Green Brick Partners - Q2 2024

Transcript

Operator (participant)

Thank you for standing by. My name is Angela, and I will be your conference operator today. At this time, I would like to welcome everyone to the Green Brick Partners, Inc. Q2 Conference Earnings Call. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press Star followed by the number one on your telephone keypad. If you would like to withdraw your question, press Star one again. All lines have been placed on mute to prevent any background noise. I would now like to turn the conference over to Rick Costello, Chief Financial Officer. Please go ahead.

Rick Costello (CFO)

Good afternoon and welcome to the Green Brick Partners earnings call for the Q2 ended 30 June 2024. Following today's remarks, we will hold a Q&A session. As a reminder, this call is being recorded and will be available for playback. In addition, a presentation will accompany today's webcast and is also available on the company's website at investors.greenbrickpartners.com. On the call today is Jim Brickman, Co-founder and Chief Executive Officer; Jed Dolson, President and Chief Operating Officer; and myself, Rick Costello, Chief Financial Officer. Some of the information discussed on this call is forward-looking, including the company's financial and operational expectations for 2024 and beyond. In yesterday's press release and SEC filings, the company detailed material risks that may cause its future results to differ from its expectations.

The company statements are as of today, 1 August 2024, and the company has no obligation to update any forward-looking statement it may make. The comments also include non-GAAP financial metrics. The reconciliation of these metrics and the other information required by Regulation G can be found in the release that the company issued yesterday and in the presentation available on the company's website. With that, I'll turn the call over to Jim. Jim?

Jim Brickman (Co-founder and CEO)

Thank you, Rick. I'm extremely proud of our record performance in the Q2. During the Q2, we achieved another set of record-breaking results for the company. First, we delivered a record 987 homes and generated record home closing revenue of $547 million, an increase of 20% year-over-year. Second, our home building gross margin soared to a record 34.5%, which is the highest among public home building peers, as shown on slide four. Year-to-date, the net income attributable to Green Brick grew 35.3%, and earnings per share increased 38% year-over-year to $4.14. This performance was highlighted by a record quarterly EPS of $2.32, up 42.3% year-over-year. Thanks to the collective effort of our team, we have consistently generated some of the best returns in the industry.

We believe that our unique business model will continue to demonstrate its strength and position us for sustainable growth. With our record results, Green Brick's annualized return on equity for the H1 of 2024 was 28.3%. Our book value at the end of the quarter increased 26% year-over-year to $31.21 per share. Equally important, our growth was created on one of the least leveraged balance sheets and one of the lowest costs of debt among our small and mid-cap peers. At the end of the Q2, our total debt to total capital ratio was 17.7%, while our net debt to total capital ratio was only 10.9%, with a weighted average pay rate of 3.4%. As shown on slide five, since 2022, we have consistently generated exceptional home building gross margins, achieving margins of more than 30% in all but three quarters.

Our extraordinary performance is a result of our superior locations in high-growth markets, our investment-grade balance sheet, our self-development strategy, and the commitment and expertise of our team. The land-light model has gained traction on Wall Street, with many major home builders prioritizing being land-light regardless of the costs and resulting potential degradation of margins. Green Brick, however, has taken a different approach. By thoroughly evaluating and understanding our markets, we prioritize acquiring, entitling, and developing land ourselves, allowing us to achieve significant cost savings compared to retail-priced option lots. We understand land risk and compensate for that risk with strong underwriting and a very low leverage balance sheet. Land bankers, known for their sophistication in the real estate industry, often aim to maximize their profit by demanding high implicit interest rates and significant earnest money deposits, where the builders assume land development cost and completion risk.

