick comment to make, Alex, as we've looked at that, the impact from an earnings perspective and under the scenarios with the stock price increasing even pretty dramatically. And it's still actually better for the shareholders because the dilution that would have occurred had you done shares would actually be more impactful than the earnings hit. So it's something we've paid attention to when we've given some phantom shares.

Speaker 5

Okay, got it. And then, it looked to me like the debt balance came down a little bit this quarter. Did you guys pay down some debt?

Speaker 3

Yes. We did the we talked about it in the our Q2 call, but the debt exchange that we did actually happened in May. So it was a Q3 event. So that's what you're seeing is the change in the debt. We did a debt restructuring back in May.

Speaker 5

Okay. Got it. And then as it pertains to the deferred tax asset on your balance sheet, that's been obviously coming down as you're using it. Do you guys have an anticipated number of years it will take before that goes away? Is it a couple of years or 3 years or faster than that?

Speaker 3

I mean, the way to think about that is, I think we said it was, what, dollars 900,000,000 of pretax earnings that's protected by the deferred tax asset at this point. And so if we're this year, we're projecting $300 ish million of pretax. So at that run rate, if we stay at that run rate, it's 3 years, we would hope given the growth we're anticipating and we've been talking about our growth in community count, our profit will go up. So maybe it's a little less than 3 years, something in the 2 to 2.5 year timeframe. Okay.

Speaker 5

And given how cheap your stock is on a PE basis, have you guys considered buying back stock? Or is there something

Speaker 3

that restricts doing that? Yes. We did buy back shares in the quarter. We didn't we talked about it briefly. We spent $11,000,000 $11,000,000 at an average price of $139 during the quarter, and we still have some availability under the Board approval for buybacks.

Speaker 3

So when we think it's opportune to do it, we'll certainly look at it.

Speaker 5

Okay, guys. Best of luck. Thank you.

Speaker 2

Great. I'll add one other comment on the tax benefit. While the deferred tax asset will be decreasing because we're earning so much, we are active in the energy tax benefits from the energy efficient homes we build. And that is something I think we're increasingly focused on. So we will have some advantages going forward even after the NOI deferred tax benefit goes away.

Operator

I'm showing no further questions in queue at this time. I'd like to turn the call back to Eero Hovnanian for closing remarks.

Speaker 2

Thank you very much. We enjoyed the questions. We're excited about the future and we look forward to reporting a fabulous Q4 as well. Thank you.

Operator

This concludes our conference call for today. Thank you all for participating and have a nice day. All parties may now disconnect.

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Key Takeaways

  • Q3 revenue was $723 million at the midpoint of guidance, with a 22.1% gross margin, SG&A of 12.4% (12.1% ex‐phantom stock), and adjusted EBITDA of $131 million and pre‐tax income of $100 million, both beating the high end of guidance.
  • Year-over-year, revenue rose 11% driven by higher deliveries, ASP and a Phoenix land sale, while adjusted EBITDA and pre-tax profit grew 20% and 34% respectively despite a modest gross margin dip to 22.1%.
  • Mortgage rates falling below last year’s levels have reduced buy-down costs and spurred demand, with contract volumes up 23% over the past five weeks and web traffic near the 2020 COVID peak.
  • Open communities grew 20% y/y to 146, controlled lot supply expanded 34% to 39,516 (7.7-year supply) with 82% under option, supporting continued community and delivery growth.
  • Balance sheet leverage improved sharply, with net debt to net capital at 55.9% and liquidity of $250 million, leading to upgraded full-year guidance for revenues of $2.90–3.05 billion, EBITDA of $420–445 million and EPS around $29.31.
A.I. generated. May contain errors.
Earnings Conference Call
Hovnanian Enterprises Q3 2024
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