Q4 2022 Meritage Homes Corp Earnings Call
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Greetings and welcome to the Meritage homes fourth quarter 2022 analyst call. At this time all participants are in a listen only mode. A brief 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. As a reminder, this conference is being recorded it is now my pleasure to introduce your host Ms. Emily Sudano, Vice President of Investor Relations and ESG. Thank you. Please go ahead.
Thank you operator, good morning, and welcome to our analyst call to discuss our fourth quarter and full year 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 in the earnings release and accompanying slides contain forward looking statements 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 them any forward looking statements.
Are inherently uncertain, our actual results may be materially different than our expectation due to a wide variety of risk factors, which we have identified and listed on this slide as well as in our earnings release and most recent filings with the Securities and Exchange Commission, specifically, our 2021 annual report on form.
10-K, and subsequent quarterly reports on Form 10-Q, which contain a more detailed discussion of those risks. We've also provided a reconciliation of certain non-GAAP financial measures.
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 Helix series that executive Vice President and CFO of Meritage homes, We expect today's call to last about an hour a replay will be available on our website within approximately two hours. After we conclude the call and will remain active in.
Until February 16, I'll now turn it over to Mr. Hilton Steve.
Thank you Emily good morning, welcome to everyone participating on our call. This morning.
Start with a brief discussion about what we're seeing in the market and provide an overview of our recent company milestones.
<unk> will cover our strategy quarterly performance he will provide a financial overview of the fourth quarter and forward looking guidance.
Q4 marked a strong finish to a year of exceptional execution and dedication from the Meredith.
We delivered 29% more homes this quarter and generated $2 billion of home closing revenue in the fourth quarter, which was 32% higher than the fourth quarter of 'twenty, one our home closing gross margin of 25, 2%.
Quarterly SG&A leverage of eight 4% led to our quarterly diluted EPS of $7 nine stuff.
Although favorable demographics and the low supply of housing inventory should drive long term demand. We believe they were overshadowed in the back half of the year, where ongoing economic uncertainty and buyer psychology increase in mortgage interest rates and inflation.
With homebuyers on offense about when to get back into the market, our fourth quarter sales orders declined 46% year over year.
Driven by a cancellation rate of 39%.
Today's higher mortgage interest rates continue to pressure housing prices at monthly payments still remain above 2020 in 2021 level.
Despite price cuts in rate locks.
We believe that until rates stabilize home sales activity will remain choppy.
We see some potential buyers who could qualify but are waiting for further price declines as they anticipate additional builder incentives are coming.
Other current buyers were rate locked in place are below current market mortgage rates were canceled due to the buyer hesitancy as they may have been nervous about the general economy or their own financial positions. However.
Given our available inventory, we are seeing some buyers reenter the market and respond favorably to our quick movements selection as well as our incentives and companywide companywide sales initiatives.
Now on to slide four.
As the team embodies our start with hard core value marriage employees donated countless hours.
We delivered three mortgage free homes deserving military veterans and their families on veterans day, and Houston Nashville in Tucson.
It is one of the most impactful annual initiatives of the entire organization and look forward to and we were excited and humbled to continue that tradition in 2022.
We also expanded our long term history of contributing to local nonprofit organizations to further our diversity equity and inclusion mission as well as voluntary time of Donnelley financial support to organizations combating food insecurity across the country and providing shelter to those in need.
This quarter Meredith was recognized by the Phoenix business Journal, both as one of the best places to work in one of the healthiest employers and as a result of our overall commitment to ESG, Maryland, whose name is more of a 2023 America's most responsible companies by Newsweek magazine overall.
Overall, we are proud of what our team members' accomplished this quarter on top of the quarter of solid operational execution.
I'll now turn it over to Felipe.
Steve.
During the quarter and looking into 2023, we are analyzing the business through the lens of market events and actions that are within our control we cannot influence the macroeconomic factors impacting Q4 sales that Steve described.
However, we can control, how we react to them and how our business can be by focusing on our core strategies that we have held for many years now.
To reiterate our strategies and actions we have taken we remain committed to your pre starting 100% of our entry level homes. This readily available home inventory puts us in a favorable position some buyers in the current market while homes that are ready to close within 45 to 60 days.
Eliminating uncertainty and reducing stress or a premium in today's mercury economic environment.
Further line building allows us to complete homes on a shorter cycle time than a built to order model despite supply chain issues pre starting homes with a limited SKU library means we can also offer more for a product of the path of our savings to our customers.
As an added benefit when we have cancelled inventory the lack of customization or home stemming from our streamlining tier specifications, resulting in limited discounting for the future refill that hole.
Since we mainly build entry level products, we expect a higher average absorption pace and prioritize pace over price.
Like all homebuilders, we benefited from the run up in home prices for the first two years of Covid and despite higher costs, we experienced industry, leading gross margin levels.
More importantly, we increased our market share.
Consistent with our strategy, we continue to target three to four net sales per month.
As we had a net orders absorption pace of two two per month in Q4, we have taken additional actions to get back on our target, including lowering prices and utilizing a full range of incentives such as mortgage rate lock rate buy down until we find the market can you point to move our inventory and get back to our target sales pace.
The timing of these actions align with the production time line of our spec inventory, which is now completed or near completed and ready for quick move in sale spring selling season.
Further during Q4, our operations team work hard to close a large portion of our backlog despite supply chain issues impacting cycle times. We also aggressively validated every home that remain in our backlog as of year end most confirmed their commitment to their homes, some needed incremental pricing or rate adjustments that we were able to offer.
