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Morningstar | D.R. Horton Reports Strong 4Q Results but Takes More Cautious Stance on 2019 Outlook

D.R. Horton closed out its fiscal 2018 with strong fourth-quarter financial results. As was previously reported in the Oct. 9 pre-earnings release, home sales increased 8.5% year over year to $4.4 billion, due to an 11.5% increase in volume that more than offset a 2.6% decline in the average selling price of delivered homes. We remarked in our Oct. 9 analyst note that this 2.6% ASP decline was probably due to a mix shift to lower-priced housing markets and products (Express and Freedom Homes) rather than weakened demand. COO Mike Murray confirmed our view, saying the lower ASP was due to "geographic mix and a 3% decrease in the average size of our homes closed, which reflects our efforts to keep our homes affordable." We continue to believe that D.R. Horton's focus on affordability will pay off handsomely over the coming years as the large millennial population reaches the prime age for homeownership. Based on the myriad surveys we've reviewed, an overwhelming number of millennials still aspire to homeownership. In fiscal 2018, D.R. Horton's more affordable Express and Freedom Homes accounted for 39% of home deliveries.

Fiscal 2018 was certainly a strong year for D.R. Horton, but it's now questionable if that momentum will continue in 2019. During the earnings call, management offered a more opaque and seemingly less confident outlook for 2019 than we would've liked. During the call, management gave preliminary fiscal 2019 guidance of 10%-15% consolidated revenue growth. However due to "choppy" market conditions, management only offered first-quarter home delivery and revenue guidance and said the firm is "positioned to deliver double-digit growth in fiscal 2019 subject to the strength of the spring selling season." Despite the recent pause in demand, we're not changing our long-term forecast, and we therefore don't expect to materially change our fair value estimate after we roll our valuation model forward.

Improved homebuilding profitability was a definite bright spot of the quarter. Home sales gross profit margin improved 130 basis points to 21.6%, and selling, general, and administrative expenses as a percentage of home sales declined 20 basis points to 8.4%. Homebuilding pretax margin expanded 190 basis points year over to 13.2%. While CFO Bill Wheat's remarks about potentially increasing incentives to improve the sales pace may have concerned some investors, we note that 70 basis points of the 130-basis-point gross margin expansion was due to decreased incentives. In our view, D.R. Horton has some room to use incentives to improve community absorption rates and still maintain solid gross profit margins. Indeed, management expects fiscal 2019 gross margins to range between 20% and 22%, which is consistent with recent gross margin performance. In addition to the gross margin guidance, management expects better SG&A leverage in 2019 and to generate over $1 billion of homebuilding cash flow.

D.R. Horton still has one of the strongest balance sheets in the industry; it boasts a homebuilding debt/capital ratio of 21.4%. Capital-efficient optioned land has become a larger portion of D.R. Horton's controlled land. In fact, 57% of D.R. Horton's 289,000 lots are controlled via options. This strategy improves the company's risk profile while also supporting better returns. Indeed, D.R. Horton's return on inventory improved to 20.2% in fiscal 2018 versus 16.6% in 2017.