Builders agree to these additional costs in order to transfer land risk and financial burden off the home builder's balance sheet. Given the current interest rate environment, the increasing finished lot costs associated with the land-light model make it an unattractive option for us, and we anticipate these dynamics to continue. For Green Brick, we are not experiencing those increased finished lot costs, as Rick will cover shortly. More importantly, for Green Brick, being land-heavy hasn't translated into inferior returns. In fact, we have produced consistently strong return on assets and equity, as shown on slide five. Our return on equity since 2022 averaged 28%, and our return on assets averaged 18%. We have been able to significantly increase our lot position while deleveraging our balance sheet, as shown on slide 11. Additionally, in our largest markets, Dallas-Fort Worth and Atlanta, there are very few third-party lot developers.

Being able to self-develop land unlocks access to more land opportunities, especially in desirable infill and infill-adjacent submarkets. This approach also allows us to produce finished lots at wholesale prices as opposed to buying at retail and control the pace of lot deliveries. We believe our unique strategy in land provides us with strong competitive advantages to continue to gain market share in a capital-efficient manner. For the U.S. housing market, it has been challenging for most homeowners to break free from the golden handcuffs of mortgage rates, as 76% of outstanding mortgages are still locked in at mortgage rates of less than 5%, as shown on slide six. As a result, existing home inventory continues to remain near historic lows during the Q2, as shown on slide seven.

The lack of supply is more evident in infill and infill-adjacent submarkets, where we have consistently generated over 80% of our revenues. Green Brick is strategically posed to capitalize on what we believe are long-term secular demographic shifts. As shown on slide eight, a wave of Millennials and Gen Z continue to enter their prime home buying age over the next decade. Too few homes were built over the years since the Great Financial Crisis, which created a systemic housing shortage estimated to be between 4-7 million units. An aging housing stock presents another challenge. The average age of owner-occupied homes in the U.S. is estimated to be 40 years old. These dynamics create significant growth opportunity for new home sales, and we believe Green Brick is well positioned to capture additional market share over the longer term.

Over the past year, we have focused on securing new land opportunities to fill our pipeline and to build finished lots to our builders as quickly as possible. Jed will discuss more about our land and lot position shortly. Lastly, I'm excited to announce our strategic decision to establish our wholly owned mortgage company, Green Brick Mortgage, which will replace our existing joint venture in which we own 50%. We expect Green Brick Mortgage to harvest 100% of the mortgage profits in the beginning of 2025. This transition will enhance our control over the mortgage origination process, allow us to optimize our customer experience, improve operational efficiency, and capture more earnings and profitability by aligning our mortgage operations more closely with our overall business strategy and company culture. With that, I'll now turn it over to Rick to provide more detail regarding our financial results.

Rick Costello (CFO)

Thank you, Jim. Please turn to slide nine of the presentation. As Jim mentioned earlier, the second quarter was a record for Green Brick on multiple fronts. We achieved record home closings revenue of $547 million, up 20.4% year-over-year, on a record 987 homes closed, an increase of 26%. The increase in deliveries is attributable to limited competition in our infill and infill-adjacent communities, reduced cycle times, and increased starts leading to higher levels of available spec inventory. As discussed during our past earnings calls, our shift in community mix from closing out infill communities to opening new communities in surrounding infill-adjacent areas, especially under our Trophy brand, has moderately lowered our ASP from a year ago. In the second quarter, ASP declined slightly by 4.4% year-over-year to $554,000. This was our smallest decline in ASP in the past four quarters.

We continue to expect ASP to be in the range of $540,000-$560,000 for the H2 of the year, subject to changes in product mix and business conditions. Another record that we broke this quarter was home building gross margins, which reached 34.5%. Gross margins were up 320 basis points year-over-year and 110 basis points higher than our previous record of 33.4% achieved last quarter. More importantly, home building margins were strong across all builder brands, including Trophy, that primarily built entry-level and first-time move-up homes. As shown on slide four, we continue to lead our peers in gross margin performance. The gains in gross margins were due to lower incentives on closed homes year-over-year as a result of our infill and infill-adjacent communities and favorable construction and average lot cost.

