Q1 2022 Meritage Homes Corp Earnings Call
Greetings and welcome to the Meritage homes first quarter 2022 analyst call.
At this time all participants are in a listen only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance. During the conference. Please press star zero on your telephone keypad.
Please note this conference is being recorded.
Now I'll turn the conference over to your host Vice President of Investor Relations. Emily Sodano, you may begin.
Thank you operator, good morning, and welcome to our analyst call to discuss our first quarter 2022 results. We issued a press release yesterday. After the market close you can find it along with the slides we'll refer to during this call on our website at investors that meritage homes dot com or by selecting the Investor Relations.
Link at the bottom of our homepage. Please.
Please refer to slide to caution you that our statements during this call as well as the press release and accompanying slides contain forward looking statements, including but not limited to our views regarding the health of the housing market economic conditions changes in interest rate the potential benefits of rate locks community count and absorption trends.
And construction costs.
Why shouldn't and labor constraints and cycle times projected second quarter and full year 2022 home closings and revenue gross margin tax rate and diluted earnings per share.
Potential future distraction to our business from an epidemic or pandemic, such as COVID-19, as well as other those and any other projections represent the current opinions of management, which are subject to change at any time and we assume no obligation to update any forward looking statements are inherently uncertain are actual results may be materially differ.
Friend banner expectations due to a wide variety of risk factors, which we have identified and listed on this slide as well as in our press release and most recent filings with the Securities and Exchange Commission, specifically, our 2021 annual report on Form 10-K , which contain a more detailed discussion of those risks.
We've also provided a reconciliation of certain non-GAAP financial measures referred to in our press release as compared to their closest related GAAP measures.
With us today to discuss our results are Steve Hilton Executive Chairman Phillipe, Lord CEO and he left periods, our executive Vice President and CFO of Meritage homes. We expect this call to last about an hour and a replay will be available on our website within approximately two hours. After we conclude the call and will remain active through.
<unk> 12, I'll now turn it over to Mr. Hilton, Steve. Thank you Emily and welcome to everyone participating on our call.
Start with a brief discussion about current market trends and provide an overview of our recent results.
We'll cover our strategy quarterly performance.
It will provide a financial overview of the first quarter and forward looking guidance for 2022.
It's well documented that the continuing labor and supply chain constraints increased cycle times and costs across all aspects of homebuilding operations in the first quarter of 2022.
Yet despite these industry wide issues the start of the spring selling season has been robust.
So a new company records.
Our highest quarterly sales order volume, our second highest fourth quarter.
First quarter home closings.
And our highest quarterly home closing gross margin, which broke 30% the 30% threshold, our highest first quarter home closing revenue as well as our best quarterly SG&A leverage in our company's history.
The first quarter of 2022 was also our fifth sequential quarter of community count growth.
We believe that today's sustained demand reflects a desire for homeownership for millennials and downsizing for baby Boomers, all driven by life event milestone is further amplified by the low supply of new and resale housing inventory in the market.
The rise in interest rates over the last couple of months and a series of additional telegraph fed funds rate increases anticipated for the rest of this year may likely change the dynamics of what product will be purchased but we believe the underlying demand for these demographic groups will remain solid.
We continue to sell home shortly after releasing them so far in April and we're still metering sales in many communities.
Now on to slide four for recent events.
We recognize that the recent surge in interest rates and six quarters of strong pricing power will eventually impact both buyer psychology and affordability.
To alleviate some uncertainties for our customers in March Meredith purchase retroactive interest rate locks on all of the eligible floating rate loans for homes in our backlog. They are scheduled to close in the second half of 2022.
We want to help our buyers remain confident and comfortable with their decision to purchase of Meritage homes and relieve concerns around the high cost of ownership since their home purchase decision.
He will dive deeper into the details of our bulk rate locks later.
In February we announced our expansion to the Salt Lake City market.
With the first related acquisitions approved in more identified in the pipeline the new division expands our west region operations into the area of steady growth and solid in migration.
We will start our marketing campaign. This summer ahead of the first openings.
For our affordable entry level community before year end.
Last week, we reported that Melissa Clinton.
<unk> is our new general counsel with nearly three decades of legal experience you bring extensive expertise managing risk ethics compliance and governance matters and welcome to the team Melissa.
And as Aprils Earth month. This year, we bracket, we announced a national partnership with the Arbor Day Foundation and have kicked off our tree client program with them to support urban three populations.
We will have plenty of events in each of our markets during the spring and fall buying season, while over 1800 trees. This year.
Our community Kris campaign aligns our employee contributions and our corporate general and work with our ESG initiatives will help us enhance the sustainability of the markets in which we operate.
With that I'll now turn it over to Felipe.
Thank you Steve.
The 2016, our strategy has been centered around the entry level and first move up market and affordability of our product is paramount.
We have been shifting our product mix and operations to address the underserved and under built affordable entry level market.
Although efficient operations play a role our land selection also significantly impact our new home ESP.
For our new entry level communities coming online in late 'twenty, two and 'twenty three we have been buying less expensive land that is comprised of larger parcels and further on sub markets, allowing us to lower asps are still generating above average margins.
However, elevated demand and the corresponding favorable pricing environment over the last six quarters have matched our shift in product mix. This has resulted in our increased ASP on orders backlog and closing on a year over year basis this quarter.
Higher prices combined with a streamlined and efficient operating model resulted in a 15% year over year home closing revenue growth record homebuilding gross margins of 33%.
<unk> average of eight 5% and a 68% increase in diluted EPS over last year.
