As more and more of the U.S. economy shuts down to deal with the COVID-19 pandemic, corporate managers and investors are looking for a playbook or some sort of historical reference to use as a guide for how to deal with the situation. Unfortunately, one doesn't really exist.
As the financial markets begin to hiccup and the Federal Reserve returns to the extraordinary measures taken during the 2008-09 Great Recession, it is only natural to ask if we are seeing a repeat. Are we?
Let's hear from the biggest homebuilder in the country about how things look on the ground and see how things match up.
Good first-quarter numbers
On March 19, Lennar (NYSE:LEN) (NYSE:LEN.B) reported better-than-expected earnings, but it also withdrew its guidance for the rest of fiscal year 2020. Lennar reported first-quarter earnings of $1.27 a share, compared with $0.74 per share a year ago. Revenue rose 16% on a year-over-year basis. Gross margins increased to 20.5%, and its backlog was 17,632 homes or $7.2 billion. Backlog was more or less flat compared to last year.
Lennar is taking steps to maximize cash flow and the stock is cheap
On the Q1 conference call, Lennar laid out its current financial position. The company has $785 million in cash on the balance sheet and $2.1 billion in additional capacity under its revolving credit agreement. The company has a $300 million bond issue that is maturing in May, and another $300 million maturing in November. Lennar has about 33% debt to equity, down from 38% a year ago. In order to maximize cash flow, Lennar is taking steps to reduce the outflows. The company has suspended its stock buyback program and is reducing the number of homes built on spec, moving out start times, and slowing land purchases.
Last year, Lennar earned $5.74 a share. At Monday's closing price of $29.34 a share, this works out to a P/E ratio of about 5. Wall Street is looking for 2020 earnings per share (EPS) of $6.20, which would mean a 4.7 P/E. Last year, Lennar generated about $3 billion in earnings before interest, taxes, depreciation, and amortization (EBITDA), which puts the company's enterprise-value-to-EBITDA ratio under 6. While Lennar was never known as a dividend stock, its $0.50 per share projected dividend gives it a yield of 1.7%. And with EPS of $5.74, it is pretty well covered, to say the least. Take a look at the chart below, which shows Lennar's P/E over the past 5 years:
This is not 2008. We don't have a housing bubble
While the current crisis is the worst the U.S. has experienced since the Great Recession, it is important to remember that this crisis is caused by something very different. The 2008-09 financial crisis was caused by a burst housing bubble that spread through the financial sector and the overall economy. Burst housing bubbles are the Hurricane Katrinas of banking and economies -- Japan has yet to recover from its bubble that ended in 1989.
Major market shakeups caused by bubbles are also extremely rare events. The last two for the U.S. were in the 2000s and the 1920s. To exist, they require that investors, lenders, and regulators forget the lessons of the last one. We will probably never see another one in the U.S. Perhaps our grandkids will.
This time around, there is no housing bubble. Housing inventory is tight, and homebuilders will probably not have to cut prices to move inventory. In fact, on the conference call, CEO Stuart Miller said that new orders remain strong and were up 16% in the first two weeks of March.
Looking past the shock
Until the coronavirus pandemic, homebuilding was set to have one of its best years in over a decade. The supply and demand fundamentals of the sector remain the same as before. The drop in interest rates has addressed many of the affordability concerns. Jon Jaffe, president of Lennar, remarked on the earnings call that average rents are higher than PITI (principal interest taxes and insurance), which would be the typical mortgage payment. If the coronavirus issue continues to snowball and cause a full-blown depression, the homebuilding industry is going to suffer like every other one. If this turns out to be a temporary hiccup, then the builders should pick right up where they left off.