On the heels of reporting a relatively weak performance in its fiscal third quarter results Tuesday night, executives at Dallas-based Centex Homes gave color to the company's continued effort to structure for profitability in a Wednesday earnings call with investors.
According to CEO Timothy Eller, though the industry has not yet seen a stabilization of pricing or inventory levels, the company's move to transparent pricing is a necessary step to return to a normal environment. "We need to get back to reflecting value."
Centex is accelerating through the cyclical environment to a point where it might appear that the company's executives think they have leverage with buyers. But in reality, Eller is relying on his seasoned management and personal experience to employ a "consistent and well-tested strategy to navigate through this [downturn]." He sees that strategy as a precursor to a establishing predictable pricing, ensuring a predictable set of costs and ultimately, restoring predictability to margins.
Historically, at mature points in the cycle, builders price housing with little incentive. As the environment begins to change, incentives are typically added to preserve the backlog. "Now, [builders] are just adjusting everything," said Eller, "and it's a result of the mortgage environment. With transparent pricing, we are just accelerating to where we should be. It gives us a more stable basis, it gives everyone more confidence and it allows us to pre-sell."
Setting a home price and sticking to it is not done arbitrarily, according to CFO Cathy Smith. "We do a lot of work around determining what the right price for that neighborhood is. We look at 15-year trends, third-party data, average income of buyers in the area. Holistically, as a company, we have gotten there," said Smith, though she acknowledged there are still some "refinement levels" being tweaked.
Looking at the quarterly report, the disclosure that discounts and sales incentives as a percentage of housing revenue climbed 690 basis points to 15.2% in the quarter appears in sharp contrast to the philosophy. But executives noted that the implementation of the new pricing strategy is in a transition phase. As the company continues to move through backlog of sales from older neighborhoods, that metric will remain high, but assured it will retreat to "normal" levels as the company moves to new sales. "This is a two- or three-quarter transition, and we are about in the middle of it," said Eller.
As the realities become clear regarding the mortgage environment and pricing, Eller said that the pricing tactic is compelling some competitive rethinking among public peers, especially in tough markets throughout California and Las Vegas. He also speculated that many privates might not employ the strategy sheerly because they "can't afford it."
Regardless of whether others make the shift, he expressed confidence that the model would ultimately benefit Centex because it allows the company to compete on product and location. "It's advantageous, because we have many "A" locations," he said.
Other interesting revelations:
- The company came under fire from analysts for its modest free cash flow of $100 million, especially relative to its size. Certainly, when compared to builders like Meritage Homes, which has a third of the closings and a $150-million cash flow, or Ryland, which had half of the closings of Centex yet generated $300 million in cash flow, the results seemed thin. But executives pointed to the fact that the company's upcoming quarter is historically its strongest cash-flow generator by far and predicted that trend to continue. Land assets are under quarterly evaluation and some sales may generate cash. But specifically, look for the company to aggressively move through its unsold inventory in February and March. Plagued by cancellations, at quarter end, inventory stood at 25%, but Smith said, I am highly confident you will see that come way down in the fourth quarter." Eller noted that the company's target level is about 15%.
- Smith confirmed that Centex is considering the change in its fiscal reporting to reflect the traditional calendar year.
- The company discussed a bit of its joint-venture obligations, noting that Centex is currently involved in 43 JVs, 18 of which have debt. In total, there is $240 million in JV debt that the company is addressing, and, according to Smith, Centex cash flow is being used to pay that down. She noted it is a priority to accelerate payment of the highest debt in these entities wherever the company has willing partners.
- In a continued effort to simplify and optimize manufacturability, the company now has 700 house plans as compared to 4,500. A common construction process and management system was introduced in the quarter.
- The loss incurred by the company's financial services was due to deteriorating performance on warehoused construction loans made specifically for on-your-lot projects, primarily in Fla. and Calif. Though they represented only 3%-4% of total originations, they declined meaningfully. The company stopped writing those specific loan products in the summer of 2007.