In other cases, we had to cancel those sales it was clear the buyer is not the only person health with a reasonable incentive structure.
By proactively scrubbing, our backlog, we likely identify some cancellations early in the cycle normal, but this gave us more confidence that our backlog at the end of <unk>. Thank you and added available inventory for sales manager January .
While we certainly don't have a crystal ball regarding what cancellations rates will do in 2023, we are comfortable that the buyers who purchased homes in earlier March 2022 under different market and economic environment represent a smaller portion of today backlog compared to a greater portion came from buyers that have a more fulsome understanding of the current.
Market conditions, their monthly payment expectations, and the relative advantage of the rates and pricing status in.
In addition to our sales initiative opportunities purchasing team is actively rebidding, our vertical boss to capture cost savings incremental capacity is growing within our supply chain.
Chemo will touch on more details, but suffice to say we are pursuing cost savings across all cost categories in all of our markets. This year.
These intentional actions enabled us to adjust pricing incentive structures can you give I community. So they can take advantage of a supplier to build inventory as we kick off 2023.
We believe we have the right level of completed or near completed homes to sell which combined with a different mix of pricing action financing solutions and incentives allows us to offer a global package that is aligned with deep local market environment.
Now turning to slide five the share operational statistics, the 29% year over year increase in our Q4 closings to 4540 homes was attributed to our team successfully managing the persistent labor and supply chain challenges and.
G level loans made up 85% of closings up from 81% in the prior year.
Our fourth quarter 2022 sale orders of 808 homes were comprised of 89% entry level home.
82% in the fourth quarter last year.
The 46% decline in sales orders year over year was primarily due to elevated cancellation and weaker overall demand. Despite a 10% year over year increase in average communities our cancellation rate in Q4 of 39% increase from 12% in Q4, 2021 and 30% in Q3 2022.
Quarterly gross sale orders declined a more modest 22% year over year, our fourth quarter 2002.
2020, obviously absorption pace was two two per month, which was down from $4 five per month in the fourth quarter of 2021, but gross sales pace was three six per month at our 3% to four monthly target affirming the underlying consumer demand isn't deep presence in.
And finding the right pace.
The price relationship we expect our average absorption pace, we'll get back to our target of three to four net sales per month during 2023.
Moving to the regional level trends on slide six.
The highest regional Georgia pace of two six per month in the fourth quarter occurred in our Central region, which is comprised of our Texas markets orders were down 46% year over year in Texas overall with all four Texas markets holding a gross sales pace greatest three pointed out per month. We believe we are starting to bite stability in Houston, Austin, and San Antonio while Dallas.
We are experiencing a steadier environment and are gaining market share.
Our fourth quarter retail absorption pace in each region with two five per month, we still have work to do here, but all of our east eastern market actually had a gross sales pace in line with our 3% to four per month per target and we are confident that we will we are well positioned in this part of the country.
The east had the lowest reasonable decline in orders up 41% year over year and the lowest cancellation rate in the fourth quarter and Florida ASP on orders were up 11% due to product mix shift even after our price adjustments, while orders were down 25% reduction in average communities.
Consumer pullback was most evident in the west region, where the absorption pace was one six per month in the fourth quarter.
California was the only state that an increase in orders year over year, which was primarily the result of more communities, California also had a gross sales pace over three per month, given the quality of our location and our entry level positioning in the market.
Colorado, and Arizona continued spirit buyer hesitancy hesitancy to transact as they adjust to the higher monthly payments in these markets that experienced a higher write off in ASP over the past few years further cycle times in these two markets are still some of the longest and least predictable.
Although the new incremental Sebastian showing up in the supply chain now is providing a runway for improvement here.
We wanted to provide some color in the January sale as we know that's top of mind for everybody on today's call compare to the average resort and paid a $2 two per month in Q4, we saw a notable improvement in January achieving a net absorption pace greater than four point out per month per community as well as a more normalized cancellation rate in the meat.
In the mid teens, we sold over 200 houses in January .
Approximately 4% over last January we had some initial confidence that we found the right combination of pricing incentives to sell on our targeted three to four net sales per month.
Now turning to slide deck.
Two line starts a slower demand we further moderated construction this quarter, starting approximately 2100 2100 homes in the fourth quarter compared to approximately 2700 in Q3 2002 and more than 3700 in the fourth quarter of 2021, we.
We ended the period with nearly 49 months back on the inventory or an average of 18 point community 18 per community as compared to approximately 32 hours back or an average of $12 three in the fourth quarter of 2021.
Market demand dictates or target amount of available inventory in each of our communities are.
What was the key four to six months supply of specs on the ground by managing our starts to match, our sales pace and production capabilities, although excess cancellations increase our expect slightly above our target rate this quarter to align with the additional supply of inventory on hand, we will flex the slowdown starts until we reach our optimal equal liver, but as noted we are already work.
Through about 25% of these stacks in January <unk>.
Similar to last year, 79% of our homebuilding. This quarter came from previously started inventory at.
At December 31, 2022, we added over 750 complete homes to sell our 50% completed homes is higher than the last couple of quarters and coupled with our homes that can close by the end of Q1 represent about one third of our spec inventory.
We ended the fourth quarter with a backlog of 3300 unit as we closed out a significant portion of our backlog and improved our conversion rate from 60% last year to 75% this year.
Q4 cycle times continue to be similar to the earliest reported in 2020, which.
