The Baldwin Insurance Group, Inc. (BWIN) Q2 2019 Earnings Report, Transcript and Summary

Thank you for standing by. This is the conference operator. Welcome to the Brookfield Residential Properties Inc., Second Quarter 2019 Conference Call. As a reminder, all participants are in a listen only mode and the conference is being recorded. After the presentation, there will be an opportunity to ask questions [Operator Instructions].I'd now like to turn the conference over to Thomas Lui, Executive Vice President and CFO. Please go ahead sir.

Thank you and good morning, everyone. Thank you for joining us for Brookfield Residential's 2019 second quarter conference call. With me today is Alan Norris, our Chairman and Chief Executive Officer. This call is intended for current holders and beneficial owners of Brookfield Residential's debt securities, as well as prospective investors, securities analysts, market makers and other interested parties.I would, at this time, remind you that in responding to questions and in talking about new initiatives and our financial and operating performance, we will make forward-looking statements, including forward-looking statements with the meaning of applicable Canadian U.S. securities laws. These statements reflect predictions of future events and trends, and do not relate to historical events, are subject to known and unknown risks, and future events may differ materially from such statements. For more information on these risks and their potential impact on our company, please see our historical filings with securities regulators in Canada and the U.S. and in information available on our Web site.Net income attributable to procure residential for the three months ended June 30, 2019 was $60 million, compared to $50 million for the three months ended June 30, 2018. The decrease of $34 million is primarily a result of a decrease in gross margin of $47 million, primarily due to lower gross margin; a decrease in other income of $4 million; and an increase in lease expense of $3 million, as a result of the adoption of new leases accounting standard.This was partially offset by an increase in equity earnings from unconsolidated entities of $7 million; decrease in income tax expense of $6 million; a decrease in G&A expense of $3 million; a decrease in sales and marketing expense of $3 million and a decrease in interest expense of $1 million.In the first half of 2019, we delivered 1374 homes compared to 1,477 homes in the same period for the prior year. Included in 2018, we have closed 159 homes for a mid-rise condominium project in Aurora, Ontario, with no such comparable closings in 2019. Our housing gross margin percentage was lower at 16% in 2019, and reflects the increased incentives from slower U.S. and Canadian markets experienced in the latter half of 2018.Housing revenue and gross margins were $405 million and $66 million, respectively, from the three months ended June 30, 2018, compared to $535 million and $104 million for the same period in 2018. The decrease in revenue and gross margin was primarily the result of 256 fewer home closings and a 4% decrease in the Canadian to U.S. foreign exchange rate, partially offset by 1% increase in the average home selling price. The gross margin percentage decreased 3% as a result of the mix of homes sold.When looking at our housing activity by operating segment, our Canadian segment had lower housing revenue and gross margin as a result of fewer home closings, partially offset by a 4% increase in the average home selling price. The decrease in home closings was primarily the result of lower closings in our Ontario market from the timing of community openings. And an increase in the average home selling price was primarily due to an increase in our Ontario market from the product mix of homes sold.Our California segment had a decrease in both housing revenue and gross margin, primarily due to 150 fewer home closings, partially offset by 4% increase in the average home selling price as a result of the product mix of homes sold in Southern California. The Central and Eastern U.S. segment had an increase in housing revenue. And while gross margin remained consistent with 2018, as a result of an 8% increase in the average home selling price, partially offset by 18 fewer home closings.At June 30, 2019, we have 1,390 units with our backlog with a value of $730 million compared to 1,922 units with a value of $1 billion at June 30, 2018. The decrease is primarily the result of slower sales pace in early 2019 and the impact of the lower backlog entering the year. Our units of backlog in our Canadian segment at June 30, 2019 decreased by 217 units when compared to the same in period, mainly due to the execution of our backlog with lower net new home orders in 2018 from our Ontario market.Our California segment units in backlog decreased mainly due to a decrease in net new home orders in 2019. The Center and Eastern U.S. segment's units in backlog decreased 139 units due to a decrease in net new orders. Wherein 2018 in our Austin market, we had about 134 bulk home sale with no comparable sale in the first half of 2019.Our land revenue totaled $71 million for the three months ended June 30th, an increase of $17 million and land gross margin totaled $13 million, a decrease of $9 million compared to the same period in 2018. We closed the total of 1,014 single-family lots in the first half of 2019, of which 456 lots were from our Homebuilder Finance program, where minimal land gross margin is recognized at the time of closing. But interest income is generated throughout the period that the lots are owned by Brookfield Residential.Total land gross margin was reduced to 27% for the first half of 2019 but when the Homebuilder Finance program lot closings are excluded, our land gross margin percentage from our land operations was actually 45% in 2019 compared to 41% in 2018.When we look at our operating segments for 2019, land revenue and gross margin per Canadian segment decreased as a result of 28% lower average single-family lot selling price due to the mix of lots sold between the Calgary and Edmonton communities, and 19 raw and partially finished acres sold in the second quarter of 2018 compared to none in 2019. In California, land revenue and gross margin decreased due to 82 fewer single-family lot closings as a result of the time closings. Our Central and Eastern U.S. land revenue increased by $5 million and gross margin increased $2 million when compared to the same period in 2018. This increase was primarily from additional 68 single-family lot closings partially offset by the 8% decrease in single-family lot selling price.Moving to our balance sheet. As at June 30, 2019, our assets totaled $4.8 billion. Our land and housing inventory and investments in unconsolidated entities are our most significant assets with a combined book value of $3.4 billion, or approximately 72% of our total assets. Land and housing assets increased when compared to December 31, 2018 due to land acquisitions of $183 million and land development and home construction activity, partially offset by sales activity. Our investments in unconsolidated entities increased as a result of continued development of land and construction of our inventory with our joint venture partners.During the quarter, we also entered into a deposit agreement with Brookfield Asset Management, our parent company to allow us, from time-to-time, cash to be deposited with Brookfield Residential at a lower rate than our current cost of borrowing. At June 30, 2019 we had $200 million on deposit from BAM and our North American credit facility was undrawn. As a result, our liquidity available June 30, 2019 included $105 million of cash and $617 million available in our North American unsecured revolving credit facility. Our net debt to total capitalization at June 30th was 46% compared to 44% at December 31, 2018.I'll now pass the call to Alan who will provide an overview of our operations and markets.