Green Brick expects that over the two years from calendar year 2023 to calendar year 2025, our average developed lot cost as a percentage of average sales price is expected to increase only 30 basis points per year. We anticipate that this expected minimal increase in our average developed lot cost will stand in contrast to our land-light peers, who often pay annual escalators of 6%-7% to third-party land developers. Even worse for land-light peers, per John Burns' research, brokers indicate that prices rose 11% year-over-year in Q2 2024 for finished lots and 10% for both undeveloped land and development costs. Back to slide nine, SG&A as a percentage of residential units revenue for the Q2 improved 30 basis points year-over-year to 10.5%.

Driven by our record gross margins on record revenues, our net income attributable to Green Brick increased 40%, and diluted earnings per share for the Q2 grew 42% to $2.32 per share, both records for any quarter in company history. During the quarter, we benefited from a $0.11 discrete tax benefit for equity compensation deductions. However, even excluding this discrete tax benefit, we delivered the highest EPS in company history. Net new orders in Q2 were up 4.0% year-over-year to 855 homes, the highest level for any Q2 in company history. Jed will further discuss our sales pace momentarily. In the Q2, we continue to expand our footprint to position us to capture additional market share. Active selling communities at the end of the period grew 22% year-over-year to 105.

In particular, our ending community count for Trophy grew by 41% year-over-year to 38. Our cancellation rate for the Q2 remained low at 9.2%. This was, again, one of the lowest cancellation rates among public home building peers, as shown on slide 12. Our cancel rate remained in a historically low range under 10%, which it has been since 31 December 2022. As shown on slide 10, year-over-year, units under construction were up 23%, with starts averaging 952 homes for the last four quarters. Year-to-date, we have now sold 1,926 homes, delivered 1,808 homes, and started 1,980 homes, closely matching the sales pace and the production pace. Year-to-date, we delivered 1,808 homes, generating home closings revenue of $990 million and an increase of 9.6% year-over-year. Home building gross margins increased 450 basis points to 34.0%.

As a result, net income attributable to Green Brick grew 35.3% year-to-date to $189 million, and diluted EPS climbed 38.0% to $4.14 for the six months ended 30 June 2024. Next, our backlog value at the end of the Q2 increased 11% year-over-year to $650 million. Backlog is up 17% year-to-date. Now, as opposed to closing ASP, backlog ASP increased 10.1% to $732,000. Trophy, a spec home builder, continues to represent only 15% of the overall backlog value due to its reduced construction cycle times and quick inventory turns. Spec units under construction, as a percentage of total units under construction, increased slightly sequentially to 65% at the end of the Q2 as we started more spec homes. Our investment-grade balance sheet continues to serve as a strong springboard for future growth.

At the end of the Q2, our net debt to total capital ratio was 10.9%, and our total debt to total capital ratio was only 17.7%. As shown on slide 11, this level of financial leverage is running among the best of our small and mid-cap public home building peers. 100% of our outstanding debt is fixed rate with a weighted average interest pay rate of 3.4%. Furthermore, at the end of the quarter, we had $133 million of cash on hand readily available for deployment and $360 million in undrawn lines of credit. Finally, we remained active with share buybacks during the Q2. We bought back approximately 1.5% of our shares outstanding, valued at $38 million, with a weighted average price of $55.58 per share.

The remaining dollar value of shares that may yet be purchased under the 2023 repurchase plan was approximately $61.3 million as of 30 June 2024. We continue to weigh and balance investment opportunities with share repurchases with the goal of delivering best-in-class risk-adjusted returns for shareholders over the long term. With that, I'll now turn it over to Jed. Jed?

Jed Dolson (President and COO)

Thank you, Rick. Demand was healthy during the Q2. Net new orders moderated from a near record level in the Q1 of 2024, but grew slightly year-over-year to 855 sales, representing our best Q2 order level in company history. Our sales pace for the Q2 was 8.5 homes per average active selling community, down from 11.4 in Q1 when our backlog grew 31% sequentially. In the latter part of the Q2, we saw sales pace slightly moderate as we exited the spring selling season, returning, we believe, to the normal pre-pandemic seasonality that we have traditionally experienced. Increased mortgage rates during the quarter and metering of sales in certain infill communities also contributed to moderated orders. However, incentives for new orders ticked up only modestly in the Q2 to 4.5% from 3.8% in March.