Which was still approximately six to eight weeks longer than our pre COVID-19 outages. However, we are targeting aggressive reductions in construction time for 2023 and are already starting to see some improvement from our front end trade. We are hopeful that with the industry backlog clearing over the next few quarters and the capacity of backend trades like appliances flooring, countertops and cabinets, losing loose.
Denis are cycle clients and backlog conversion rate will improve in the back half of this year.
I'm now going to turn it over to Hugh to provide additional analysis on our financial results.
Thank you Felipe like last quarter, we'll start by providing a better color on our VFR business before.
The financials in detail.
I'm sure they'll current partners in the fourth quarter only represented a low single digit percentage of our net orders volume as the rental operators much like the rest of the sector are pausing to analyze our financial hurdles and adjust underwriting target. We're encouraged to see some incremental interest in January and continue to believe in the viability of this channel.
Due to the historical countercyclical strain, a rental market and higher interest rate environment.
Let's turn to slide eight and cover our Q4 financial results in more detail.
Home closing revenue grew 32% year over year to two <unk> billion in the fourth quarter of 2020, Q, combining 29% greater home closing volume and 3% higher ASP when compared to prior year as we overcame supply chain challenges to close a substantial portion of our backlog and our fourth quarter <unk>.
22 home closing gross margin was 25, 2% to 380 bps deterioration through 29, 5% a year ago was the result of greater incentives and higher direct cost as well as several nonrecurring items, including $10 9 million in warranty adjustment related to two specific cases.
And $4 2 million and write offs for option deposit and due diligence costs for terminated land deals, which were partially offset by $5 4 million in retroactive vendor rebates in the fourth quarter of 2021, we had $2 5 million in write offs for terminated land deals in our warranty or rebate.
Adjustments, excluding these nonrecurring items adjusted fourth quarter 2022 home closing margin was 25, 7% compared to 29, 2% in Q4 of 2021.
We expect our price concessions elevated discount and a continuation of financing incentives for rate locks and buy down will negatively impact gross margin in 2023, however, with our sales ASP down 10% to $389000 this quarter when compared to last year, we have already taken material.
Pricing actions, demonstrating our commitment to elevating our sales pace and although we're not projecting by based cost savings to offset the challenging market conditions. Today, we are starting to make some headway to reduce direct cost and improve cycle time. There are full company initiatives to drive substantial cost reductions with success.
Story that $15000 per home in savings, Justin Q3 already emerging in some divisions, particularly in our slower market, where trade has excess capacity. However, we likely will benefit from the full impact of these savings until the tail end of 2023 and into 2024.
They won't be captured in our home starts until mid to late this year, we still believe that long term our normalized gross margin will benefit from better operating leverage from our increased value and our streamline operation and we'll end up at or above 200 bps from our historical average of 20%, although the next several quarters.
Are likely to be bumpy.
SG&A as a percentage of home closing revenue was eight 4% for the current quarter, which was a slight improvement over eight 5% in the prior year, our higher revenue allowed us to better leverage our SG&A. This was partially offset by higher commissions and advertising costs to reflect our response to the current sales environment.
We believe marketing cost and broker commission will remain above historical averages in the near future, which combined with lower expected closing volume in 2023 will drive lower SG&A leverage.
Fourth quarter 2022 effective income tax rate was 23, 3% compared to 23, 8% in the prior year tax credits were earned on qualifying energy efficient homes under both the 2022 inflation reduction act for the current quarter in the 2019 taxpayer certainty and disaster tax rate.
<unk> for the prior year overall higher home closing volume combined with the lower outstanding share count in the current quarter led to a 13% year over year increase in fourth quarter 2022 diluted EPS to $7 nine.
To highlight a few full year 2020 to result on a year over year basis order units declined 15% closings were up 10%. We had 80 bps expansion of our home closing gross margin to 28, 6% in fiscal 2022, and SG&A as a percentage of home closings.
Revenue improved 90 bps to eight 3%, we generated a 35% increase in net earnings and diluted EPS was a record $26.74 for the year at 39% increase from 2021.
Turning to page nine.
Given slower market condition. We are also focused on exercising balance sheet discipline, we reduced spend on land telephony and home inventory ending the year with over $860 million in cash and generating $562 million of free cash flow. Just this quarter at December 31 2022.
Nothing was drawn on our credit facility and our net debt to cap was just six 8%, which is well below our maximum internal thresholds of Hy 'twenty with no shares repurchased during the quarter. We ended 2022 with $244 million available under our authorized share repurchase program.
The spring selling season, we felt it was prudent to grow our cash position to maintain maximum flexibility in an uncertain environment in the coming months, we will look to strike a balance between cash preservation for operation and returning dollars to shareholders and we expect to provide additional updates on our next quarterly call.
Shifting gears I want to remind everyone about how impairments are calculated when we estimate that the cash to be generated from the sale of homes in a community is not expected to cover the cost we will incur in that community and impairment is present, we review all of our assets every quarter and determined that there were no impaired communities in Q4.
Despite the reduced asp's and higher direct costs.
Looking at our expected home prices in 2023, we do not expect broad based impairment across our assets onto slide 10.
Even with the increased liquidity. This year, we grew our community count 5% in 2022 to 271 communities at year end in Q4, we opened 21, new communities compared to 11 in Q3. This year the ongoing supply chain issues and lack of chance farmers continue to extend the timeline in front of me.
New community openings. Additionally, we have strategically slowed and at times pocket some of our openings to take advantage of the opportunity to rebase and lower our vertical cost. So that these communities can opening a more competitive position when they come online we expect to continue to open new stores throughout the year and returned two or three.
