Lennar (LEN 0.40%) recently reported strong fourth-quarter earnings and the stock has risen 11% since the announcement a week ago. But something even more interesting came out of that report, and it hinted at a new strategy Lennar is developing to take advantage of the growing demand for single-family rentals. The national homebuilder also explained how the measures it is taking will reduce the company's risk should a downturn in the real estate sector return.
Strong earnings and growth indicators
Growth indicators for Lennar in the final quarter of the fiscal year, such as deliveries and new orders, were up smartly at 16% and 23% respectively. While deliveries were up 16%, revenue rose by only 8%, which was a result of lower average sale prices. Average sales prices fell from $413,000 to $400,000 which was driven by a higher concentration of starter homes, which naturally carry a lower price tag.
Gross margins increased to 21.5%, a jump of 10 basis points and an indication that the change in product mix to more starter homes is not negatively affecting profitability on each home.
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Lennar continues with its "land-light" transformation
Lennar continued with its plan to become more "land light," which is a reduction in its inventory of homesites. Owning land for a homebuilder has advantages and disadvantages. On one hand, a company will save money by buying earlier when prices are rising. On the other, it is a use of cash and it ties up capital that could be used for other purposes, such as other growth opportunities or stock buybacks.
Builders will often use option contracts, which give the right to buy land at a predetermined price for some set period of time. Companies will often refer to this as "controlling" a site. At the end of the contract, the builder can choose whether to buy the land at the agreed-up price or walk away. By doing this, builders can lock in prices without paying up the full amount up front.
During the quarter, Lennar reduced its inventory of land from 4.4 years' worth to 4.1 years' worth and increased the percentage of controlled sites to 33%. The company then deployed some of that cash to pay off debt and buy back stock.
A new, lean concept reduces risk for Lennar
Lennar introduced a new concept in its conference call, which addresses the single-family rental market. With interest rates at historically low levels, single-family rentals have been a popular asset class for professional investors searching for yield. Investors bought single-family foreclosures in bulk during the financial crisis, rehabilitated the properties and then rented them out. The inventory of distressed single-family homes is largely picked over at this point, so investors are now focusing on new developments. Lennar Chief Executive Officer Rick Beckwitt described the activity on the earnings call:
"Last quarter we daylighted our single-family rental program, where our homebuilding operation will be building and selling homes in bulk in communities where the land is owned by third parties with no lease up-risk to Lennar."
This means Lennar is building homes with much of the risk pushed onto other parties. Such a strategy is very much in line with Lennar's "land light" focus since the company is taking no risk on land pricing to begin with -- it is someone else's property. Lennar also takes no risk on vacancies -- again it is someone else's project. Lennar contracts to build the properties, sells them in bulk to the buyer, and then moves on. From a balance sheet perspective, this activity is highly efficient in that land and finished properties are not tying up capital. The new concept will not have a meaningful impact on earnings until 2022, however, management is excited about it and what it can do for future earnings.
Cheap valuation, with some tech upside
The entire homebuilding sector was on a tear in 2019, benefiting from the unforeseen drop in interest rates. The SPDR S&P Homebuilder ETF rose 27% last year, while Lennar was up 30%. The stock is trading at 9.4 times 2021 earnings, which is a cheap valuation for a company at this stage of the current housing cycle. Historically, home builders will trade at higher multiples when the cycle is near its bottom and very low multiples the closer it gets to the top. Lennar is trading with a low multiple in a home-buying cycle that forecasts to run for years on pent-up demand alone.
Lennar's P/E multiple is single-digit despite its position in the cycle, which is nowhere near historical peaks. Lennar's "land light" strategy will give the company more flexibility when the eventual housing downturn arrives. Lennar is trading with a cheap multiple yet has taken steps to mitigate the cyclical nature of the business and has a lot of higher-growth irons in the fire. Investors who lack exposure to the housing sector should consider adding some since the fundamentals for homebuilders such as demand, demographics and interest rates are highly favorable right now. Lennar is a sector leader, with some possible tech upside.