And as Steve noted demand is still healthy today.
In addition to early Marcellus from January to April our cancellation rate of nine 6%. This quarter is similar to the last eight quarters and low compared to our historical levels and was typically expected for entry level products.
The credit profile of our homebuyers remain stable and consistent historical average of high 30 for Dci and high 730 for five quarters I believe we believe that our portfolio quality homes are attractive alternative for customers, who are priced out of the move up communities.
Being that we continue to monitor our leading indicators for any early warning signs or changes to the market and we remain ready to adjust our near term operations Accordingly.
Although we continue selling them fairly quickly we recognize current dynamics are not sustainable indefinitely and eventually in homebuilding demand will stabilize we welcomed in the market stability, which we believe is necessary for sustainable long term growth.
We can flex with market condition and slow down if there is any choppiness in the market demand and focus on smaller price per homes with fewer amenities.
Impaired to other NGL offerings are affordable home offer surprisingly more with quick move in timeline.
This quarter, we are announcing Q formal relationships with large national build to rent operators selling that individual hall and contracting for both communities over the next several years, while we do not have specific targets for this line of business. We expect this to be a high single digit to low double digit percentage of our annual closing volume long term.
In the first quarter 2002 built around accounted for under 5% of closings volume.
Slide five.
Given a long dated cycle time, we are pleased that our first quarter closings of 2000 and 858 home. We're just 32 homes below the challenge challenging comp to prior year.
Entry level comprised 86% of closings up from 73% in the prior year total orders of 3874 for the first quarter of 2022, reflecting an increase of 12% year over year, driven by a 32% increase in average active community count and our salaries stock despite the decline in Alberta.
<unk> of $5 80 per month in Q1, 2021 to $4 nine per month this quarter.
We intentionally restricted our pace to align our targeted production delay.
Ensure an excellent customer experience that includes both the opportunity to lock in a mortgage rate and how the quick and flexible move in process.
Entry level comprised 83% of quarterly orders up from 76% in the first quarter last year as we continue to shift our product mix and two level also represented 81% of our average average me compared to 73% a year ago.
Slide six move.
Moving to the regional trends all of our regional regions achieved growth in average community count and order volume in the first quarter of 2022, our central region, which is comprised in Texas had our largest increase in reorder volume was 16%. This resulted from a 21% increase in average active communities combined with our highest regional.
<unk> added order pace this quarter of $5 eight per month pricing power led to 20% increase in ASP on orders compared to the same quarter last year, given the state's favorable economic and business environments.
Closely behind our central region, our increase year over year orders growth of 15%. This quarter was primarily due to a 45% increase in average occupancy at our largest retail increased this quarter. This more than offset the 20% year over year decrease in average order pace to $4 five per month, the east region had the largest decrease in Ngls.
Community, resulting in 82% of average atrophy, selling NGL products during the quarter compared to 70% in Q1 of last year.
South Carolina had the highest increase in order volume this quarter more than doubling its 2021 volume to due to a community count ramp up over the last four quarters.
The West region first quarter 2022 orders volume increased 5% year over year as a result of a 21, 8% increase in average community count that was offset by a 19% decline in outdoor.
Given solid market conditions strong pricing power and Paramount limited entry level and first move housing inventory in the region. The West region had our highest we don't increase in ASP on orders this quarter up 21%.
Although Colorado remain the lowest percentage of entry level mix at 50% of its average occupancy for the quarter were continued to shift towards a slower product in this state we expect it to absorption pace will start to increase overtime and.
And in Arizona, where the housing market remains robust our quarterly orders decreased year over year by 9% due to metering from numerous supply chain issues, which led to a 25% decline in our average assets.
Average absorption pace, despite a 21, 2% growth in our communities.
Turning to slide seven we accelerate starts to over 4000 homes in the first quarter from approximately 30000 homes in the fourth quarter of 2021.
We expect to continue ramping up starting in the second quarter of 2022 as a community count increases as we work to return to our optimal level expertise of four to six months of supply we.
We continued to navigate production challenges to increase the amount of <unk> and our entry level communities.
80% of our home closings. This quarter came from the previously started spec inventory, which increased from 71% a year ago. We ended the period with over 3200 spec homes in inventory or an average of $12 one per community as compared to approximately 2300 is back on average or $11. Two in the first quarter of 2021.
At March 31, 2022, less than 5% of total specs were completed versus our typical run rate of one third due to sustained demand and supply constraints.
With our cycle times, while our cycle time did not expand in Q1 sequentially over Q4 last year were still about six to eight weeks of additional time from our pre COVID-19 construction schedules.
We are pleased we were able to hold the schedule from worsening and are now pushing to gain some time back over the next few quarters.
In addition to the extended cycle time, we are also selling later in the construction cycle to maximize margin and maintain a best in class customer experience.
Our customers appreciate the ability to lock in their mortgage rates in a rising rate environment and to plan for a move in date that fits their deadline.
Given the longer cycle times and later sale, we ended the quarter with a backlog of nearly 6700 units as our conversion rate declined from 62% last year to 50%. This year when the supply chain stabilized. We anticipate site provides a shortened and backlog conversion rates will pick up again.
We continue to lead our streamlined operations and pre sided all entry level homes before selling to help us navigate supply and labor constraints. For example, we were able to lock in supply volumes that are bound with our vendors well in advance and provider trades visibility into our scheduling while operating consistent and repetitive line work that doesn't require the most skilled.
Labor.
Additionally, given our reduced FTE count, we can remain nimble and substitute our selections of vendors a certain product availability runs low.