300 community target over the next several quarters.
This quarter, we continue to rightsize, our land portfolio walking away from underperforming land deal or recently sourced yards, where we cannot secure clothing extension, even with slightly more than 10000 terminated masters here. We still ended 2022 with four five year supply of lots within our target of four to five years. So we're <unk>.
<unk> that we have all the land we need right now in Q4, we did not add any new lives under control, while we terminated roughly 3700 loss with a corresponding write off of $4 $2 million. These terminated loss relate to approximately $280 million of future land and development spend that we will not be incurred.
Great.
For full year 2022, after considering $15 8 million of walkaway charges through terminated land deals, we only have $92 $5 million in incremental exposure really to deposit and do the due diligence for future lots under control, which includes next phases of our existing communities.
And this makes up less than 2% of our total asset.
During the fourth quarter, we spent only $351 million on land acquisition and development, bringing our full year total spend to $1 5 billion.
With reduced land acquisition about two thirds of the spend was on land and omnicom.
We expect our 2023 land acquisition and development bank to be at or below the $1 5 billion extended in 2022, despite the anticipated community count growth.
At December 31, 2022, we had approximately 63000 total lots under control compared to approximately 75000 total lives at December 31, 2021 about.
About 73% over total lot inventory at December 31, 2022 was owned and 27% with options and the terminations of option lot understandably drove the mix of controlled but not gone lot lower than the prior year, we had a 65% owned inventory and a 35%.
<unk> lot position with just under 50% of our current portfolio sourced from land secured in 2022 or earlier, we are comfortable with the basis that the land control as well as the balance of owned and option lots.
Finally, turning to slide 11, and looking to Q1, we expect clothing to be between 22, and 2600 unit with corresponding revenue of $940 million to $1 1 billion, we expect margins to trend down to 21% to 22% and our tax rate to be around 22% to 23%.
With limited visibility and market condition, we're holding off on providing full year guidance at this time with that I'll turn it back over to Felipe.
Thank you.
To summarize on slide 12 January is off to a great start but too early to quantify the strength of the spring selling season, we are prepared to find the right combination of product pricing and status for all of our communities to achieve a pace of three to four sales per month.
Our commitment to pre starting 100% of Reg level hub, streamline operations and prioritizing pace over price positions us to capture market share gain leverage and maximize profitability as market conditions evolve.
In conclusion, I would like to thank all <unk> employees for their hard work and a job well done in 2022 their dedication drove our success and with that I'll now turn the call over to the operator for instructions on the Q&A operator.
Thank you ladies and gentlemen, the floor is now open for questions. If you would like the opportunity to ask a question. Please press star one on your telephone keypad at this time.
<unk> total indicate your line is in the question queue. You May Press Star two if you would like to move your question from the queue for participants using speaker equipment. It may be necessary to pick up the handset before pressing the star keys.
In the interest of time, we do ask that you. Please limit yourself to one question and one follow up again that is star one to register a question at this time. The first question today is coming from Truman Patterson of Wolfe Research. Please go ahead.
Hey, good morning, everyone. Thanks for taking my questions.
First just a.
Making sure I heard this correctly did you all say previously that January net orders were about 1200 and up 4% year over year.
Yeah, we have sold about approximately 1200 houses in January a little bit over 1200, which over last January was up about 4% and then our absorption pace per store was right around four and a half per.
Percy sales per community.
Okay. Okay, perfect. Thank you and I realize not reading too much into it.
January trends, but.
We have lower lumber costs beginning to flow through the P&L you all mentioned, perhaps some other stick and brick costs may be hitting later in the year.
We also have some higher land costs and you.
You know, maybe an uncertain pricing or incentive environment that maybe you all found the floor, but I'm, hoping can you help us think through you know when Q gross margins. If you all think that.
It might be kind of a floor for the year or should we still expect it to be pretty choppy.
I'll, let hilla dive into more detail.
Description of what's going on in Q1.
But I mean, it's just really.
<unk> two murky right now to know what pricing.
Is going to do obviously, we've been aggressive we're an affordable spec builder. So we're going to price ourselves in the bottom two coral piles of our competitive set community by community, which is what we've done we've done which is why our prices. Our asps are down now into the three hundreds from 480 at the peak.
So we feel like we've made some really significant adjustments to be affordable and to find the pace that we need to and.
I feel like we're well positioned for the long term.
But it's hard to tell what our competitors are going to do.
Some builders still have quite a bit of backlog that they're going to close out and I don't think they've adjusted pricing yet.
So we'll have to wait and see how that plays out and we certainly don't know.
What interest rates are going to do we're.
We're happy to see them stabilize where they are feel optimistic about that but those two factors are really driving our inability to predict pricing at this point and then I'll let hilla.
Kind of how we got to our Q1 margin guidance guidance.
So thank you Felipe Q1 is primarily what we saw in activity over the last four five months.
The ASC that youre seeing in our sale and we maintain we had fairly decent gross sales in Chile, the scrubbing of the backlog and the cancellation that brought the net sales down in Q4. So we think we've found market for three to four net sales per month January definitely proved that out right now, we're not comfortable giving guidance beyond Q1, but what we're seeing.
Q1 reflects the current sales environment does not reflect anything yet in the direct cost.
Initiatives. However, as we said we don't think that the margins are really going to materialize until the latter part of the year and notwithstanding that there is no other increases that are coming our way kind.
Kind of looking at where we are and we're comfortable that our current pricing structure were down almost 20% from the peak and we're able to sell.