We were still able to raise base prices moderately in approximately a third of our communities due to our footprint of infill and infill-adjacent submarkets, where supply is limited from both new homes and existing homes. Incentives were only targeted in select communities where traffic and orders were below desired levels and/or with spec homes at later stages of construction. We continue to offer many of our buyers the flexibility to use their incentive package for closing costs, partial rate buy-downs, or both. Buyers who close using our affiliated mortgage company continued to demonstrate strong qualifying profiles with an average FICO score of 741 and a debt-to-income ratio of 38% during the Q2. With home building gross margins at an all-time high of 34.5%, we possess an abundance of flexibility in price adjustments if the market shifts.

We remain optimistic that with our focus on infill and infill-adjacent locations, we are well-positioned to capitalize on long-term secular demographic shifts and rising demand if or when mortgage rates drop. Through the diversification of our seven brands and a wide array of product types and price ranges, we believe Green Brick will appeal to a broad base of home buyers led by the growth of Trophy Signature Homes in the entry-level and move-up segments. As Jim mentioned earlier, Green Brick has been able to generate superior returns and growth over the past several years because of our unwavering approach to capital allocation and our land strategy. To propel this growth forward, we have diligently executed under a strategic capital allocation plan that we believe positions us for future success. In the Q2 of 2024, we increased our spending in land acquisition and finished lots to approximately $119 million.

We spent another $40 million in land development. Year-to-date, our total spend has reached over $300 million, and we are on track to meet our original land acquisition and development target of $700 million in total for the full year of 2024. Please recall that this is taking place with a total debt-to-capital ratio of under 20%. We have added close to 10,700 new lots, offset by approximately 3,800 starts for a net increase of approximately 6,900 lots owned and controlled, a 26% increase year-over-year. Approximately 67% of these lots will be infill and infill-adjacent locations, with the remaining 33% in outlying high-growth corridors. This brings our total lots owned and controlled to over 33,300, a new all-time high for the company, and a 16% increase from the start of the year.

Excluding 16,700 lots in long-term communities, it provides approximately five years of lot supply based on the start pace in non-master communities over the last 12 months. Over 97% of our current inventory of lots owned and controlled are expected to be self-developed. We believe the emphasis on self-development will allow Green Brick to continue generating industry-leading gross margins and performance as these self-developed lots avoid expensive premiums charged by third-party land developers and allow us to control the pace of lot development and delivery as well as starts. Cycle times now have stabilized and averaged 5.4 months for homes that completed construction during the Q2. This was a reduction of more than two months from the Q2 of 2023 and five days shorter than the previous quarter.

As the third-largest home builder in Dallas-Fort Worth, we see potential to further optimize our cycle times and reduce costs by leveraging our scale. Securing high-quality land remains our top priority. Despite persistent high mortgage rates, our land markets remain competitive in most of our key submarkets. We continue to underwrite deals with a minimum of 21% unleveraged IRR threshold. Our deep local market presence, knowledge, relationships, and reputation grants us an unrivaled visibility on land opportunities, while a robust balance sheet enables us to act swiftly. Slides 13 and 14 provide additional detail on our finished lot pipeline in submarkets of Dallas-Fort Worth, and Atlanta, two of our largest submarkets. We currently have 41 communities under development. Over the next six months, we plan to complete these lots for delivery to our builder brands of approximately 1,700 lots.