To address our anticipated incremental start throughout the rest of the year from a community count growth, we strengthened our long term relationships with our critical national and local Bennett, we view our trading partners not just supplier and are willing to lock in guaranteed volume for their commitment to deliver on that additional capacity to meritage homes.
Our whole team from fuel purchasing agents up to the executive suite continue to engage with our partners demonstrating our focus on finding workable solutions.
I will now turn it over to Hela to provide additional analysis of our financial results.
Thank you.
First I wanted to start by covering the retroactive rate back Steve mentioned earlier, we believe that today's buyer is aware of the current interest rate environment and after locking in fixed rates with our mortgage team for the duration of the construction cycle as buyers comfortable with them on maintaining however, we also recognize the borrowers in our bag.
There were pre qualified for floating rate loan several months ago, we now find themselves in a different technological and financial position regarding our home purchase after the studying some steep surge in interest rates since the start of the year you wanted to review this concern for our buyers and in March we purchased retroactive below market.
Interest rate locks and apply them to all eligible floating rate loans in our backlog that are scheduled to close in the second half of 2022. The response from our customers has been overwhelming and we believe this action will help limit future cancellations in Q3, and Q4 of this year and demonstrate <unk> commitment to provide exceptional value.
In service to its customers.
Let's turn to slide eight and cover our Q1 financial results in more detail.
<unk> revenue grew 15% year over year to $1 2 billion in the first quarter of 2022 as a result of the 17% increase in A&P due to sustained homebuilding homebuilding demand even as we continued to shift our product mix towards entry level home closing volume declined 1% impacted by the continuing supply.
Chain issue pushing some of our linked quarter soybean to Q T.
Our first quarter 2022 home closing gross margin was a record 33%. In addition to our favorable pricing power selling homes later in the construction cycle helped us avoid cross risks and maximize margin and 560 <unk> improvement from 24, 7% margin a year ago, mainly resulted from higher.
More than offsetting higher lumber and other commodity costs as well as the benefit of lower interest costs stemming from improved interest rates on our refinanced debt Kevin lumber volatility. We anticipate the next couple of months to be choppy due to timing of a number of exit Q1 with potential savings impacting margin in the back half of the year.
The interest cost savings and margin should be permitted.
SG&A as a percentage of home closing revenue was eight 5% for the current quarter and 130 <unk> improvement over prior year or.
Internal and external commissions higher revenue and the benefit of technology on our sales and marketing efforts allowed us to better leverage our SG&A. In addition to continuing our pursuit of overhead efficiency, we expect the incremental revenue from clothing volume growth will drive additional SG&A leverage in the future.
First quarter of 2022 effective income tax rate was 24% compared to 26% in the prior year the higher rate in 2022 reflects the expiration of the 2019 taxpayer certainty and disaster tax relief Act under which we earned eligible energy tax credits and qualifying.
So within 2021 since the energy tax credit has not yet been inactive beyond 2021, we're not assuming any such benefit in 2022 at this time.
Pricing power expanded margins and improved SG&A leverage combined with the lower outstanding share count led to a 60% year over year increase in first quarter 2022 diluted EPS to $5 79.
Turning to page nine we maintain a strong balance sheet and ample liquidity during the first quarter at March 31, 2020, our cash balance was $520 million compared to $618 million at December 31, 2021, primarily.
Stemming from land spend and inventory rose $291 million during the quarter as well as share repurchases, which totaled about $99 million for over 1 million of shares have come down.
Net debt to cap remained low at 16, 9% as of March 31, 2022, we continue to target a maximum net debt to cap rates in the high 20 <unk>.
Debt maturities until 2025, we believe we have sufficient flexibility should current economic conditions change we continue to focus our capital spend primarily in opening our incremental need and getting specs in the ground to help us gain market share. In addition to reviewing buying back shares to offset any grants and keep our dilution neutral meaning opportunistically repay.
Richard incremental shares just like we did this quarter. After these purchases we still have $54 million remaining on our share repurchase authorization as we consider cash our cash spend we look to balance our operational cash needs with maximizing long term shareholder value.
Onto slide 10.
At March 31, 2020, we had over 75100 total lots under control flat sequentially from Q4 2021 based on a trailing 12 months closings, we had nearly six year supply of lots, which is slightly above our target of four to five years, given the incremental volume that it started to flow through from the new communities that have.
From a grind over the past few quarters, we have a five year supply of lots based on our forward projections about 15000 homes for 2022.
The first quarter of this year, we secured over 4100, net new block, 30% lower than prior year, our net loss channeling into 27, new communities of which approximately 93% of our entry level to maintain our focus on affordable homes in the future. We prudently grew a lot position that slower pace. This quarter than you did in 2021, primarily.
Placing our stock since the 300 community count goal is within our reach we anticipate growing beyond 2022 at a more normalized pace and we continue to gauge for changes is some bank trend in all of our markets.
Opened 32, new community and grow our community count from 269 at the start of this quarter to 268 by March 31 2022.
We spent over $371 million for land acquisition and development this quarter, which was essentially flat year over year.
There could be a comprehensive stabilizing our go forward land acquisition and development and Greg will be more measured.
These options are staggered purchasing terms, where financially feasible to preserve liquidity as we manage our capital as your balance sheet metrics and margins, we do not target an arbitrary percentage of option land. Each deal is evaluated based on its own financial Merit.
65% of our total lot inventory at March 31st was owned and 35% with the options in line with Q4 2021 as of March 31, 2021, we had a 60% owned inventory and a 40% option position now.
