Forestar Group Inc. — Form 10-Q Summary
Reporting period: Quarter and six months ended June 30, 2014. Amounts are in U.S. dollars; financial statement amounts are in millions unless otherwise noted.
Business context
Forestar operates in real estate, oil and gas, and other natural resources, including timber and water. Its real estate portfolio is concentrated in Texas and Georgia. The company’s stated strategy is to grow segment earnings through disciplined investment, increase returns, and reposition non-core assets.
Financial performance and liquidity
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Revenue | $83.0 | $60.1 | $167.6 | $157.6 |
| Operating income | $26.9 | $3.6 | $42.8 | $13.1 |
| Income before taxes | $22.8 | $2.1 | $36.5 | $9.1 |
| Net income attributable to Forestar | $14.8 | $0.5 | $23.2 | $4.5 |
| Diluted earnings per share | $0.34 | $0.02 | $0.53 | $0.13 |
- Q2 revenue rose about 38%; first-half revenue rose about 6%. First-half real estate revenue was broadly flat, while oil and gas revenue increased and other natural resources revenue declined.
- Q2 operating income included $16.9 million of gains on asset exchanges and sales: a $10.5 million noncash timber-rights-for-land exchange gain and $5.7 million of oil and gas property sale gains. These items materially lifted reported earnings.
- First-half operating cash flow was $19.0 million, versus $34.9 million in 2013. Investing cash outflow was $47.7 million, including $44.6 million for oil and gas properties and equipment. Financing cash inflow was $20.6 million. Cash declined $8.1 million to $184.2 million.
- At quarter-end, total debt was $400.3 million, compared with $357.4 million at year-end 2013. Cash less total debt was approximately negative $216.2 million. The company reported $291.8 million of unused revolving capacity and $474.1 million of available liquidity, including cash.
- The company issued $250 million of 8.5% senior secured notes due 2022 and used proceeds to repay its $200 million term loan. The revolving facility was increased to $300 million and extended to May 2017, with two one-year extension options. Interest expense increased year over year.
- At quarter-end, Forestar reported compliance with debt covenants: interest coverage of 6.68x against a 2.50x minimum, total leverage of 37.8% against a 50% maximum, and net worth of $695.0 million against a $589.4 million minimum.
Material changes and segment developments
- Real estate: Q2 segment earnings increased to $27.3 million from $8.1 million; first-half earnings were $50.9 million versus $27.6 million. Results benefited from more lot and undeveloped-land sales and the $10.5 million exchange gain. First-half 2013 had benefited from the $41 million sale of the Promesa multifamily property.
- Oil and gas: Q2 segment earnings were $9.5 million versus $4.2 million, including $5.7 million in property sale gains. Production revenue increased with higher oil volumes and prices; exploration, production, and depletion costs also rose. First-half earnings were $10.3 million versus $9.4 million.
- Other natural resources: Q2 segment earnings rose to $2.1 million from $1.0 million, helped by a groundwater agreement and a timber-lease termination gain. First-half earnings declined to $1.6 million from $2.2 million, reflecting lower fiber volumes.
- Real estate assets were $538.5 million, up from $519.5 million at year-end; oil and gas properties were $253.2 million, up from $232.6 million. The company acquired two Austin multifamily development sites for $19.5 million in the first half.
Outlook, risks, contingencies, and unusual items
- No formal earnings or revenue guidance is provided. Management described U.S. single-family housing conditions as improving and multifamily markets as strong, while noting that restrictive mortgage lending, economic uncertainty, and other factors could constrain recovery.
- For full-year 2014, the company planned to drill or participate as a non-operator in approximately 155 gross wells and projected $82.7 million of drilling and completion expenditures. Management said the budget could change with commodity prices, drilling results, costs, and opportunities.
- Oil and gas commodity prices are a material exposure. A 10% reduction in realized prices would have reduced production revenue by $2.4 million in Q2 and $4.1 million in the first half, based on reported production. No commodity hedges were outstanding at quarter-end.
- Forestar’s reimbursements from the Cibolo Canyons special improvement district depend on approvals, available tax revenues, and other factors. At quarter-end, $40.0 million of infrastructure reimbursements remained pending, excluding interest; timing and collection are uncertain.
- The company reported venture-related performance bonds and letters of credit of $26.9 million. It also provided construction completion, repayment, and nonrecourse carve-out guarantees for venture projects. A subsequent July 2014 Littleton venture includes a $46.4 million construction loan and Forestar guarantees of completion and 25% of principal and accrued interest, subject to reduction upon specified conditions.
- Management said ordinary-course litigation and environmental reserves were adequate and did not expect proceedings to materially adversely affect the company overall, while acknowledging that charges could be significant in an individual period. Estimated remaining remediation cost for a California site was $0.9 million.
- Management identified risks involving housing and land demand, entitlements, district reimbursements, oil and gas prices and operations, financing and covenant compliance, partner performance, and the execution and returns of strategic investments. No material changes to previously disclosed risk factors were reported.
Important facts for investors to verify
- How much of the earnings increase is repeatable after separating the $16.9 million of asset exchange and sale gains from operating performance.
- Whether residential lot and undeveloped-land sales, oil and gas production, and planned drilling investments generate sustainable cash flow and acceptable returns.
- The timing, approval, and collectability of Cibolo Canyons district reimbursements, and the company’s exposure under venture guarantees and performance commitments.
- Debt service costs and covenant headroom following the 8.5% notes issuance, as well as liquidity needs for real estate development and oil and gas spending.
- Whether the planned 2014 drilling and completion program proceeds as budgeted given commodity prices, operator plans, service availability, and drilling results.