By the end of 2024, we expect to have an inventory of approximately 4,700 finished lots for our subsidiary home builders, with over 1,900 of those finished lots being allocated to Trophy. Green Brick is well-positioned for continued growth into 2025 and beyond, having secured both short and long-term land needs. For the H1 of 2024, Trophy, our entry-level first-time move-up value builder, closed 810 homes, representing approximately 45% of our total number of home closings, resulting in 34% of our total home closing revenue. We expect this platform, for which the company now controls over 23,500 home sites, to continue contributing significantly to our 2024 earnings and beyond. With that, I will turn it over to Jim for closing remarks.

Jim Brickman (Co-founder and CEO)

Thank you, Jed. In closing, I would like to give another round of applause and thanks to our incredible team. Our record-breaking quarter is a direct result of the hard work of our people and years of meticulous planning and execution. These results are just the beginning for Green Brick. With a cooperative economy, our superior investments in land and lot inventory, and constantly improving building operations, have created a long runway for sustained growth, particularly through Trophy. This concludes our prepared remarks, and we will now open the line for questions.

Operator (participant)

We will now begin the question and answer session. To ask a question, you may press Star then one on your touch-tone phone. If you are using a speakerphone, please pick up your handset before pressing the key. To withdraw your question, please press Star then one again. At this time, we will pause momentarily to assemble our roster. Your first question comes from the line of Carl Reichardt with BTIG. Please go ahead.

Carl Reichardt (Managing Director and Partner)

Thanks, everybody. Hope you're doing well. So, Rick, historically, we've talked about your starts pace and that being a driver to delivery volume six months out, and you've been running 952, I think was the average, is what you said. So now Trophy's growing, supply chain's more normal, lot count is up. Can we expect that sort of 950, maybe 1,000 start pace to start picking up as we look quarters out, or is your anticipation that it'll stay kind of flat from there as we move into 2025, based on what you know now?

Rick Costello (CFO)

Well, it's certainly going to be a function of what happens on the sales floor. We're obviously developing a lot of communities and a lot of lots, but we're not really going to suggest forward beyond what you see. I mean, you're talking about the best indicator, but we're not directionally, eventually, it's going to go up, but from the timing standpoint, we're going to remain silent.

Carl Reichardt (Managing Director and Partner)

Okay. But the relationship, the six-month relationship, you expect that that will continue on a go-forward basis. It won't shorten to five months or go to seven or something like that based on the mix that you plan?

Rick Costello (CFO)

Five months or seven months of what?

Jim Brickman (Co-founder and CEO)

Cycle time? Are you talking about cycle time?

Carl Reichardt (Managing Director and Partner)

So what I mean is if I look at your starts six months ago, two quarters ago, and I model that as deliveries six months hence, that relationship has held pretty tight, pretty consistently over a long period of time. So I'm wondering if cycle times are improving, if Trophy's more a bigger portion of your mix going forward, does that shrink down to like a five-month lead as opposed to a six?

Rick Costello (CFO)

Over time, it will certainly shorten because Trophy's delivering houses in 3.8 months versus 5.3 overall. So yeah, I mean, certainly, that is a dynamic, and it's a positive one.

Carl Reichardt (Managing Director and Partner)

Okay. So that answers. Okay. And then can you guys not mind at all, Jim, talking a little bit about July? And as I sort of look at rate movements have come down a lot, there seems to be a lot of elasticity in the marketplace for demand based on how rates are going. Is your sense that that's still the critical driver to how sales roll, or are you seeing any sort of softening related to the consumer being concerned about their job or the election or sort of macro things beyond just sort of the mathematics of homeownership?

Rick Costello (CFO)

Good question, Carl. Let me do a segue on this. One of the things CEOs just don't talk about very much anymore because everybody's talking about financial engineering and doing a lot of other stuff is our goal is to create value entitling, developing larger, longer-duration neighborhoods that people want to live in, okay, today and tomorrow. For some reason, that whole message of creating neighborhoods that people want to live in is absent from so many investor calls that I read transcripts of. That's really our primary goal. July sales have maintained at a pace that we expected. We didn't have to incentivize sales any more than we expected to achieve those sales. We aren't seeing really any diminished demand in any of our businesses other than one or two neighborhoods in Florida are soft right now.