Thank you, Thomas and good morning everyone. Brookfield Residential's results for the first six months of 2019 were slower than last year, and attributed to the slow U.S. housing market in the latter half of 2018 and early 2019, combined with the ongoing economic and regulatory challenges in the Canadian market.For the six months ended June 30, 2019, Brookfield Residential recorded income before income taxes of $30 million compared to $65 million in the same period of 2018. The U.S. housing market improved in the second quarter with a decline in mortgage rates. This was combined with positive economic fundamentals, which were supported by continued job growth and limited housing supply. Although, many of our U.S. markets were not as robust as the prior-year spring selling season, we had net new home orders of 1,069 homes for the first six months of 2019 compared to 1,361 homes for the same period in 2018. We are encouraged by the return of the market but remain cautious as affordability is a key consideration in markets such as California and Denver, Colorado. In addition, trade tensions and potential tariffs provide some degree of uncertainty, and continues to affect consumer confidence.Our Canadian operations continue to be impacted by the stress test mortgage rules and the economic conditions in Alberta. The new shared equity mortgage program may be implemented prior to the federal election this fall, but we anticipate a marginal benefit to perspective homebuyers. The Alberta economic environment continues to be challenged by federal regulatory policies with the passing of Bill C-69 and C-48, which may change future investments in the energy sector despite the federal government reapproving the Trans Mountain pipeline expansion in June.Net new home orders in Canada increased to 558 homes in 2019 when compared to 344 homes in 2018. The increase is directly attributable to 98 home orders from the new communities in Ontario where interest has been positive and at pricing that is similar to the homes closed last year. As per our expectations, the majority of these Ontario home sales are scheduled to close in 2020 versus 2019. Also in the second quarter, we had $300 million Class B junior preferred shares of Brookfield BPY Holdings Inc. redeemed and we used the proceeds to purchase $300 million of Series 1 Class A preference shares of Brookfield International Limited.With our backlog at June 30, 2019 consisting of 1,390 units with a value of $730 million, the second half of the year continues to lend itself to generating the bulk of the year's net income with the highest proportion in the fourth quarter. We remain optimistic about the balance of 2019. And based on current forecast, we'll reaffirm our previously provided limited guidance of closing 950 homes and 850 lots in Canada, and 1,950 homes and 1,650 lots in the U.S. Our backlog also has improved margins over homes closed in the first half of 2019 as we reduced our selling incentives and our Q2 sales. We continue to project the number of multifamily, commercial and industrial parcel sales in both countries in the last half of the year.That wraps up the review of the results. Thank you for joining us in the Q2, 2019 conference call. I will now turn the call back to the operator who will moderate questions.

