With more cash than Meritage Homes has ever had sitting on the balance sheet, low debt levels, and a right-sized cost structure, a return to profitability seemed more achievable at the end of 1Q2009 than it had in at least six quarters. So attainable, in fact, that management is preparing to outlay some of the company's cash, investing in land and construction, to fuel some organic growth in key geographic markets.
During an earnings call Tuesday morning, CEO Steve Hilton said "opportunities are accelerating" when it comes to land deals. Between the liquidation of land banks now held on their books to private developers increasingly having their credit pinched for future development phases, Hilton said he was confident that the company would be able to reload its lot pipeline, which numbers 15,069 controlled lots, with lots picked up at distressed pricing.
Hilton suggested that the need to replenish its lot inventory, which largely had been liquidated in the name of cash generation and cost containment as home sale volumes had dropped off, was driven by the fact that some operations--namely, those in California, Colorado, and Florida--were down to less than a 1.5-year supply of lots. Management estimated that the company as a whole had 2.9 years worth of lots under its belt.
Although Hilton noted that although the land-banking industry had pretty much gone the way of the dinosaur as the housing downturn protracted, he thought the company would be able to secure rolling options or seller-carry terms on any new land deals, shifting the company's owned versus optioned lot mix back toward options. The company's lot portfolio had shifted to more owned lots--55% of the total lots controlled--which was a higher percentage than the company has had in the past few years.
Hilton also told analysts that management was underwriting deals assuming gross margins in the ball park of 20% and more normalized sales rates of three-to-four homes per community per month.
To achieve that kind of sales velocity, Hilton said the company was focused on two major initiatives. The first was rolling out new, smaller, more affordable product, and the second was reducing construction costs.
Hilton's description of the unnamed product line echoed to some extent KB Home's sketch of its new Open Series plans. Basically, the homes are smaller, with fewer architectural frills, a design decision that allows the company to lower its base pricing and attract first-time buyers, many of whom are motivated to buy by the federal home buyer tax credit and even some state tax credit programs. The company has a target average selling price of between $200,000 and $225,000 for the new plans.
The transition to the new product will primarily occur in markets outside Texas, Hilton noted. He specifically pointed to Phoenix and Orlando as two markets where they company has aggressively moved to introduce the new product.
"It is working well," Hilton said of the product's launch. "There are several communities in Phoenix where we've had extremely strong sales."
The traction the new product is experiencing also is encouraging management to up its spec level to be able to meet demand. Whereas the company has about 3.2 specs per community, a level Hilton deemed "lower than we believe is necessary," it could have as many as four or five per community going forward. CFO Larry Seay warned that this investment could turn the company cash flow negative in future quarters, although he also noted that any investment would also be off-set in whole or part by continued liquidation of land.
Although gross margins have held steady year over year at about 12%, Hilton said he expected that even with the new product's lower price points, margins would improve--primarily because of lower costs to build. He said that hard construction costs were down 30% to 40% from a peak in 2006 thanks in part to a competitive bidding process and divisional benchmarking program. The savings were showing up big time based on a cost per square foot metric; Hilton said the company had an average cost to builder of roughly $40 per square foot, with several geographic regions down as low as $35 per square foot.
But the place where cost reductions and sales velocity come together is in inventory turn.
"We'd like to turn our assets about three times a year," Hilton said.
To achieve that kind of turnover, Hilton said management has been keenly focused on reducing inefficiencies to improve cycle time. From point of sale to closing, Hilton said the company is averaging 31 days; a full construction cycle runs between 120 and 150 days, depending on the market.
"This is a major shift for us, and there's opportunity to drive it even lower," Hilton said.
By shaving off building days, the company would effectively extend its selling season while reducing interest expenses. Both would play into the company's ability to access capital.
"This allows us to build more with less capital and requires us to carry less debt," Hilton explained.
For a report on the company's financials for 1Q2009, please click here.