D.R Horton (DHI) Q1 Confrence Call Summary
4-20-07: After listening to DHI Q1 conference call, we believed homebuilders will experience more tough times ahead. The market condition remains challenging especially places such as California. To compete, DHI plans to aggressively cut prices in the coming quarters and further reduce cost. During the conference call, the CEO kept stressing DHI has the highest operating margin; therefore the company has the best chance of meeting market demand. This essentially means they plan to cut prices and will do what it takes to move inventory.
The overall market condition remains challenging across the board. The CEO singled out Northern California as the most challenging. The problem with this area is the high price. In cities such as Sacramento there are now fewer buyers due to recent acceleration of prices. To put it into perspective, about 2-3 years ago, 30% of California’s population was able to afford homes; today it is close to 10%. In addition to the affordability factor, stringent mortgage requirement will further erode prices as homebuilder must compete harder for quality buyers.
To help move inventory, DHI has started to adjust their prices downward in the last 30 days. The company expects further price adjustment will be needed in the coming quarters. We suspect DHI will need to aggressively cut prices in Q3 and Q4 to meet their numbers. The picture painted is of a grim future; investor should expect more pain in the short term. The company also warns sluggish sale is expected to continue into the first two quarters of 2008.
Looking ahead in the next quarter, investors should expect flat growth in home construction. The goal of inventory reduction is 30%. Sales in Q1 were slower than expected. Moving forward, the company plans to take aggressive pricing adjustment. The rate of cancel homes remains above 30%. DHI expects cancellation rate to remain about the same in Q2, perhaps even increasing slightly.
On the financial services side, DHI increased their loan by $14 million in Q1. However, there are signs of trouble in this unit as the payment default rates are increasing. No specific numbers were provided, but defaults are going up.
One bright note from the call was the land inventory in California. The company purchase 2/3 of their land in 2004 and prior. This means DHI likely bought it a good price. This should help DHI in their pricing strategy. Moving forward, the company expects to drastically reduce its land inventory; does not plan to acquire more land.
The company expects to generate about $1 billion in free cash flow this year. When asked what they plan to do with the cash, the number goal is to use it to reduce debt. Bottom line is DHI and the other homebuilders should expect a challenging environment. As far as we are concerned, the bottom has not been reached. 2007 could be another bad year. Don’t expect DHI shares to do much until the real estate sector stabilized. Trading today at $23 per share, we will hold our position but will not buy more as the condition remains too cloudy.