An acceptable pace that we don't feel like we need to move any further at this time, although we're constantly adjusting with market condition.
Okay perfect. Thank you for that and.
You all clearly have streamlined business model generally with fewer vendors skus and floor.
Plans than competitors I'm, hoping we'll leave lumber alone, it's clearly down a lot year over year. It's it's.
It jumped up here pretty.
Pretty quickly you know so far in January but I'm, hoping you can help us maybe quantify the magnitude of potential cost tailwind.
That you're experiencing as of todays starts outside of lumber.
Well.
We're going through an entire re bidding effort right now.
You have mentioned.
Aggressively re bidding all of our communities.
Her spring starts we also have been holding off on opening some new communities to really rebid those to get our cost as far as we can so.
So it's way too early to let you know exactly what that's going to look like but as we said in our script, we're having success on the front end and less success success on the backend.
As it relates to the build so we've seen in some of the hardest hit markets that we've recovered over $15000 per house, which you know on a 200000 dollar.
Construction budget you can do the math.
In other markets like Florida, we havent seen it.
Seen that because the market is still pretty stable starts are still going out pretty fast and we haven't seen that opportunity, but that's all we're prepared to say right now because we literally are going through this effort right now, but the early feedback from our vendors is that there's opportunity here and we're going to capture everything we can.
And we'll report back to you next quarter on how we did.
Perfect. Thank you all and good luck in the upcoming quarter.
Thank you. The next question is coming from Stephen Kim of Evercore ISI. Please go ahead.
Yeah, Thanks, very much guys exciting times.
I appreciate all the color and particularly the commentary on January really dovetails with what I've been hearing.
You know a lot of excitement out there, but everyone seems extremely cautious about.
Predicting.
The sustain.
Sustainability of the rebound so with regards to that obviously the sales that were extremely good your over your three to four order per month pace in January .
And so the market clearly has done a kind of an about face and I'm wondering if you're beginning to ratchet down incentives at the community level or taking other actions, which would effectively.
Hmm.
I mean that you're raising your net price.
Yeah.
So at the end of the day.
We're going to try to get four net sales per store.
How we built our business and we're going to try to get a 21% to 22% margin at that pace.
We built we build everything from that point point of view.
So we went out there we had some additional inventory.
And I'm optimistic that having that inventory really is why our sales are but rebounded in January we're not sure. The market frankly is it any better other than fact that it's the spring and not the winner and.
And interest rates have somewhat stabilized.
From our perspective, it's about how to move in ready inventory, which we have that's what consumers want and that's why we feel like we saw the January result.
A number of communities, where we've made adjustments we did see very strong elasticity in demand when we lower prices and we were able to achieve even above our four net sales. So in those communities. We're pulling back on incentives, where we think that is sustainable and will back off on <unk>.
<unk>, we don't have to use rate buy downs nearly as much as we did now that we're selling all stack.
People can move into relatively quickly and we can drive those costs down so it's community by community, but it's one month.
And we're going to go take market share right now we're going to be aggressive, but we can do more than four months at today's margins will probably take more than four months at today's margin as the spring selling season, and we want to go get that go with this market share by other builders don't have the spec homes.
To go get it so we will pull back a little bit where it makes sense, but for the most part we're a couple of hours options or sorry, our margins are and we're going to go try to sell more houses.
Yeah that makes a.
A lot of sense your commentary, though about community count and your rollout of those communities.
It would seem to be a bit at odds, though without running hotter than for a month. So correct me if I'm wrong. If this demand actually proves to be deeper and broader than anyone's really willing to bet on yet.
Do you have the ability to do an about face on your.
Community count openings or community openings. So that you can maintain a positive year over year community count over the course of the year.
We can always accelerate opening our communities. If demand is really strong I think we don't feel that that's prudent today. So it would have to be really strong for us.
Make a decision to do that right now.
Where we're seeing some meaningful opportunity to load off lower our vertical costs on those new openings and I think that's probably more critical for the long term success of the community then opening it up early and getting positive community count comps because we are big.
Big investments, we made and we don't want to compromise the integrity of those communities by opening them up at high vertical costs that don't underwrite.
So that's number one number two is it still not getting any easier to open these communities get to municipalities municipal approval get transformers to the job site and frankly get finished inventory.
So that when we open up a community we have ready to move move in ready inventory in every single one of community. So that that's driving the decision is the operational discipline, there and I don't think we're going to compromise that just hit our commitment to accelerate community count. This year, it's more about opening up those communities with strong momentum.
Opening about clean well executed opening up with standing inventory ready to move in and opening up with the best vertical cost structure. We can just to clarify is that 300 community count target that we say, we're going to hit a couple of quarters that are really facing the rebating process. So as we said, it's going to take US a couple of quarters to get through that.
Every day, we said, we're not going to have some starts until the latter part of this year, which is exactly aligned that our community count opening target that we just provided and opening a community where that inventory doesn't really work as we said that the volume that we're seeing is because we haven't been able to go back and putting a whole bunch of specs in the ground at.
And insulated cost when you know it's coming down in just a couple of quarters doesn't seem to be the right decision. So we're willing to be patient to make sure we drive that accelerated pace, while not sacrificing west sales type we can set the target that and just have those sales in the back half of the year instead of more anemic at a lower margin pace in the front end of the year.
And just one last comment the cancellations in Q4 were all part of the issue with people opening up communities without production and then you're hoping to hold onto your buyer for nine months.
And that just doesn't make any sense. When we don't know where interest rates are going to do so we want to open up with move in ready inventory customers are willing to.