Carl Reichardt (Managing Director and Partner)

I appreciate the answer. Thanks a lot, guys.

Operator (participant)

Your next question comes from the line of Alex Rygiel with Riley. Please go ahead.

Rick Costello (CFO)

Alex, are you on mute?

Alex Rygiel (Senior Managing Director)

I am. Sorry about that, gentlemen. With incentives up a bit sequentially, does that suggest some modest headwind to gross margins in the Q3? And where were or are incentives in July relative to Q2?

Rick Costello (CFO)

Well, we really don't want to talk about that in specificity. We're focusing on the current quarter. But certainly, what's happening on the sales floor translates more quickly with as much spec concentration that we have, particularly in Trophy, where 70%-80% of their homes that they close in a quarter were sold the same quarter. So if interest rates are going up, incentives go up. If interest rates are going down, incentives come down, subject to changes in seasonality, which we really saw a lot of people take vacations in June, and traffic was down. So I mean, the direct answer is it will be more variable, but it runs both directions, good and bad.

Alex Rygiel (Senior Managing Director)

That's helpful. And then as we think about monthly absorption, clearly, the last few years or so, been a notable step up in that absorption, understanding your mix shift and all. But is that sort of kind of the new norm of let's call it three per month per community?

Rick Costello (CFO)

That's a very comfortable level. Really, when you look at it from a year-to-date standpoint, Q1 was a lot quicker from an absorption standpoint, but we also grew backlog sequentially 31%. As a predominantly a spec builder, that is not necessarily where we're taking the organization. The fact that we're up sequentially, sorry, year-to-date, still like 17% is a strong dynamic, which tells you that the year-to-date numbers are very pleasing to us because we have that equality between sales starts and closings.

Alex Rygiel (Senior Managing Director)

Very helpful. Thank you very much.

Rick Costello (CFO)

Okay. Thanks, Alex.

Operator (participant)

Again, if you have questions, please press Star then one. And your next question comes from the line of Jay McCanless with Wedbush. Please go ahead.

Jay McCanless (Equity Research Analyst)

Hey, thanks for taking my questions. The first one I had, I think, Jed, you may have talked about pricing, only being able to raise prices in roughly a third of communities during the quarter. I would have thought with the infill, the heavier weight of infill, you'd have been able to push a little more price. So maybe what was going on with that?

Jim Brickman (Co-founder and CEO)

I think just some seasonality that we exited toward the later part of the quarter.

Jay McCanless (Equity Research Analyst)

And then I guess with Trophy selling and closing 70%-80% of their homes in a given quarter, I guess what's plan B if things start to slow down, if we start to see some job losses, etc.? Do you think those homes go into the SFR BTR market, or what's the business plan for those if things do slow down from the economy standpoint?

Jim Brickman (Co-founder and CEO)

Jay, this is Jim Brickman. No, we don't sell into the build-for-rent market. We focus on creating nicer, longer-duration communities, and the people that are moving in those communities are not expecting to move into a rental community. One of the really huge benefits of making 34.5% margins is that we can take a 10% margin hit and still have margins that are typical to our peers. If our peers take a 10% margin hit, they go negative income. I don't lose sleep over a few jobs. We're in this business for the long run, and we have plenty of cushion and margin to maintain sales velocity.

Rick Costello (CFO)

Hey, Jay, this is Rick. One more. I mean, that was answer A and B. But also, in that environment where there are job losses, obviously, the Fed is going to respond with more aggressive rate cuts, and the number of people who will qualify with those rate cuts exceeds the number of people who will be without jobs. So I think that the numbers work pretty well for us, especially being in stronger job markets like Dallas and Atlanta.

Jay McCanless (Equity Research Analyst)

Okay. Great. Thanks for taking my questions.

Rick Costello (CFO)

Thanks, Jay.