In a call with analysts Tuesday, Meritage Homes CEO Steve Hilton said the company is starting to see land pricing deflate and is optimistic that more deal-flow in the second half of the year will allow the company to buy land "cheap enough to build on and make a profit."
With a strong balance sheet, and more than half of its land holdings in the state of Texas, Meritage executives spoke candidly about the opportunity to leverage the company's lot-option model with plans to work through its short lot position of legacy lots, then reload by gravitating toward opportunities that might hit the income statement in 2009.
Specifically, Hilton pointed to finished lots in Northern California that his division had paid $125,000 for that are now available for $45,000 to $50,000. "Before, we were building 2,800-square-foot houses on those lots," he said. "But if you build a smaller house with less features and can price it in the [upper] $200,000s, there is a compelling opportunity to find a broader audience." He also predicted, under those circumstances, the company could make a 20% gross margin.
With modeling like that, the prospect sounds like it would be tantalizing to many companies, especially with the acknowledged "vulture funds" trying to deploy capital by chasing land. But according to Hilton, "The competition might not be as keen as you'd suspect."
His theory: "Public builders can pay more than vultures for finished lots, privates won't be able to get credit, and a lot of other publics can't participate."
Currently, Meritage only owns about 900 lots in California, and it's the builder's small exposure in the hard-hit state that allows it to capitalize on opportunities quickly.
"Where we are going to find those lots is from banks and land developers who need to sell them," said Hilton, speaking to the plight of the smaller private builders as banks take control of their land.
In light of successfully reducing inventory and specs to normal levels, Hilton said the builder has pledged itself to less aggressive pricing and therefore predicts less charges. "Most builders are now trying to hold on to prices, and we're doing the same. Stabilizing prices should ultimately lead to consumer confidence."
Hilton also reaffirmed his commitment to the company's "Texas franchise" when asked if he viewed the region as "a great place to hide out, or a great long-term market. It has large cities and great job growth," he said. "The margins are lower, but the stability is there. If you are willing to accept lower margins,...you run a tight operation, and don't design your margins away, you can make money in Texas year in and year out."
That being said, Hilton also predicted the company would eventually pare back its total exposure to be more in line with a historical one-third of its business in the state.
Also of interest was discussion surrounding the company's joint venture activity. In this last quarter, the company took a $14.4-million charge related to its Arizona JV north of Phoenix on the former land of the Chrysler proving ground. "Toll is managing it, and we have 18 months to go; we'll see where we are in 18 months," said Hilton, adding that "there won't be" a capital call related to the project.
In its previous earnings call, management was very transparent about the disclosure of its JV activity and liabilities. Referencing some of the information previously released, CFO Larry Seay noted, "Overall, Meritage has done a pretty good job of isolating JV problems from the parent company."