In the first quarter of 2022, we remain selective regarding the land secured we continue to underwrite to normalize incentive volume and absorption as well as consistent minimum gross margin thresholds, although we havent changed our underwriting gross margin hurdle. Most deals are coming in above that which provides us a cushion to absorb further cost increases.
Potentially higher future incentive this discipline enabled us to keep land cost lower and in turn moved down the pricing band when these new communities come online.
Finally, turning to slide 11, and April our demand remains healthy and steady even as rates continue to rise.
We may undersea supply and labor issues in ramp up or start we anticipate incrementally higher ordered including throughout the rest of the year for full year 2022, we're projecting total soybean between 14000 515500 unit.
Closing revenue of $6 five to $6 9 billion home closing gross margin in the low 20% range and effective tax rate of about 25% and diluted EPS in the range of $26 30 to $27 nine.
We remain on track with our 300 community example, just around the corner in Q2 this year.
We continue to expect the full year community count this year to grow between 15 and 20%.
As for Q2 2022, we are projecting total closings to be between 3030 200 unit home closing revenue of $1 three to $1 4 billion home closing gross margin in the high 29% range and diluted EPS in the range of $5 60 to $6 10.
With that I'll turn it back over to Felipe.
Thank you you are to summarize on slide 12, we believe we are well positioned to navigate supply and labor disruptions take advantage of our increasing community count and ramp of our starts and continue to capitalize on market demand by offering affordable yet quality product that said, we are prepared for today's rising interest rate environment given our.
On entry level, and first move up product and a proven strategy and operating model are driving lower costs through pre started inventory we.
We have a healthy land position in a disciplined and prudent land playbook with a focus on accelerated community counts. Since late 2019, we were very active in the land market post Covid, which is now starting to become visible in our community count growth and will continue to come online over the next several quarters. The older vintage land is producing outside profit that's visible in.
Our strong gross margins due to both being secured before the significant land price run up it started in the back half of last year and benefiting from the AFP appreciation over the last six quarters.
Additionally, our strong balance sheet enable us to remain nimble and flexible for any market conditions for the first time in company history. We will have 300 communities. We believe that our community count growth will mitigate potential absorption decline should the market slow down further will allow us to continue to leverage our incremental revenue to achieve economies of scale.
With that I will now turn the call over to the operator for instructions on the Q&A operator.
At this time, we'll be conducting a question and answer session. If you'd like to ask a question. Please press star one on your telephone keypad, a confirmation tone will indicate your line is in the question queue.
You May press star two if you'd like to remove your question from Mchugh.
For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star Keys. In addition, we ask that you. Please limit to one question followed by one follow up question. One moment. Please while we poll for questions.
Our first question is from Stephen Kim with Evercore ISI. Please proceed with your question.
Alright, Thanks, very much guys are impressive result as has become unusual.
Right now there is a lot I think of.
Confusion and questioning around the entry level segment of the market as it is it the better place to be or is it the worst place to be you know in a rising rate environment I think most everyone's saying.
The entry level buyer is going to be squeezed more and some people are taking potshots at that segment. So since you are so big there I figured I'd ask you.
Is it we're still seeing demand greater than supply.
Your communities, including your entry level communities.
And that's in terms of order taking is there anything about the order taking.
Which.
You know reflects in any way to kind of like an obsolete lower mortgage rate.
Or is it fair to say that the sales that you are making today are reflecting the demand and supply intersection.
At rates today, and if that staying strong why should we necessarily expect to see at weekend if rates sort of remain where they are and the economy remains similar to how it is today.
Thanks, Steven Yeah. So.
We're aligned with the second payment, which is the demand is.
Based on current rates.
The buyers that we're seeing come into our communities.
We are expecting a 5% raise by a 5% rate whatever it is today.
And they are entering that market expecting that rate at the current pricing and thats the payment that they're looking for so that's what we're seeing today now what I would tell you is that given the stability of our FICO scores and some of the backend ratios. We're looking at clearly the buyer.
They're shifting around so we believe that there are buyers that are being priced out of the affordable one a new face if you will and they're moving down to buy an entry level home. So someone who is thinking about or looking for a house in the five hundreds is now looking for a house in the 400, so we do.
Do see people shifting.
Around that kind of those price band based on interest rates going up and down.
Yeah. Stephen this thesis is really their population that need how they and we believe both millennials and baby boomers need housing, they're solving from monthly payment and interest rates go up that is P is a half needs to come down there as long as you're offering attractive project, which has been our thesis all along.
After a little bit more surprising wise, but we like to call. It internally as long as you're operating a little bit more when they're coming down the pipe and in looking at our home they're not disappointed with what is now a substitute product for them. So the demand is still there as long as you can talk for a for a price point a monthly peanut then.
We're still seeing that demand exceeds supply.
I wanted to add to this is not all entry level buyers are created equal.
So our strategy was always to position our products for the entry level buyer, who is willing to pay more and it's a little more qualified there are entry level buyers that are literally just driving for affordability and then theres a whole bunch of buyers out there that have a more discerning preference.
They are trying to get into school districts.
Millennials that are driving a lot of that and so more feet of high quality and high level buyer that is willing to pay more and is looking for that payment at he was that looking for those high quality locations and that that market is very strong.
Great. Yeah, that's very helpful. I mean, I think at the end of the day, it's sort of sounding like a rising rates is just forcing the market to focus on what they need and maybe we're in a niche market rather than a wants a market and that's totally fine given the scarcity out there.