Thank you. We will now begin the question-and-answer session [Operator instructions]. Our first question comes from James Finnerty with Citigroup. Please go ahead.

Just want to get your thoughts on the facility with BAM, the deposit facility. What is the cash used for? Is it reflected on the cash line? Is this something that you intend to use, going forward? I know you said in the release that you tend to pay down by year end. But we will be drawing out it again?

Yes, this is Thomas here. And this is a very similar deposit agreement to what we had signed and agreed to in 2016. And just taking a look at from an overall Brookfield perspective, it was just cash available from our parent company at a lower cost of borrowing, and it is repayable back to them on demand. So we do anticipate that we will be required to repay this at some point within the year at the request of our parent company. The funds that were used was basically for general corporate purposes, but also utilize to pay down our North American credit facility. So we would treat them as a borrowing at this time. So we anticipate that when BAM does require these funds back, we would just draw back on our credit facility.

Great, thank you. And then on the upcoming bond maturity, just any thoughts there with regard to refinancing, and would you look to be refinance the entire amount? Or is there some potential for overall debt reduction at that time?

The markets obviously bringing some opportunities to homebuilders and many have done some offerings. We're continuing to evaluate our options for 2020 bonds for refinancing at some point in the future. We don't really have an update at this time. So when we do we'll obviously launch and let the group know.

Great, and then the last question would be just in terms of closings and orders for the quarter. Where were they relative to your expectations? And I'm referring to home closings and home orders.

In terms of the expectations within home closings for the quarter, they continue to reflect, as Alan mentioned earlier, that it reflects a little bit of a slower U.S. market in the last half of 2018 combined with the slower Canadian market that we also experienced in Alberta and Ontario. As you recognize and then we spoke to all of last year, Ontario, we have very limited sales and closings. And the lower closings in Canada does reflect the fact that we have limited sales rather in the last half of 2018. Alan can provide a little bit of the overview of what we're seeing in each of the markets, but were much more recognized that the majority of our closings will still come in Q3 and Q4 of the year.

James, this is Alan here. Just to add to Thomas' comments. I mean, I think from an Ontario point of view, we stayed out of the market and we've discussed this in past calls consciously as we are closing our backlog. And I think we've now started to see a little bit reaffirmation that our strategy was correct in Ontario to stay out. We've launched some new communities and we're seeing some grounding from a price point of view back at levels pre the frothiness. So I think we're feeling more comfortable with that particularly market. And obviously the market was slow for all participants in the market in the last half of last year, and the other part of this year, which obviously gives rise to slightly lower closings at that point, although, we have a reasonably good margins sitting in our backlog. At this point, I'm slightly ahead of what we did through the first half.