Engage with something that moves in 30, 60, 90 days they can lock their rate and I think it minimizes your cancellation exposure. So we know we've got our.
Insulation down to where we want them now and we're going to run our business to make sure. We keep those cancellation rates low assuming that interest rates will continue to remain volatile.
Yeah. So that's interesting for me because I think that you said.
<unk> that you'd like to see rates stabilize.
And what you just said is that we've seen a lot of volatility in the mortgage REIT, which we certainly have and so I'm curious.
You sort of suggested that.
Debt buyers need to see some rate stability, but I'm curious if that's really true for instance, if we were to see the mortgage rate dropped into the fives, which it certainly seems as possible here in the relatively short term.
Do you not think that that might represent an additional boost to homebuyer sentiment as that starts to make the headlines.
I mean, you clearly got App can be a trick question if rates are lower there's more demand.
Absolutely one to one relationship so yes, if rates go to five we're going to see stronger demand, but we're going to stay with our operational discipline are selling move in ready stacks.
It's about our supply chain, it's about our cost structure and Tobias about not knowing what the future holds we could see a great a strong spring selling season, but rates could go up in the back half of the year the fed may.
<unk> made their speech yesterday, they certainly didn't say they were going to lower them.
So we don't know yet and we're going to focus on operating the way. We think is in the best interest of our company.
Thank you once again, ladies and gentlemen, we ask that you to please limit yourself to one question and one follow up to allow as many people the opportunity to ask a question today. The next question is coming from Alan Ratner of Zelman <unk> Associates. Please go ahead.
Hey, guys. Good morning, Thanks, as always for all the great info.
Yeah first on the pricing side.
Yeah like you brought up <unk>.
Average order price down 20% over the last couple of quarters, which is obviously way more than the market is down and certainly way way more than your peers are and it sounds like maybe some of that as you guys being more aggressive, but I would imagine there's a decent amount of mixed in there as well so.
I'm, just curious if youre able to kind of parse that out for us because I do recall a couple of quarters ago. When you were kind of given the impairment.
Sensitivity I think you said like home prices would need to drop 20% for for there to be any meaningful impairment risk and now you're saying, there's obviously not a ton of risk out there, which makes a lot of sense given the current market I'm. Just curious if you could kind of drill into that a little bit.
I'll, let you.
Unpack the impairment question, but I would just tell you it's not a lot of mix. It's mostly just price. We absolutely are ISP was close to 4%.
Middle of last year, and we're now close to 390.
And it's mostly store to store, primarily the biggest adjustments have been in the west and certain parts of Texas, although a little bit to the east and you know.
Our position is that we're an affordable builder.
We have to get to a payment that makes sense for our customers and we believe that payment exists when we're under 400 ASP.
We underwrote most of our OEM, that's coming through our income statement two years ago, assuming RSP was going to be in the threes to low fours, and that's where we position our products.
And then so we're about competitively positioning ourselves at the bottom of the graph or slightly above the bottom of the graph and.
And being the affordable new homebuilder in our competitive set so all of that is mostly price. It's yes. We've opened up a few new communities and there may be at lower Asps.
A geography.
With the east.
Yes.
When we're looking at it.
We mentioned it just on a mix perspective, 89% of our sales in the quarter were entry level, it's not that different from 82%.
Last year's fourth quarter, so the mixes in somewhere in the <unk> category. So that's not highly material sure. There's always geographic shift that's difficult to quantify but California was a fairly material portion this quarter, but Colorado went down so it's always a little bit of that but that's not driving the majority of.
That shifted the majority is really from true reductions or incentive. So he gets really notable that with this material.
A price reduction that we're still north of 20% margin that gives us the confidence to say as we sit here today, we don't see broad based impairment with north of 20 margin not just in the current quarter bidding a quarter that we gave guidance for <unk>, how does that math work how can you dropped 20% from 31 six.
They'll be above 20, there's some other pieces that go into the mix certainly some increased efficiencies and simplification of the product, but then also the higher volume.
It's helping us leverage some cost that particularly as we found the fourthquarter. So there's there's a lot of other pieces that roll into the incident of calculations, but overall you are seeing the impact of lower pricing already in our numbers, which is why we feel comfortable especially looking at our January numbers that without any larger.
Material shifts in the market that we have a good H P to hit our three to four net sales combined and where we've made the most meaningful adjustments.
In Phoenix Denver, We've also saw the most meaningful direct cost savings, which have softened.
And.
What our margins have died when we quoted earlier in our script that we got $15000 per house, that's in Colorado, and Phoenix, That's where we got those numbers, where the market has adjusted the most and also where prices ran up the most.
Last three years.
That's all really helpful and I think it's it's really impressive.
<unk> been able to reduce prices as much as you have in bringing affordability equation at a more reasonable level for your consumers and still generate the margins you are I think it obviously speaks to the execution of the operation there so well positioned to kind of take continue taking share from that regard.
Second question, we heard from another builder last night.
Gave similar commentary on January activity, but they did kind of adding a comment that they might have seen a bit of a leveling off of the improvement over the last week or two kind of implying that things really accelerated kind of back half of December into early January .
Not to get too fine here on weekly activity here, but is that a statement you would agree with or do you feel like the market is continuing to gain momentum at this point.
I mean.
We just gave out monthly now you want the weekly sales trends.
Daily.
I'll just tell you we would not agree with that statement.
Okay perfect.
Thanks, guys best of luck.
