A company missing an earnings target slightly or posting tepid growth isn't necessarily a big deal. In the homebuilding business lately, though, any result that is less than double-digit growth really stands out. So when Lennar (NYSE:LEN) announced its fourth-quarter earnings last week that showed a modest decline year over year, it does make one wonder what is going on.
So let's dig into Lennar's financials and see what happened this past quarter that made the company miss earnings guidance.
By the numbers
|Metric||Q4 2017||Q3 2017||Q4 2016|
|Revenue||$3.78 billion||$3.26 billion||$3.37 billion|
|Homebuilding operating earnings||$478.8 million||$386.3 million||$436.7 million|
|Net income||$309.6 million||$232.7 million||$313.4 million|
If we were judging this quarter on sales alone, then Lennar's results would have looked just fine. The company reported higher revenue on more new home deliveries and higher average selling prices across all four of the company's sales regions. New orders were up 11% with higher sales prices, and the company exited the quarter with a robust backlog of $3.55 billion. By those results, it was a good quarter.
Where the company seemed to have run into the most trouble was that the cost of new homes sold rose faster than revenue, which ate into margins for the quarter. This isn't a major red flag since gross margins were still a respectable 22.4%, but it's certainly something worth keeping track of in future quarters. Other executives have mentioned in recent quarters that labor costs are on the rise, so this isn't something unique for Lennar. The silver lining is that management has been able to keep its sales, general, and administrative costs to just 8.4% of revenue, which is a great number for the homebuilding business.
One thing that management noted about this quarter was that it elected to delay taking a $70 million writedown of its deferred tax assets until the first quarter of 2018 when new tax rates kick in as a result of the recent changes to the corporate tax rate. Lennar noted that it expects its realized tax rate to decline from 34% in 2017 to 25% this year.
What management had to say
Aside from the boilerplate language that executives give in their press release statements, CEO Stuart Miller pointed to the upcoming merger with CalAtlantic (NYSE:CAA) as a catalyst for the rest of the year.
Our company is very well positioned for future growth and we look forward to another strong year in 2018. Our pending strategic combination with CalAtlantic, which is scheduled to close on Feb. 12, 2018, will add to the future growth of our company as we strategically combine two great companies in markets that we know well with products that we know well, to create the leading homebuilder in the country.
What a Fool believes
Consolidation could be a big theme for the homebuilding industry in the coming year. Companies are deleveraging after several terrible years after the housing collapse and cash coffers are starting to fill up. One of the reasons that Lennar and CalAtlantic are joining forces is to make the company a top three player in 24 major metropolitan markets across the U.S. With lots of big-time players looking to add scale in the hottest real estate markets and a slew of smaller players with concentrations in those premiere markets, don't be surprised if we see more M&A activity.
There are a lot of things to like about the homebuilding business right now. Housing starts continue to climb as Millenials enter the market; unemployment is low; interest rates are low to encourage borrowing; and homebuilders will be one of the largest beneficiaries of the recent changes to the tax code. These all point to improving results for Lennar and the lot. The one thing for investors to keep an eye on is labor costs. Low unemplyment is a double edged sword for these companies as it tends to spur higher wages over time. With Lennar's homebuilding costs growing faster than revenue, it could be the one thing that keeps this stock from posting impressive returns over the next several years.