I wanted to ask a question about your gross margins and your outlook. Obviously, you called out lumber, which is something that does you know gyrate around a lot and we're watching it just like everybody else, but in addition to that what we're wondering is whether or not there is any other incentives that are sort of being contemplated in your outlook.
It wouldn't be terribly surprising maybe to see incentives an increase to some normalized level, maybe you could help us understand one are you, including any incentives increase in incentives maybe.
Maybe like for example, offering to buy down rates at the closing table or something like that and then too.
What is the normal level of incentives that you would run through your gross from our cost of goods sold.
Versus where it is where it has been let's say in the in the first quarter of this year.
Sure.
Yeah, as we look at our gross margin guidance.
We're not we're not expecting margins to continue to go up from here from the Q1.
As you can see from the full year guidance and a lot of that is being driven by the continued cost increases that we're seeing.
We saw some very meaningful cost increases in Q1, and we're still seeing those and then on top of that we are we are thinking that theres going to be incremental incentives, whether they come in the form of rate buy downs or actual true incentives, maybe some additional real tariff focus or whatnot to hit or the back half of the year and to move those.
Buyers through.
Through the process. So we're being sort of conservative with that is as you sort of look at this rising interest rate environment, which is resulting in our full year guidance as it relates to what our incentives were in Q1 versus what a normal environment looks like they were basically absence in Q1, we didn't really have.
Any incentives other than the mortgage by now that we gave was really for our backlog.
But in a normal environment, where you could see anywhere from you know somewhere around 3% 4%.
Housing is in sort of the supply and demand is imbalanced, we typically sort of underwriting new land around 3% to 4% and that cost.
Rate lock, even that is reflected already as we mentioned it for Q3 and Q4 closing it at that.
That's a portion of what you're seeing flow through the margins in the back half of the year I.
I would say decline when we're guiding to 28 and we just closed out the quarter at 33, there's obviously a sequential decline coming in about half of the year a portion of it is that a portion of an incremental conservatism.
He needed it's difficult to gauge.
That or what you read what you read about the expectation.
Happen to fatty over the next one to two months, it's difficult to gauge what the market is going to be and we don't have 100% of our expected backlog to close out the year just quite yet.
Yeah sure I was that's what I was hoping you were going to say here that and incorporated that conservativism just to clarify one thing, though when you talk about normal incentives in a normal market is it also true that in a normal market home prices are rising at a sort of a low to mid single digit rate.
That that's typically what happens but.
When we look at a new piece of land and we buy a new piece of land today, we are expecting prices to appreciate we underwrite at current prices run right at current cost, but when we are doing is underwriting at traditional incentive structures that currently don't exist in the market today.
Yep got it okay. Thanks, very much guys.
Our next question is from Truman Patterson with Wolfe Research. Please proceed with your question.
Hey, good morning, everyone. Thanks for taking my questions.
First just wanted to follow up on one of Steve's questions before but.
Your business model you have a shorter order to close cycle time, you reiterated your 15000 closings, which I think indicates you're expecting demand.
To remain pretty healthy strong growth for meritage or at least the next couple of quarters. Despite the move in rates.
Just trying to understand at the margin if theres been any shift in your consumer behavior outside of that mix shift is there more hand holding to get them across the line.
Are you seeing more traffic that you have to get qualified before they place the order et cetera, just trying to understand what you all are seeing on the ground floor.
Yeah all of the above.
Definitely more handholding and getting people comfortable with getting qualified what their loans can be what their payment is going to be certainly happy to go deeper in the priority list. We still have really deep strong priority list on a subdivision by subdivision level, but were often happened to go deeper into those versus.
Yeah.
Theyre being the pressure of the first one to buy <unk>.
They won't get it going in three four deep into our priority list to find the right buyer for the right home.
So we're seeing all of those leading indicators come off of.
What was just unprecedented highs.
Where it was it was sort of just a frenzy out theyre still very very very strong, but I wouldn't I wouldn't categorize it as a frenzy anymore. So I will say that once we get the buyers. The qualification process is not any more difficult.
And it is than it was previously right when we're looking at in our FICO DTI.
And ltvs are not not any different than the worker.
Having to go down deeper into the Red for sure, but part of that is because of the size box in someone else's home becomes available. They have remained on a whole bunch of priority list personally cant get down that were still able to qualify the buyers.
<unk> and <unk>.
Financial metrics and all of the all the leading indicators around traffic and web activity contact center activity. Those are all very very strong as well they certainly come off of their peaks.
Given the rise in rates, but still very very strong flow of inbound interest in our homes.
Okay. Okay. So the priority lists are still deep you're just having to go a little bit further in.
I'm trying to understand.
The level of Investor activity in your core for sale communities either.
Smaller mom and pop investors or larger institutions.
And whether or not there's been any change in investor activity given the rate backdrop.
Kind of part two of this question.
The BTR platform.
If the for sale market.
Consumer Decelerates.
I'm trying to understand the appetite of the BTR.
Investor If you will how quickly do you think you'd be able to mature that platform.
Yeah.
Yeah.
We have a pretty strong pretty tight governor on the amount of investor activities, we allow in our subdivisions in our communities. We've always done that so we try to limit it to around 5% of the overall community.
And open that up to a mom and pop investors and whatnot. So when we look at the last four quarters, that's about where it's at is about 5% we haven't seen.
We don't particularly increased activity have you seen more interest from mom and pop I'd have to follow up with you on that I do think the investor interest in the market has has grown but we don't we govern that pretty closely.
