Public Builders' Dilemma: How Big A Miss To Guide To For 2021
As 2021 Q4 approaches, public homebuilder face a harrowing prospect: How to level-set to reality on delivery misses without jeopardizing 2022 forecasts or penalizing operators in the field.
The Street doesn't like misses. And there's one thing Wall Street investors are even more averse to than a miss. A surprise miss.
This poses a big time dilemma for homebuilders right now – especially the now-19 publicly traded homebuilding enterprises anchored to quarterly earnings performance and disclosures – perched at a moment of reckoning as they re-forecast 2021 and budget for 2022.
What's not in question are misses – as a slew of supply chain disruptions, one nastier than the next, collides head-on with even the most conservative financial and operational reforecasts leading from the ending of Q3 into calendar fourth quarter.
Homebuilder executive strategists are already telegraphing challenges to prior guidance as the days tick away to Q4. In preparation for Fall investor forums, some of them are trying to get ahead of the bad-news narrative of underperformance on start-to-completion deliveries.
Despite the extraordinary efforts of our trade partners, the supply chain issues that have plagued the industry throughout the pandemic have increased during the second half of the year,” said Ryan Marshall, President and Chief Executive Officer of PulteGroup. “We continue to work closely with our suppliers, but shortages for a variety of building products, combined with increased production volumes across the homebuilding industry, are directly impacting our ability to get homes closed to our level of quality over the remainder of 2021. In light of these challenges, we are providing routine updates on build schedules to our backlog of homebuyers, who remain committed to close on their new homes.”
Based on the reduced closing volume and changes in the geographic and buyer mix of homes anticipated to close in the period, the Company now expects third quarter gross margin to be in the range of 26.4% to 26.6%, and SG&A of 9.9% of home sale revenues.
“Industry disruptions have also impacted the timing of community openings such that, even though we continue to limit sales pace in many communities in the face of ongoing buyer demand, our average community count for the third quarter is expected to be down approximately 15% from last year,” said Marshall. “We continue to expect community count at year end to be down 5% to 10% from last year and then gradually expand as 2022 progresses.”
We believe Pulte will not be alone in re-guiding investors to lowered delivery re-forecasts. From what we hear, no homebuilder – public or otherwise – is immune to the shock and stress building materials and product supply disruptions are throwing into the system.
Both publics and privately-held firms – accountable to investors, lenders, financing and capital sources, etc. on a time-released basis – are looking at a harrowing stretch ahead. They very likely know they're going to need more time to deliver on what they've got in the works, but it's almost impossible for them to know how much more time they're going to need.
The big dilemma – for public homebuilding enterprises, anyway – hits like a gut punch in three critical areas of their business lifeblood of people, land, and money.
The nexus of the issue hits intra-year reforecasts for 2021, impacts critical budget planning for 2022, and the related challenge of striking a balance between investor-shareholder interests and those of critical executive and management talent.
The key area of focus here is on budget planning, forecasts, re-budget versions – eg. V1, V2, V3 – reforecasts, etc. in both how they're derived, and what's been impacting them when it comes to matching forecasts to reality.
A common starting point for many companies is that division leaders offer a first estimate of units, absorption rates, community performance, etc. This first input in the process is often referred to among finance and operating pros as a "sandbag" projection. That is, it's looked at skeptically as a low-hanging-fruit performance level. The reason for this ties to how division and regional executive and management-level operators are bonused. If they exceed forecast numbers, they trigger bonus compensation.
What follows the "sandbag" projections are management inputs.
Some select strategic management disciplines among some of the homebuilding firms call for rigorous, community-by-community detailed review and challenge with the division leaders and operators and the senior executive C-suite. This way, the C-suite challenges regional and divisional leaders to raise their forecasts on an evidence-based, account-by-account, line-item review of the portfolio.
An alternative approach amounts to a broader-brush C-suite approach that "sees" the sandbag number and raises it by, say, 10% – thereby establishing a go-get on the performance side.
What happens – according to an executive who's served on the corporate finance team of at least three public companies – is that C-suite guidance tends to lower the "sandbag" ultra-conservative estimate by 10% in its communication with Wall Street analysts and investors. That's known in public homebuilding finance speak as the "handicap" number.
What's happening now is this.
- Corporate, regional, and divisional bonus structures for 2021 were set – generally – at a level of up to 10% higher than the "sandbag" projections divisional and regional presidents put in during the initial 2021 budget process last Fall. All of the bonuses that were to trigger based on executive management's "go-get" number are now at risk.
- Further, public company C-suite leaders have been trying to keep pace with a constantly-shifting outlook on their 2021 completions, and their guidance to date mostly factored in some modest catch-up on the deliveries front in 3rd and 4th quarter that was to have eased at least some of the causes of schedule elongation. A lot of that now lies in the thrall of partially completed construction phases, missing materials, critical path impediments to settlement.
- This predicament bears directly, not only on 2021 calendar year performance versus budget, but on 2022 budget planning. The reason for this is that much of the obscurity and uncertainty regarding unstarted new homes and communities sit squarely in the way of predictable or reliable forecasting. Resource allocation, particularly for land acquisition and development capital to be put into place for new neighborhoods, is straitjacketed by unknowns.
Most of the unknowns, for the moment, apply to timing, but those timing matters are what cause both misses and surprises on The Street.
A factor that plagues most homebuilding enterprise planning and forecasting processes – and their basis in fast-shifting real-world circumstances – is the wide use of fairly primitive computer software tracking systems that signal how far a start-to-completion construction process has come, and, precisely, how close it is to being finished.
You can have a system that shows a 'phase' is checked-off as complete, but what it may not show is that another 'phase,' say windows, is not done," says our finance executive source. "What makes now different from the past is that now there's no way to get the particular material or product that that home needs. You literally can't find some of the materials, even as a workaround or Plan B."
The delicate path public company C-suite execs need to navigate is how to keep both Wall Street, their businesses, and their talent organizations all in balance through a period that promised continued turmoil and challenge.
You're getting to the point where construction managers and purchasing people are under incredible, mounting pressure," says a 2nd executive we talked to about the intensifying challenges. "You're seeing a growing panic at the VP level and below, where they're saying to themselves, 'if we disclose the reality, they [the C-suite] will take our bonuses."
While the average selling price spiral over the past eight months has meant that, by and large, public homebuilders can meet close to their guidance on pre-tax earnings, the unit volume deliveries challenge roils below the surface.
This under-the-surface issue, as third quarter rolls into fourth quarter, and as 2022 budgets are developed, escalates as a source of risk.
Most of the builders are going to miss on Q4 deliveries guidance," says our executive source. "What they're not going to want to do is to miss on Q1 2022. That's when they'll get hammered if they're off the mark. That means they've got to get granular in their forecast analysis. That pressures people in the field to fess up on what's really real."