Lennar 4Q earnings review (Part 3 of 3)
A quarterly record for gross margins
For the fourth quarter, gross margins increased 330 basis points, to 26.8%. Last year, fourth quarter gross margins rose 23.3%. For the full year, gross margins rose 24.9%, compared to 22.7% in 2012. Gross margins increased for a variety of reasons—primarily a decrease in sales incentives, an increase in average selling prices, and a greater emphasis on the higher-margin communities (particularly communities where land was purchased after the housing bust). On the cost side, land costs increased, as did labor and materials.
One issue that has bedeviled the builders has been the dearth of skilled labor. One of the effects of the long housing bust has been an exodus of skilled construction workers, who were unemployed for so long they found new careers in trucking and the energy sector. As a result, wages are beginning to increase, and that will crimp margins going forward. Of course, wage increases will be positive for the economy as a whole and particularly the homebuilding sector.
Earnings per share
Lennar reported net earnings of $164 million (or $0.73 a share) compared to net income of $124.3 million (or $0.56 a share) a year ago. The prior year’s number included an income tax benefit of $18.6 million, which makes the comparison look even better. For the full 2013 fiscal year, Lennar earned almost $0.5 billion (or $2.15 a share) versus $679.1 million (0r $3.11 a share) the year before. 2012′s net income included a $435.2 million tax benefit, so again, the comparisons aren’t apples-to-apples. With Lennar trading at $39.26, that equates to a P/E ratio of 18.3. The Street believes Lennar’s growth is unsustainable and is forecasting earnings of $2.46 a share for 2014. This gives it a forward P/E of just over 16.
The secular story versus the cyclical story
There are two major stories happening with the builders, and those are the dearth of homebuilding since the real estate bust as well as low household formation numbers and low building that have created a lot of pent-up demand for new homes. As I mentioned earlier, we recently hit 1.1 million housing starts (which is an annualized number). This is a big number compared to the past few years, but it’s not big historically. We’ve averaged about 1.5 million units a year since the 1950s. During recoveries, we’ve seen years where starts were above 2 million a year. We averaged 924 last year. Given how much we’ve underbuilt, there’s a secular (long-term) story that should buoy the builders for several years. If the economy recovers and the first-time homebuyer returns to the market, we should see housing starts at least approaching average levels if not spiking like they have in prior recoveries. Lennar’s stock price is probably priced for another 1 million year in housing starts. If starts improve, Lennar’s earnings will improve—even if margins fall.
The cyclical side is different—the builders are very cyclical stocks. This means when times are bad, they trade at very high multiples. When earnings are great, they trade at single-digit multiples. So an investor could get it right about earnings only to see multiple compression offset the earnings. While Lennar could experience high earnings growth, it’s not a “growth stock” the way Twitter (TWTR) is, and it will never command the type of multiple that Twitter will (when it eventually earns money).
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