Why Lennar Corporation's Recent Results Are Built to Last

A look at why Lennar's reasonable valuation and rosy outlook make the stock intriguing.

Jan 6, 2014 at 2:29PM

After the entire sector saw earnings and stock prices crumble a few years ago in the midst of the housing meltdown, homebuilders are back in style. Examining the economic statistics further demonstrates this fact; for instance, new home sales in November surged almost 23%.

Lennar (NYSE:LEN) is an industry leader, and certainly has benefited from the positive macroeconomic environment. However, the company's astute management has experienced every conceivable cycle in real estate since its founding. One of the co-founders, Leonard Miller, started what would eventually become Lennar in the 1950s, and his son took over as CEO in 1997.

All told, fourth-quarter earnings gave investors plenty of reason to cheer. However, despite a nice rebound in Lennar's stock price over the past couple of years, it is not too late to jump into the mix. The homebuilder's top and bottom lines grew 42% and 32%, to $1.9 billion and $164.1 million, respectively. The news is even better for investors since the valuation has become more attractive. Since mid-2012, the P/E ratio has fallen from the upper 60s to the current 18 times.

Digging into the numbers
Analyzing the results closer proves this is not just another fixer-upper with a can of paint splashed to cover defects.

Important metrics such as home deliveries increased 27% year over year, to 5,650, while new orders in both units and dollar terms grew 13% and 34%, to 4,498 and $1.4 billion, respectively . This shows that demand is strong because both the number of units grew and the company was able to raise prices, as evidenced by the fact that the orders in dollars rose at a faster clip than than the number of units.

In fact, there was an 18% boost in the average selling price from the prior year. Besides the dollar increase in new orders and backlog, this helped fuel better gross and operating margins on home sales. The former expanded 330 basis points, to 26.8% while operating margins improved by 470 basis points, reaching 16.9%.

Looking ahead, backlog was up 19% year over year, to 4,806 homes, reaching $1.6 billion, a 40% increase in dollar terms. Backlog should turn into future revenue as these homes fall under contract. Typically, the homeowner has to put down a deposit, although one can cancel under certain circumstances.

Results at its financial services segment were one of the few dark spots in an otherwise sunny report as a slowdown in refinancing hurt results. However, with revenue of about $100 million, it accounts for only about 5% of the company's top line.

Hidden assets
Experience has its benefits, particularly in the real estate industry. In the recession of the early '90s, the company picked up some cheap real estate. Similarly, a couple of years ago, Lennar sought to take advantage of low prices by starting its Rialto Investments segment. This business invests in distressed real estate loans and properties, and it appears to be another smart business decision for the company.

Earlier this year, the company started a fund to invest in mezzanine commercial loans. These are riskier than bank loans, but should provide a nice source of income as distressed properties and loans become more scarce now that much of that inventory has been cleared.

For the quarter, the segment's revenue rose almost 64% to $58.9 million, but operating earnings skyrocketed 227%, to $15.6 million.

Lennar's balance sheet is also in decent shape. It had $4.2 billion of debt from its homebuilding operations, and its debt to total capital, net of cash, was 45.6%, the same as in the year-ago period.

There are other industry participants that are not in as strong a position. Beazer Homes (NYSE:BZH) still reported a loss. For its fiscal year, which ended Sept. 30, the company's loss from continuing operations was $32.1 million. It probably is not much solace to its shareholders that it is narrower than the $135.6 million lost last year. Beazer's balance sheet is also not in great shape, with $1.5 billion of debt, compared to just $240.5 million of book equity.

D.R. Horton (NYSE:DHI), which has a similar market cap, saw revenue rise nearly 44% for its latest fiscal year, which ended Sept. 30. However, its earnings were nearly halved to $464.4 million. The company had to pay income tax, a reversal from a large income tax benefit a year ago. Its net homebuilding debt to total capital ratio of about 37%.

Final thoughts
It is not the bottom of the market, which is difficult to time in the best of circumstances. Those with a crystal ball would have made a lot of money by investing in the stock a few years ago. Nonetheless, thanks to an improving economy and housing market, as well as a reasonable valuation, this homebuilder's share price should have room to rise.

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