Residential construction giant Lennar (LEN -2.36%) issued fiscal third-quarter 2020 earnings results on Tuesday, and its shares closed the day down 3.9%. While new orders and housing starts improved at the healthy rates of 16% and 17%, respectively, over the prior year, investors may be expressing slight disappointment in the company's projected fourth-quarter home deliveries, as my Motley Fool colleague Dan Caplinger observes. Lennar advised investors to expect 15,500 to 16,000 deliveries next quarter, which, even at the top of the range, will trail fiscal fourth-quarter 2019 deliveries of 16,420 homes.
Nonetheless, the overall report showcased the company's strength in an extremely difficult year for the construction industry, and in my opinion, it justifies the stock's 41% year-to-date appreciation prior to today's retracement.
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Trimmed output; higher economic value
In Lennar's earnings press release, CEO Stuart Miller noted that the company used the third quarter to catch up on the coronavirus-induced construction pause across the country, which had heavily affected its second quarter. The gradual resumption of homebuilding was evident in Lennar's output tally: It delivered 13,842 homes, just 2% over the number delivered in the comparable prior-year quarter.
Nonetheless, gross margin on homes sold rose 270 basis points year over year to 23.1%, and 150 basis points sequentially over the second quarter of 2020. Management attributed the higher profitability to a focus on construction-cost reduction, and it highlighted the fact that Lennar clinched gross margin improvement even as the average home sale price of $396,000 was essentially flat against the average price of $394,000 in the comparable quarter.
Lennar also achieved cost control in overhead related to homebuilding: Selling, general, and administrative expenses declined by 2% against Q3 2019. Combined with the amplified gross margin, slimmer operating costs pushed operating earnings from the homebuilding business up by approximately 24% to $813.7 million year over year.
The company's financial services segment also contributed appreciably to firmer earnings. Higher volume and wider margins in the mortgage business (and to a lesser extent, a pickup in title business volume) produced a leap of 80% in operating earnings in this segment, to $135.1 million.
Homebuilding and financial services momentum was slightly offset by a $5.1 million loss in Lennar's multifamily segment. But overall, net income increased vigorously, climbing 30% versus the comparable quarter, to $666.4 million. Diluted earnings per share rose 33% to $2.12, slightly outpacing the advance in net income due to a lower average share count versus the prior year.
Putting cash to good use, and getting leaner
Lennar's cost discipline and ability to ratchet up earnings during the pandemic illustrate that management has its priorities in the right place; looking at the company's cash-allocation decisions only buttresses this point. The organization paid down $400 million of its debt over the last three months; moreover, it said it "had no borrowings under [our] $2.4 billion revolving credit facility and ended the quarter with $2.0 billion in cash and homebuilding debt to capital ratio of 29.5%, an all-time low."
Part of the company's ease in juicing margins and optimizing its balance sheet stems from a recent dedication to reducing ownership of land. Controlled (versus owned) homesites increased no less than 5 percentage points to 35% against the prior-year quarter. In addition, Lennar's metric of its "years owned" supply of homesites dipped from 4.4 years this time last year to 3.8 years at the end of the third quarter. Executing on an ambition to own less land is steadily reducing transaction and carrying costs associated with land-based inventory.
Looking forward
Lennar expects to carry its current order momentum into the fourth quarter, and projects a range of 13,800 to 14,300 orders, which will mark a healthy distance past the roughly 13,100 orders taken in the fourth quarter of 2019. Deliveries will be somewhat tepid as discussed above, as the company continues to make up for lost time earlier in the year.
Among construction stocks, Lennar is notable for how well it has adapted to the pandemic, and management anticipates that the company will maintain its increased gross profitability, with gross margin landing between 23.35% and 23.5% in the fourth quarter.
Based on these various outlooks, Lennar is likely to conclude fiscal 2020 with a solid earnings report, and the homebuilder remains in great shape to hang on to most of the stock appreciation it's enjoyed so far this year.
