For homebuilders, the first-quarter earnings season has been a tale of pre-COVID and post-COVID. The residential real estate sector was having its best year in over a decade going into the spring selling season. Given the free-fall in the economy, homebuilders should be struggling; however, at first glance, it appears things are not as bad as feared.
Earnings were strong, but that was to be expected
Like most homebuilders, D.R. Horton (NYSE:DHI) reported strong earnings for the Jan-March quarter and withdrew its guidance for 2020. Earnings per share increased 40% to $1.30 per share on a 9% increase in revenues. Orders increased 20% in units to 20,087 homes and 22% in dollars to $6 billion, with a 19% cancellation rate. The cancellation rate was flat on a year-over-year basis. For the month of April, sales were down only 11% compared to a year ago. It also looks like we are seeing an improvement in sentiment: Orders in mid-April were higher than they were from mid-March to mid-April.
Major markets holding up
On the conference call, the company discussed some of the different markets, noting that Texas and Florida "held up pretty well" but there were declines everywhere else. For most of the country, construction is considered an essential activity. So aside from a few markets like Washington, the Bay Area, Pennsylvania, and New Jersey, building continues. Those markets where construction is halted only accounted for about 4% of closings in 2019, so stoppages are having a limited effect. Social distancing rules do limit the number of workers on a job site at any one time, so homes are taking longer to build.
Incentives, but not price cuts
Sales offices are no longer accepting foot traffic or walk-ins due to COVID-19 issues. Sales are by appointment only, which is reducing the number of potential buyers. Despite the drop in people looking at homes, pricing seems to be holding up. The company said it is offering some or the more typical incentives, but they are minor things like free fridge Fridays, landscaping services, or a break on closing costs if the buyer uses D.R. Horton's mortgage company. These sort of incentives are used all the time, so it shouldn't have a material effect on margins. Fears of lower traffic have not translated into price wars, which was the big concern for the builders. On the subject of sales, CEO David Auld had this to say on the conference call:
You've got to maintain a certain level of pace, and we adjust the incentives to maintain that pace. So reality is Texas, Florida have held up better, given all the constraints. And really after the shock of the first couple of weeks, our people out there have kind of got a rhythm and figured out how to sell houses. And all in, from my perspective, things are better than I had -- than I was concerned they might be.
Liquidity is solid for the time being
The company has about $2 billion in liquidity between cash on the balance sheet and undrawn capacity on its revolving credit facilities. Unlike many other companies, D.R. Horton has not suspended its share buyback program, and it declared its normal quarterly dividend.
Mortgage credit problems will affect D.R. Horton less than other builders
As of now, the headwinds in the economy primarily revolve around job losses. However, mortgage bankers are also becoming more conservative, which will make financing new houses more difficult. This set of circumstances is driven primarily by the government's CARES Act, which permits borrowers to skip making their mortgage payments for up to a year, with no questions asked. The Mortgage Bankers Association estimates that 7.5% of all mortgages in the US are in forbearance, and that has made everyone in the mortgage ecosystem cautious.
This could last a while, too. We could see tighter mortgage credit even after the economy reopens and we start seeing people go back to work. Luckily for D.R. Horton, its average sales price is around $300,000, so high loan balance restrictions aren't going to come into play like they will for the luxury builders like Toll Brothers. D.R. Horton's low average selling price puts it at the low end of the builders, as it heavily targets the first time homebuyer. Still, the possibility of home sales falling through because the borrower cannot get financing will remain an issue for the whole sector.
The fundamentals for the sector remain strong
The fundamentals for homebuilders were strong going into the crisis. While homebuilding is a highly cyclical industry, the current supply and demand imbalance should prevent the typical recessionary homebuilding bust. Simply put, there just isn't much in the way of inventory to unload. You aren't going to see the price wars and margin compression you normally see in a recession. Interest rates are at all-time lows and borrowers with good credit will be able to get a low interest rate mortgage. While no one knows how long the COVID crisis will last, at least one builder is weathering it pretty well.
D.R. Horton focuses heavily on the entry-level homebuyer and that is where the demand for housing is most acute. Yes, the company withdrew guidance for 2020, however that seems to be the common thread with companies this earnings season. D.R. Horton's Southeast and South Central markets seem to be the least affected by the COVID crisis, and the company has sufficient liquidity to repay the $400 million in debt maturing this year. The lengthening of the sales and construction cycle will help the company conserve cash as well. D.R. Horton is in the right markets with the right demographics, and may well emerge from the COVID-19 crisis in better shape than once feared.