The first quarter was a monumental one for Lennar (NYSE:LEN) (NYSE:LEN-B) as the company completed its $9.3 billion deal for CalAtlantic, which made Lennar the largest U.S. housebuilder. While we didn't see a full quarter of the combined company, the impact of the deal was apparent up and down the company's most recent earnings release.
Let's take a look at the company's most recent earnings release and see what it means for America's largest homebuilder for the rest of the year.
By the numbers
|Metric||Q1 2018||Q4 2017||Q1 2017|
|Revenue||$2.98 billion||$3.78 billion||$2.34 billion|
|Homebuilding operating earnings||$413.7 million||$478.8 million||$71.3 million|
|Net income||$136.2 million||$309.6 million||$38.0 million|
When compared to the prior-year period, it would appear that Lennar knocked the cover off the ball. It should be noted, though, that the company closed its CalAtlantic acquisition in the quarter. Just about every income and operating metric was touched by this deal one way or another, so it's hard to do an apples-to-apples comparison of the company's results.
While deliveries, new orders, backlog, and average sales price all increased, margins declined across the board because of higher costs. According to management, most of those declines are a result of one-time transaction costs that should dissipate over time. Lennar's adjusted gross margin (adjustments include acquisition costs and revaluation of Cal Atlantic's inventory) was 21.6%, which was actually higher than in the first quarter of 2017.
At the end of the quarter, Lennar had delivered 6,765 homes. It easily replaced all of those deliveries with an astounding 8,456 net new orders. This led to a backlog of 17,566 homes valued at $7.7 billion.
The one thing that may be a touch concerning for investors was the deterioration of the balance sheet to complete the CalAtlantic acquisition. Lennar's net debt to capital jumped up to 42.5% and left the company with $734 million in cash. Compared to some of its peers, though, this is still a relatively healthy debt level with so much work in the backlog. If the company is able to deliver on its 2018 orders, then chances are those debt metrics will decline.
What management had to say
The thing that could kill an acquisition like this one is the possibility that that market quickly turns south. Based on CEO Stuart Miller's prepared statement, it doesn't look like that'd be an issue anytime soon. Here he is laying out what his team at Lennar see in the market today:
We continue to remain positive on the outlook of the housing industry in general. Although interest rates have ticked up, unemployment remains low, the labor participation rate has been increasing, and wages have been moving modestly higher, though we think, even higher than the data the government captures. Feedback from our new home consultants indicates that our customer base feels confident in both job security and compensation levels in spite of the political noise that abounds.
Against a backdrop of higher demand, the production shortage over the past years has in fact resulted in supply shortages that are the underpinnings of at least stability and probably continued expansion of this housing recovery.
What a Fool believes
Over the next few years, rising interest rates (and rising labor costs) could be the largest detriment to Lennar. However, if wage growth is able to keep pace with inflation and rising interest rates, then housing should remain rather robust. There is a lot of pent-up demand from younger people who delayed home purchases for several years following the recession, and that age cohort is the largest one since the baby boomers. Combine that with a constrained supply of new homes, and you get a situation of rapidly rising home prices and better margins for Lennar.
Even though Lennar's results look pretty good, they don't reflect a full quarter of post-acquisition results. There are also those pesky one-time charges related to the transaction. Once we get a full quarter of results with Lennar and CalAtlantic combined, it will be easier to make a call as to whether the company is better off after the acquisition.