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Favorable Housing Market Aids Lennar (LEN) Amid Rising Costs

·5 min read

Lennar Corporation LEN is poised to gain from solid housing market fundamentals, improving SG&A leverage as well as strategic land investments. Also, its dynamic pricing model, asset light strategy and solid backlog level bode well.

Notably, shares of Lennar have gained 28.6% so far this year, outperforming the Zacks Building Products - Home Builders industry’s 22.7% rally. The price performance was backed by a solid earnings surprise history. Its earnings surpassed the Zacks Consensus Estimate in the trailing eight quarters. Moreover, earnings estimates for the fiscal second quarter and 2021 have moved up 10.4% and 20.1%, respectively, in the past 60 days. This positive trend signifies bullish analysts’ sentiments, indicating robust fundamentals and the expectation of outperformance in the near term. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

However, Lennar has been facing the brunt of rising input cost of raw materials (mainly lumber) and high cost of labor.

Key Growth Drivers

Favorable Housing Market Backdrop: Lower mortgage rates have been driving the U.S. housing market in recent times. The interest rate on mortgage has dropped for the second week in a row for the week ended May 13 and is the lowest since early February. The interest rate on a 30-year fixed-rate mortgage dropped to an average of 2.94% for the said period from 2.96% a week earlier, as reported by mortgage giant Freddie Mac last Thursday. In sync with this, builder backlogs remain elevated, indicating that residential construction will stay steady in the coming months and contribute to economic growth. Despite the hiccups stemming from extremely tight supply, rising prices and increasing input prices, home sales have been increasing at a solid pace.

New single-family home demand has seen a V-shaped recovery throughout the country amid widespread stay-at-home orders and Lennar has been in a prime position to benefit from the same. Lower interest rates have helped the company deliver a solid performance. For first-quarter fiscal 2021, it reported better-than-expected results. This marked the eighth consecutive quarter of an earnings beat. Deliveries grew 19% from a year ago to 12,302 homes.

SG&A Leverage: The company was successful in meeting the target of achieving lower SG&A percentage in fiscal 2016, 2017, 2018, 2019 and 2020. During fiscal 2020, SG&A expenses — as a percentage of revenues from home sales — improved 20 basis points or bps, courtesy of improved operating leverage as a result of an increase in home deliveries and continued benefits from technology initiatives. In fact, first-quarter fiscal 2021 SG&A rate of 8.4% marks the lowest percentage for a first quarter in Lennar’s history. The company is focused on reducing operating costs in order to drive the bottom line and cash flow.

Strategic Efforts: Lennar is using the dynamic pricing model, which enables it to set price according to the evolving market conditions. Courtesy of this strategy, Lennar has been taking advantage of the strong demand trend, which is helping it maximize cash flow and return on inventory. Lennar ended first-quarter fiscal 2021 with a backlog of 22,077 homes (up 25% year over year) and potential housing revenues of $9.5 billion (up 32% year over year). The company is well positioned to deliver solid results for fiscal 2021, given strong backlog and current housing fundamentals.

Meanwhile, Lennar has maintained its relentless focus on a land lighter strategy. The company continues to migrate toward a significantly smaller land-owned inventory, thereby driving business and cash flow. At fiscal first quarter-end, controlled homesites as a percentage of total owned and controlled homesites increased to 45% from 31% in the corresponding year-ago period. As a result, the year’s supply owned decreased to 3.4 years from 4 years in the prior year. It continues to make progress in reaching the goal of three-year supply owned and 50% homesites controlled by fiscal 2021-end.

Major Impediments

Higher construction costs are a cause of concern for Lennar and other homebuilding companies like KB Home KBH, PulteGroup PHM as well as D.R. Horton DHI. In addition to the existing threats, increasing lumber prices — which have been rising since mid-April — could dampen the housing market momentum.

Also, higher land and labor costs are threatening margins as they limit homebuilders’ pricing power. Labor shortages are leading to higher wages while land prices are inflating due to limited availability. This is somewhat putting pressure on homebuilders’ margins.

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PulteGroup, Inc. (PHM) : Free Stock Analysis Report

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D.R. Horton, Inc. (DHI) : Free Stock Analysis Report

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