Thank you. The next question is coming from Mike Rehaut of Jpmorgan. Please go ahead.
Thanks.
Morning, everyone. Appreciate you taking my questions.
I just wanted to circle back and make sure I'm understanding some of the puts and takes on the gross margin side, and obviously appreciating you're only giving first quarter guidance at this point, but if I heard right you said that.
Yes, you're thinking about your long term gross margins being in a.
21% to 22% range.
I believe you said.
<unk> is where you are on the first quarter.
How should we think about the puts and takes beyond.
First quarter, just directionally at least because you obviously, we're talking a lot about reduced construction costs.
Either materials or labor or boats.
Which everything else equal it could be a tailwind as you had said might impact late 2023 early 2024.
I'm wondering if there's anything that would kind.
Perhaps even offset that.
If you're thinking about trying to hit a 21, 22%.
It could even still be above that given some of the lower construction costs or.
Is there any lag in the impact of the incentive and pricing environment that you've seen over the last few months that might.
Create a little bit of a even a further dip in the second quarter.
Relative to where you are in the first quarter.
So thanks for the question Mike.
The 'twenty 2021 'twenty, 2% that we guided to for the first quarter. That's already at home that are on your production. So we know what those costs are right at their clothing in the quarter, we either can mean to them with backlogs or their specs that can close in the quarter. So we havent good visibility into Q1, now and that's not to be too cute here, but when we.
Spoke about our long term trend, obviously, we're not talking about 2023 as a whole we're talking about long term trends, we sat at or above 200 beds from the normal margin of 20%. So I think that what we were trying to communicate there is that the long term margins are 22% or north of that so to be honest.
And we kind of just really got our whole.
Operational structure in place right at Covid right 2019 is the first year that we really kind of had out all engine humming.
And a new strategy and then we had COVID-19 it was impossible to look at what he and the environment will be in a normalized pace. So at the beginning we thought it would be 21. Since then we raised it to 22 and on today's call. We said normalized would be at or North of 22, as we continue to harvest the efficiency that we're seeing in the business. So when we look at Q.
One I don't I can't predict sitting here today, it's the trough I know never builder ticked acquisition, you said, that's going to be the low point for the year by not providing guidance for the whole year, we're not confident that we understand all the dynamics for the rest of 2023, but we do feel confident in the long term operational structure that we.
Half of.
That long term will be 22% or higher and that clarifies over the coming quarters will give additional insight there.
No that's great.
That's helpful. I appreciate that and just to make sure also.
One element of my question around.
The current pricing environment would you say that.
In terms of where you are in the last couple of months in terms of incentives on orders.
That that is more or less fully reflected in your first quarter.
Gross margin guidance or no.
Because I would assume that incentive levels in December were higher than that.
And then October lets say, but maybe I'm wrong on that so just trying to get a sense of Av.
Where the what the first quarter gross margins reflects then.
If current incentive levels are higher than that are in line with that.
I'll just clarify I know you said incentives there just to clarify we don't look at incentives because we're a spec builder, primarily with 89% of our volume coming from entry level that we use based price incentives and financial discounts interchangeably, because we're solving for a PMA for the buyer. So all in what you're seeing in our Q1 guidance.
Including the January sale. This is this is our current volume and what we expected those stacks that Keith mentioned and we have a third of them entering the year ready to close in the quarter. We sold some of them. If he sold 200 of those in Q1 already so what we're seeing in the margin guidance of 21 to 'twenty two.
Reflects the current environment.
Great. Thanks, so much.
Thank you. Thank you.
Thank you. The next question is coming from John Lovallo of UBS. Please go ahead.
Good morning, guys and thank you for taking my questions as well.
I know you mentioned about potentially being more open to two returning.
Capital to shareholders, but just thinking about your liquidity position the stock's valuation, there's no debt coming due to 2025, I mean is there an opportunity here to get <unk>.
Ziv on share buybacks.
Okay.
<unk> is an opportunity to get aggressive on share buybacks to consider other methods of getting cash to shareholders to look at the debt Paydown. We're looking at everything in China make sure that what we view optimizes their return to the shareholders, while keeping eye on.
And in the strongest balance sheet position possible.
There is definitely some action that will be taking in 2023, but the magnitude and which action today, we're still burning through with our with our board.
Stay tuned for next quarters calls for some more visibility into that.
Okay, that's good to hear.
And then the 89% of orders.
Tree level.
I can this go and how would you like it to go and is there any just remind us is there any margin differential on.
On the entry level versus other parts of your portfolio.
Yes.
Theres really no differential.
We have three consumer segments.
That we focus on.
The entry level buyer.
What we call them move down value conscious buyer and then the boom.
Classifier, and it's kind of blurring the lines get blurry. Some of them are the same people same type of families aspirational entry level buyers are kind of move up value conscious. So either you can go it can get all the way up.
19, 95% and debate based on your definition of our customer.
Customers in our <unk>.
Our communities, but our target is 70, 75% entry level and 25% to 30%.
Value conscious move down and move up buyers and so I think it's it can move around depending on what interest rates are doing and what the market's doing but.
That's kind of a sweet spot.
Got it thanks very much guys.
Thank you. The next question is coming from Carl Reichardt of <unk>. Please go ahead.
<unk> morning.
Felipe you mentioned that cycle times in Arizona, and Colorado, where the longest in the company I'm just curious why why is that.
So good question.
It's a couple of different things I think.
And they're both different actually they're not the same reason but in.
Arizona There was just so much demand during COVID-19 and I, just don't think the trade capacity could keep up with.