The build for rent that's our thesis as well, although we are also waiting to find out how they perform along the way here right now there have a very very strong interest in anything that we can provide to them.
And we see it as an opportunity to mature or quite quickly if our for sale business work too.
Soften our decline that's at least the conversations and the partnership and the relationships we have.
In place today, and as we've sort of tried to increase that volume over the last couple of quarters as we look into the remaining of this year. There is a very very strong interest from those partners are buying anything that they can buy from us how youre going to see a ramp up in that individual home sale activity as Lee mentioned it.
A little bit under 5% of the current quarter, but asking and grow throughout the quarters of the year that inventory has already been identified and committed and we roll into next year. We mentioned that there is entire communities that are structured to be sold to the bill for an operator, so youre going to see that volume CUSIP.
<unk> in our in our results again.
The new emerging market for everyone here.
Institutional.
BFR participating in.
Home construction, so we'll see what the appetite is but for now it's incremental business for us it's not taking away from our core business. It's additional unit that we're identifying and securing for them with additional labor. So this is just a plus for us at this time.
Perfect. Thank you and good luck in the coming year.
Thank you.
Our next question is from Alan Ratner with Zelman and Associates. Please proceed with your question.
Hey, guys. Good morning, Thanks for taking the questions and great performance in the quarter.
First question, maybe just on that VFR topics and says since you were just addressing it what are the economics I know, it's early but what do you expect the economics to look like Theyre, just recognizing there's going to be some mix shift as that business grows from 5% to double digits of your volume over the next year or so.
I'm, assuming that you're not expecting margins on that business to be kind of the 30% type level youre generating today and for sale, but.
Are there any notable mixed differences either on price or margin that we should think of.
No. It's actually consistent there are certain costs that we don't have the bank.
Utilizing.
Our platform and we pass those savings to our operator partners.
Actually it's a net neutral for us and it's a net saving for that and since they are buying the majority of what theyre getting just straight off the animal that theyre getting the savings.
There were passing along for costs that we don't have to spend and actually net neutral right now and there might be some shifting across P&L line items, but net net it's the same for us at this point in time as the new communities roll on and there might be a slight de Minimis 100, 150 bed variant.
The falling Canadian University of individuals' homes, but again.
Not material at an accelerated pace.
The leveraging and the efficiency in our community is still going to result.
Net neutral impact.
Meritage.
Okay, Great now that's helpful. Hilla. Thank you for the color there.
Second it would love to chat a little bit about some of your comments on on the land acquisition side.
Kind of pulling back a little bit there this quarter and.
I know you guys, obviously made a concerted effort to really kind of accelerate that community count growth before a lot of your peers have which has really worked out well I'm curious with your new lot acquisitions down year over year.
Consistent with the plan you've had in place or was that in reaction maybe to what youre seeing in the mortgage rate environment and some some concerns going forward. There just trying to figure out like whether this returned to more normalized growth as more of an inflection or a change in thinking or whether this was always kind of the path you envisioned.
Both I mean.
We were very intentional about getting to 300 and stabilizing which we're going to accomplish here this quarter.
From there, we always plan to more measured growth to allow us to get the organization positioned to be successful and frankly not take on unnecessary land risk I mean, the opportunity to get to 300.
We put that goal out there in 2019 for Covid slowed us down a little bit but as soon as we saw what was going to happen out of Covid, we jumped in and delivered on that a lot of that land by the way that we are closing thats, making up to 300 today and stuff that we bought two years ago contracted two plus years ago.
So, it's really well priced low residual land, that's going to be flowing through our business plan for the next two years, we really don't need any land frankly for the next two years at all.
But has an interest rate have risen we've rationalized.
All of our land the land in our pipeline that were closing the land that allows us to grow from the 300 next year and beyond and looking at every piece of land through the lens of a higher interest rate environment and does that make sense going forward clearly land prices have escalated quite a bit over the last six.
Quarters until the land that Youre seeing out there in the market today to me frankly is kind of uncomfortable. There is some good opportunities out there you have to be very disciplined and look at 'twenty deals to find the one that your wife, which we're still viewing but I think you can expect us to have a much more measured and tempered.
New land pipeline from here as we look at just making sure we have the best 300 communities in our portfolio and then just grow modestly from there until we see exactly what interest rates are going to stabilize that.
Yeah, I think that strategy makes a ton of sense and given all the uncertainty and I would imagine that given the moderation in growth that should translate to some pretty pretty healthy cash generation as well.
I agree.
Alright, Thanks, a lot guys I appreciate it.
Our next question is from Carl Reichardt with BT RG. Please proceed with your question.
Thanks, Hey, everybody I'm, sorry, if I missed this but did you talk about how many homes you had actually under construction at the end of the quarter.
And our spec homes in total sum total homes.
Since the stack plus the backlog.
It's like 95% 9500 or so.
Yes 95.
Yes, <unk> got 100 houses in backlog in <unk>.
$93 65, and the actual number yep yep, okay. Thanks for that and then.
Just trying to think about about pricing strategy here.
And as you are.
We're looking going forward I mean, obviously the average order price is up a ton year on year and has been for the last three or four quarters and then is this the point in time now as we look at our models, where we ought to really effectively start flattening. It out on a go forward as you look at the new communities coming online in the mix there and it seems like this is kind of now where we should start to flatten it and I'm just curious if you think that.
It makes sense or the expectation here is that maybe you'll take the hit to margin, but you'd still see.
So just thoughts on that.
I can give you my thoughts I mean.
We're a ground up company right.