So therefore, just given the re-affirmation of your targets for full-year with the second quarter, I mean, it's from our perspective, I thought your closings and orders were better than what we were anticipating. I was just trying to gauge was it in line what you were expecting for the quarter. I know you want to try this by quarter, but now that the quarter is passed, was what you generated in terms of closings and orders and in line with…

So I think we are close to where we thought we would be from the point of view of given the lower backlog entering 2019, because originally when we would prepare our expectations for 2019, that would done in September, October last year but assumed a slightly quicker recovery in the marketplace. So, given that it didn't come back, I think we're okay with where we are now and we will have stronger performance in the last half, obviously, as well as bottom line.

The next question comes from Lee Brading with Wells Fargo Securities. Please go ahead.

I think, this is -- is this the first quarter, at least looking at my notes that you guys have separately disclosed the Homebuilder Finance program?

Yes. Good morning, Lee. That is correct. This is the first quarter that we have split out the Homebuilder Finance program. In previous quarters, there were very minimal and the impact to the overall margin did not have a significant impact as we did this time around. So yes, to answer any questions around it but this is first the quarter, I mean…

Yes, I guess going forward, is it something that will be more material, so you need to continue to separate it out? Or is it a one-time event?

We'll continue to split it out, yes.

Yes. And just on the business side, really we're utilizing some excess capital and we were using, in many cases, markets where we already have a presence, but in some other markets as well. And it's got fairly good return from a point of view of most of the financing is between two and three years generally with a reasonable rate of return. So, it's a good utilization of our capital.

Got you. You answered some of my questions, so typical holding period is two to three years. Is there a typical rate and I guess the minimal gross margins? So your -- instead of gross margin recognition, it's you financing, so its rate dynamic, I guess. Is it a more profitable transaction fee versus an outright selling of land?

No. It would typically range between 12.5% and 14% from the point of view of the interest income earned. And we would take ownership of the lots and then we'll be providing options to builders who would take that and then they would pay interest for the most part. So with our knowledge of the marketplace and everything else, we have good backstop in case of something happens. And as I said, the security is the lot. So we are in a fairly good position. But it's a very -- it's a fairly traditional way of looking at it. But that's -- the multiple capital can be of 1.2, 1.5 depending on the term.

And are they -- was it typical type of builders, is that across the board, large or national, or is the smaller builders? And I guess you've touched on the markets. Which markets is it typically in?

I mean, I would say probably 60% to 70% of markets that we are in and the rest would be in some other markets that we're comfortable with. And the builders range from nationals to private, so I'm not going to go through the names. But we have a variety of builders that we deal with.

And then you talked about is it tougher comparison in Canada on the delivery side due to lack of a mid rise product, I guess, this coming quarter on a year-over-year comparison. I guess, could you just talk about the mid rise market, what you see going forward?

Specifically, the mid rise was in Ontario closing, mid rise product that we did there. They've become a little bit lumpy. I mean, we're not concerned about the mid rise market, which don't have that much on a regular basis coming in. Typically, in Alberta, the multifamily market would be town homes. In many cases, we do the odd, three, four storey walk up type, that's a tough market in today's times to these economics. We may have some future mid rise in the Ontario market coming up in the next little while. So they tend to be a little bit lumpy, there's not as much there in a flow.

And then ASP was up nicely across all your markets. Looks like the biggest increase was in the Central and Eastern U.S., up almost 8%. Just curious on was it a particular market or particular product driving it?

Basically, you're correct. It is within a certain market there within the Central and Eastern U.S. when you take a look at our discussion in the previous year. A lot of the closings in 2018 last year were from our Austin market, which typically have a lower ASP compared to this year where the majority of the closings they've come from are Washington DC markets, which does have a bit higher of a ASP in comparison and even within the Austin market, just due to the mix of the product that we're selling. In 2018 there were more the cottages, which is a smaller product that we had typically sold there. Whereas this year, there're more of the larger single-family homes with the higher ASP closer to the average for the segment of just under $500,000. So primarily, it's the mix within Austin and then just higher proportionate of our Washington DC closings.