The amount of starts that were being pushed out both of them both in multifamily and single family So tremendous ramp up.
In 2020, 'twenty, one just put a lot of constraints on them and they just weren't able to keep up and we saw some pretty meaningful expansion in cycle times across a lot of categories not just front end versus back end, but across the board. So just big market lots of demand, Colorado has always had.
The labor issue.
It's always been difficult to attract.
Skilled labor there.
It's a lot of folks don't get into that business. There. It's always been somewhat constrained and then when you add a surge in demand that we saw again out of Covid.
You just saw our cycle times get really really long.
So two different reasons I think Phoenix recovers relatively quickly as demand has slowed significantly here and so we're already seeing that I think we'll be able to get our cycle times down here relatively quickly as demand slows Denver's always going to be a challenge we always had the longest cycle times there we build basements we.
We do a lot of high density there because of affordability.
So we'll continue to have challenges there, but hopefully we'll do better as the market slowed there as well.
Thank you for that I appreciate it and then second in the past you've talked a lot about the importance of keeping your pricing near to below FHA conforming loan limits, obviously, you've had a big jackup in those limits has that helped at all in January are you hearing that from consumers are seeing that in terms of apps.
No, it's really not even a factor for us anymore, because FHA and conforming loan limits have gotten so high. So now it's just all about where we're positioned against our competitors that we want to be as I said earlier on the bottom to the middle of the bottom of the graph, depending on who we're competing with and really.
B the affordable offering in the market.
It's just driven by our pricing and our research department that looks at every community every week and tells us where we need to price our inventory to find the ideal pace, but it's no longer really connected to that unless it is right. It clearly matters, we want to be below that.
But we probably want to be well below that these days given how highly us just visibility Kyle FHA for the year for us with 15% of our total mortgage floor. So certainly some people are using FHA, but it's so high that a lot of people are just getting a conventional loans.
I need the assistance.
FHA that the dollar it kind of got a little bit disconnected. It was at the two year lag as to where they needed to be and they came up right when AMC started to come down.
Okay. Thanks Hilla thankfully.
Hey, operator, we'll take one more question.
Certainly our final question today is coming from Alex Barron of housing Research Center. Please go ahead.
Okay. Thank you.
Yeah I wanted to.
Regarding your land position.
How you guys are thinking about.
What's transpired I guess in the last few weeks and your approach to land going forward.
Do you feel theres going to be.
<unk> two.
To replace.
The stuff you guys cancel that better deals or are you just going to hold off or.
How are you guys thinking about the current lending environment.
Yes.
We're definitely getting.
Be cautious and patient here.
We're going to get through.
Certainly the spring.
Sort of reevaluate what the market looks like with the long term prospects look like.
We're seeing some opportunity out there I saw a survey recently that land prices have started declined modestly I think around 5%.
I think that's enough.
We got to get our land development costs down as well or things are hard to underwrite it.
Today's interest rate environment is.
The new reality.
So we have plenty of land.
You articulated we have the ability to maintain our 300 community count trajectory for the next couple of years without really buying anything so it will be about when it's time to grow from there.
We're in some new markets, we clearly want to be active there, but we want to be patient as well. So I think you're just going to see us be really early patient, we're definitely going to get through the next couple of quarters to read the tea leaves kind of evaluate what 'twenty 'twenty four 'twenty five we're going to feel like before we start ramping it up that being said we have.
$850 million sitting in the bank.
If opportunities present themselves.
We will certainly go getter, Alex just to clarify Youre hearing from all of our peer Bell. There is a lot of folks are talking options that don't make sense, we're walking away from land deals those land deals selling days. So we're just going to be repackage insult to the builder a cheaper price.
Some point there is going to be in dumping jumping point that we're going to enter the market any opportunistically more than having land committee every meeting buying land aggressively, but there will be opportunities to buy land at more attractive prices.
Got it and.
If you reflect back to the last two years I mean, we had.
Supply chain issues than we had rising interest rates.
What do you think are the I guess lessons for you guys or how are you thinking about maybe if either of those two things you know, let's say the market reaccelerate when we start to see some faithful issues again, what what do you think you'd be doing differently. This time to capitalize on these opportunities.
Or how would you approach things differently. This time around given your experience in the last two years.
Well, we're always learning.
I think that we've demonstrated over the last five years.
That we're probably one of the we're an extremely agile.
And proactive organization.
We've been ahead of a lot of the trends we came out of COVID-19 more aggressively than anybody grab market share we pivoted our strategy I think we're playing.
With the right strategy and the right part of the market we are back.
So we're going to continue to be agile.
Do this job 24, seven we're paying attention to everything we have a very aligned engaged team out there we talk all the time, we listened to one another and we're going to continue to collaborate as a team.
And move quicker and faster than we had before so that we can take advantage of whatever opportunities present in this market, but also.
Properly manage the risks that are still evident as well so it's about being agile and it's about being willing to change and innovate.
Constantly and we have a real strong capability here and we'll continue to invest in that and.
That's what we've learned right Don.
Don't continue to think that everything that was going to be and just be willing to evolve and adapt.
Alright sounds like the plan well best of luck guys. Thank you. Thanks.
Thank you operator, I'd like to thank everyone, who joined the call today for your continued interest in Meritage homes. We hope you have a great rest of the day and a great weekend. Thank you.
Ladies and gentlemen, thank you for your participation. This concludes today's event you may disconnect. Your lines at this time or log off the webcast and enjoy the rest of your day.
Okay.
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