300 communities that make up our business plan and every community has a different story. Some have a lot of runway somehow are a little bit of runway somehow demand for years.
We're scratching for our five a month, so we price to the local market conditions, what are the competitors doing what's the resale market doing who the buyers coming to our communities.
So we're pricing based on supply and demand dynamics in each in each market that supply and demand demand market dynamics have been so upside down.
All the way through frankly, even today they are still there that we're pricing our products based on the demand in the market.
So it's hard to say what prices are going to do from here. If you look at what's going on in April I would expect prices to continue to go up based on the dislocation of demand and the ability for us to bring supply to the market.
It's hard to say.
Maybe the interest rates will start to diminish the demand to a point, where we're not going to continue to push prices.
Certainly our costs continue to go up as well. So we'll just have to see month to month, but we have a lot of communities.
Where they are on coastal California, coastal Florida core core infill urban Texas markets et cetera, where there's there's underserved demand for decades in those markets and we're going to price to the market I think you've seen from our margin.
We're not shy to do what the market. We're not we're not trying to take what's available in the market. We're going to have we're going to increase our pricing.
In line with what everyone else again, maybe even push a little bit more.
Does a challenge affordability. It certainly does and I think we're trying to get there by buying cheaper land starting in a lower A&P, but we're not scared to take what the market is giving us.
Yeah, that's exactly right and we continue to have.
The land we are buying the land we are bringing on this year not only is it bringing our ASP down.
Even though the market's appreciated a time, but it is producing.
Very very strong margins. So we're bringing all these new communities.
We've had the highest community count growth in the industry.
Frankly, the only community count growth in the industry.
Completely flipped over our community count mix, and we're producing industry leading margins. So it's all about the great work that every single one of our land teams have done in every single one of our markets buying the right land to help us deliver affordable products.
Really strong margins.
And I really appreciate the detail there. Thanks, so much.
Our next question is from John Lovallo with UBS. Please proceed with your question.
Hey, guys. Good morning, and thank you for taking my questions.
The first one is I guess on the on the purchase of the mortgage rate locks for the customers and backlog I mean, it seems like a very good customer service.
Action that you guys took but I'm curious given how tight supply is right now I mean do you think that you could have actually sold those homes with folks dropped out of backlog at higher prices and why I'm asking. This is this move is not a reflection or is it of <unk>.
Demand concern going forward.
It's not a demand concern issue.
Who we are as a company and treating our customers right.
We're not buying below market rate locks for current customers. They know what the interest rate is an Iraqi walking in the door today that folks that bought houses surmised when the interest rate was around three and when theyre going to go to the closing table, it's going to be five and half.
Theyre going to probably fall out can we sort of have we absolutely can meet the other half is it the right thing to do is that the right thing as a company to treat your customers. It's the way not one or two but a large block of your customers. We now feel like it was the right thing to do the market moved a little bit more quickly on all of us and what we thought.
Yeah.
And finally to build the houses there even in the time that they're locked into the tenant their clothing, just the variability is likely more than what they were expecting frankly more than what we were expecting rates to probably moved up dramatically.
Looking at everyone was expecting to see.
Yes for us like I said, we're not we're not now.
Offering below market anything for new customers and we're selling at the same pace and we're definitely not.
Thinking this as an indication.
Demand in the marketplace, although we are now.
<unk> all customers eating our mortgage company with an interest rate locked now at market rate. After they know what it is but we just think that is.
It's good business and it's good for their.
Comfort to know that the rate that they are locking in a monthly payment that they're solving for today is the monthly payment that is going to be available to them because the house before we allowed.
Loans to float there wasn't a lot of variability in the market.
Today, we're asking all buyers seeking a mortgage company a lock in the current rate.
Okay that makes a lot of sense. Thank you.
And then I think you guys mentioned that you did not see any further extension in cycle times in the first quarter if.
If that's correct I mean that that's different than some of your competitors are saying so I'm. Just curious what do you think has allowed you to sort of maintain the cycle times when others are seeing further extension.
Yeah that is true we didn't see any additional incremental.
Schedule delays or I guess, our schedules didn't expand from Q4 to Q1.
It's just the commitment to this to all spec strategy starts pre planning those starts.
We set a number of different times, we started planning out our business six months ago for this year. We now knew all of these communities were coming we got in front of our trade partners. We built out the plan we're committed to the plan.
Despite rising interest rates, we say, we stay committed to that plan.
And because of that and our intention of scheduling out our starts and planning out our starts and then the fact that our business is so streamline and our trades can perform better when we have less complexity I think thats, what what what has occurred and it's played out in our cycle time.
Here to tell you that it's not a mess out there.
It's still very very bad so very difficult to get material and labor to our site.
And things Havent gotten any better, but they definitely didn't get worse for us last quarter, and we're not seeing them get worse this quarter and I just think it's again the commitment to the stacks and planning out the business well in advance.
Great. That's helpful. Thank you.
Our next question is from Michael Rehaut with J P. Morgan. Please proceed with your question.
Yes.
Thanks, Good morning, everyone. Thanks for taking my questions.
Firstly I just wanted to kind of break down.
Maybe potentially get a little more specifics if I missed it I apologize on the the rate lock.
Actions in terms of number one what percent of your backlog did this impact and when you talked about floating rate loans I assume.
Most of your loans have been or are fixed rate. So I was just kind of curious on the percentage of the backlog that this impacted and what roughly what was the.
The dollar impact.
Abiding that to the company.
Yeah. So these are mortgages through our mortgage company partner, which is about 80% of the business that we do and neither in mortgages just for Q3 and Q4.