And then -- so you touched on the incentives. You have of a disclosure here in your docs said it's very good in detail and as far as on incentive side. I guess, increasing from 2% last year revenue to 5% this year. But the one that really jumped down was Canada, went up from 1% to 8%. I guess what are the types of incentives that are happening there? And have seen it -- is it leveling off or easing?

Yes, I could speak to just the number side of it initially and then Alan could add any insight on the specifics of the incentives that are being provided. There is a higher incentive in Canada. You are correct for the home closings that we had. Predominantly, the incentives that were provided are in Alberta, in Calgary and Edmonton, just for the spec, inventory that we have there. And then for the closings in the quarter, we did have some higher spec in Ontario, that's just due to the exit -- continued execution of our backlog that we had coming in initially from 2018. It's many in the community and openings that we've had so far in 2019 in Ontario, the level of incentives should come down in that market specifically but being balanced with continued incentives in Alberta. And Alan, like I said, can speak to on the specifics.

I'll just expand on the Ontario ones. I mean what happened as we said earlier we had sold it without a significant backlog going into 2018. And then with the stock selling quite honestly as we continue just to work on our backlog and work with our customers. I mean what some of those incentives relate to is as negotiating with many of our customers when in fact they'd entered into contracts that, what I'll the peak pricing and we wanted to work with them to try and get it back to where the market was. And so we've worked closely with them perhaps to get increased deposits from them, I mean return for some price relaxation that we had in the contracts to try and work closely with the customer. So hopefully, those are mostly just a one-off because the sales that we're entering into now are more levels we were closing last year and this year. So I think it's a bit of a one-off when it comes to the Ontario thing hopefully. And some of it, as Thomas alluded to on the Alberta stuff, some of it's just working our way through some of the product that we had on standing spec in Alberta.

And the typical incentives in Canada, I guess, it's just basically absolutely reducing price? Or is there a mix of options?

In some cases, in Alberta, maybe a combination. Most of in Ontario was just really reducing price. I mean, if you look at the marketplace there, it peaked probably nine months prior to the slowdown in the Ontario market. And I would suggest that it's now gone back down to what I call that nine month pricing that was there pre the nine months when it write up. So all we're really doing is working with our customers to try and bring it back down and again we work with them, so they could cause -- they had deposits up but in many cases, it was -- they were not going to be able to close. So we worked with them to try and come up with some common ground and so we pushed some of it through incentives.

And this is more of a macro industry question, I don't see more discussed out there in the news. And I don't know to what involvement you have or if you've seen it. The involvement I guess has single family rental companies. Do you all sell to deliver bulk sales to them, or any product to them? Or -- and I guess start there and then I've a follow up after that.

One, we believe that it is a new asset class and we have no issue with working with many of the lots, single-family rental companies. We did transaction with one of them in Austin market in last year and closed about 134 units with them in one of our communities. We're looking to what work them in some of the other markets as well. And we don't have a problem with adding that type of product as a segmentation within some of our communities across the board. So I think it is a new asset class and it is attractive to certain consumers out there and customers, and so we can use that as -- again, for the segmentation of the product offerings that we give in our communities.

And then I guess on the Austin side. What price point is that? Is that a different product that you are going to make, or is that a product that you already have and you're able to deliver?

It was very similar to product we had in the community. And again, we found the immediate income for many of those renters, were such that they could have been buying product. But it was just a lifestyle choice that many of them were making. So to me, it's just an additive to our community offerings.

This concludes the question-and-question-and-answer session. I would like to turn the conference back over to Alan Norris for any closing remarks.

Thanks very much. I appreciate everybody's interest. Thank you. And we will chat again at the end of Q3. Thank you.

This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.