Lennar's 2nd quarter 2014 earnings: Rising margins and prices (Part 4 of 4)
The secular story versus the cyclical story
There are two major stories happening with homebuilders:
- The dearth of homebuilding since the real estate bust as well as low household formation numbers
- Low building, which has created a lot of pent-up demand for new homes
Low household formation numbers weren’t driven by fertility rates 30 years ago. They were driven by the lousy economy. The important thing to remember is that even in lousy economies, people still get married, have kids, and ditch the roommates. So, if you look at the drop in household formation numbers, remember the drop represents people who want to buy a home but aren’t able to at the moment. That will change.
The U.S. 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. The U.S. 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. Starts averaged 924 last year. Given how much the builders have underbuilt, the secular (long-term) story 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. Lennar is different than most builders in that it has started a multi-family building unit. As we’ve seen from housing starts data, multi-family is a notoriously volatile sector. But there has been a dearth of multi-family building too, as professional real estate investors have concentrated on buying foreclosed or distressed properties for rentals.
The cyclical side is different. 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 (LEN) could experience high earnings growth, it’s not a “growth stock” the way Twitter (TWTR) is. Lennar will never command the type of multiple that Twitter will when it eventually earns money. This same analysis applies to other builders, like D.R. Horton (DHI), KB Home (KBH), PulteGroup (PHM), and Toll Brothers (TOL).
Investors who are interested in investing in the homebuilding sector should take a look at the S&P SPDR Homebuilder ETF (XHB).
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