So prior to them run up in interest rates only about 25% of our backlog roadblocks right. It's low by historical averages, but pretty much in line with the last three years people aren't walking rates that the like for like.
As we head into the rate's going to go down not going to go now let me just clarify there is a onetime slowdown on this rate lag, even though it's below market. There isn't one time rate slipped out in this market as well, but the expectation and buyers have been settled maybe February of this year is that rates are only going to go lower knocking in Ohio, So very few a lot.
It changed dramatically in the last five six weeks.
Everyone is asking to lockdown.
They are going in our favor, but what was in the backlog before we are definitely not locked so post this action.
Great majority of the backlog that we have now locked for the back half of the year, Yes, no don't get don't get.
Nomenclature mixed either we're not talking about people, having interest only loans that float.
Everyone's on a 30 year fixed but they left the rate flow until they close the house correct. So we were locking the rate, but no. One was doing arms are interest only loans that were floating this as if they were letting it flow during the build time and then locking 30 days before they close and we wanted to lock.
Earlier on in that.
We're not we're not given the specific cost.
For competitive reasons, but the cost is baked into our guidance.
Got it no. Thanks, Thanks for that and then I guess just more broadly then.
I understand.
The.
First half gross margins versus second half I guess doing the math it would point to.
Second half gross margins somewhere in the 27% range roughly speaking.
If you look at that maybe 250 ish basis point differential let's say.
Hello.
I'm sorry.
Yeah, he's still there sorry about that.
If you look at the difference between the two first half and second half.
I was just trying to get a sense of how much is conservatism.
Versus some of the cost increases and maybe other anticipated.
Increases in incentives that you are anticipating.
Well, we're not going to get a breakdown.
The margin analysis for the full year, but I think you hit on all the items Mike.
A piece of it in the rate lock piece of its future anticipated incentives per home that we haven't yet sold it will be closing in the back half of the year and Sunday is timing of lumber right and we have just higher direct costs flowing through everything that we're starting to build now that's going to be in the back half of the year has higher.
So there is a whole bunch of different dynamics that are flowing through the expectation to the back half of the year. Although obviously, we still raised our full year guidance by <unk> 27 in two.
<unk> thousand 70, 75 last quarter tests low 28, so we are still forecasting an improvement from where we were just three months ago, but overall, we're also trying to be realistic and cautious as to what the next couple of months old.
Thanks.
Our final question is from Deepa Raghava with Wells Fargo. Please proceed with your question.
Hi, Good morning, everyone. Thanks for taking my question.
A very high level question for me since everyone is.
Is welcoming housing stability here.
How do you define the stability and idealistic market is that 1617 housing starts with a 7% volume growth pricing may be 1% to 2% annually in line with overall inflation I mean like what volume do we not end up stretching.
Light chain that we have right now.
And also in that scenario what is merited.
<unk> to grow and take care.
Quite a ramp from that 300 community count base that just portfolio itself.
Yeah.
Yes, I mean.
I think.
When you look at annual housing starts historically, they've been one five or so and so we're not even close to that.
But Mary strategy has always been to get to 300 communities.
We think between what have you and entry level, we can do.
Kind of blended absorption rate between four and five.
And that 15000 units.
Over annual periods, and so that that's our strategy and then we grow based on what the market will give us from there and what the landmark it will get give us as well. So that's really the strategy is not that complicated.
When you think about.
Home prices.
When things are normal prices are moving up 3% to 4% a year.
What they've done over the last two years.
So that's how we think about it when we look at new land.
We think about we don't include depreciation and we don't include cost inflation, because our assumption is that home prices will go up 3% to 4% and cost will go up two or 3% and you'll end up with what you what you underwrote. So that's what's normal for us.
We've constantly said that we think the market will normalize to a three to four months of absorption pace over time, we're clearly not there we're still metering sales across the entire industry for a variety of reasons that have been articulated and I don't think if we opened up all our communities today and just let them.
Right they would run at a much higher pace than three to four right now, yes, I think I think that was maybe back to the first question that Steven asked which is.
What do you think of the NGL space I don't know that it has.
3rd% tied to total housing starts.
<unk> been building and we think that we're building in the area. That's the most underserved so the.
Stabilized market for us may not be.
Direct extrapolation as to housing starts back a normalized pace.
We said four ish, a little bit meeting widen that with normalized.
When the market does that other dynamic makes sense priced at their normal supply chain come back into alignment labor makes sense and that's the environment that.
We're looking for that gravity international and the buyer doesn't have a fear that they're buying it at a bad time in the market.
That's great color. Thanks for that my follow up is on SG&A and I apologize if I missed it.
Are you able to provide some numbers around that for the year. I mean, you talked about some additional leverage leverage coming from this new volume reset do you have.
Now back to Ed.
G&A.
Yes.
I wouldn't expect it to do something tremendously different than what we're doing right now we have guided to higher closing volumes. So it's going to bump around there's always some.
Nuance is as to what happens quarter to quarter back at eight 5% that we had this quarter I would expect that seems to lead not too different from that.
That's great. Thanks, very much it was a good quarter and good luck. Thanks.
Thank you.
Well.
A question and answer session and I will now turn the call over to CEO Felipe Lord for closing remarks.
Thank you so much for your time and your interest in Meritage homes. We really appreciate you listening to our story and we look forward to see you next quarter. Thank you.
This concludes today's conference and you may disconnect. Your lines at this time. Thank you for your participation.
Okay.
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Yes.
Okay.
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