Lennar Rides On Strong Housing Demand, Rising Costs A Woe

Lennar Corporation’s (NYSE:LEN) diversified line of home offerings for first-time, move-up and active adult homebuyers and positive housing market fundamental are the driving factors for this leading homebuilder in the United States.

However, labor shortage along with rising land and labor costs pose a threat to the company’s margins.

Last quarter, the company’s earnings and revenues surpassed expectations on for the seventh time in a row. Its third-quarter fiscal 2017 adjusted earnings of $1.06 per share surpassed the Zacks Consensus Estimate. Also, the bottom line improved 5% from $1.01 reported a year ago. Solid demand for homes, favorable job market and interest rates along with increased consumer confidence helped the homebuilder post higher numbers.

Total revenues of $3.26 billion outpaced the Zacks Consensus Estimate of $3.22 billion by 1.3%. The top line also grew 15% year over year as the homebuilding, financial services and multi-family segments performed significantly well.

Key Growth Drivers

Lennar is one of the well-positioned homebuilders to capitalize on the housing recovery driven by diverse revenue mix, steady top-line performance, above-average order growth and improving SG&A leverage.

The company offers a diversified line of homes for first-time, move-up and active adult homebuyers. Additionally, it regularly upgrades homes to cater to the changing consumer requirements. For example, it introduced NextGen homes, or a home within a home, to allow the homebuyers — who need to accommodate children and parents — to share the cost of their mortgage and other living expenses.

Meanwhile, Lennar’s continued focus on digital marketing is driving traffic to its communities. Also, the company uses various technology initiatives to improve its operating model. In this regard, Lennar’s dynamic pricing tool seems to be quite successful.

Furthermore, Lennar’s ancillary businesses like Rialto and Multi-Family provide diversification as well as complementary long-term growth opportunities. Notably, Rialto is a significant source of valuable homebuilding deals and an important contributor to cash flow.

These initiatives have helped Lennar to deliver stellar performances. Evidently, the company’s total revenues grew 17% year over year in the first nine months of fiscal 2017 on the back of a solid 28.3% rise in homebuilding revenues. The top line was primarily driven by a 13% increase in the number of home deliveries and a 3% rise in the average sales price of the homes delivered. In the meantime, Lennar’s core homebuilding results remain consistent with the slow and steady housing recovery.

Lennar remains focused on continued improvement in the SG&A line from operating leverage and investments in technology. In sync with this, it plans to reduce SG&A expenses in the range of 8.5-8.6% in the fourth quarter of fiscal 2017. The company maintained its 7% to 10% growth target and is focused on driving operating costs down, in order to drive bottom line and cash flow.

Moreover, Lennar has agreed to take over CalAtlantic Group Inc. (NYSE:CAA) in a deal worth $9.3 billion (including debt) announced on Oct 31. This, in turn, might make Lennar one of the country’s top three home builders among 24 of the top 30 U.S. markets. The combined entity will have a footprint touching approximately 50% of the U.S. population and is expected to generate meaningful cost savings. The deal is expected to close in the first quarter of fiscal 2018.

Concerns

Rising land and labor costs are threatening margins as they limit homebuilders’ pricing power. While labor shortages are leading to higher wages, land prices are inflating due to limited availability. Going ahead, more inflation is anticipated that might dent homebuilders’ margins. In the first nine months of fiscal 2017, Lennar’s gross margin on home sales decreased 90 basis points year over year, primarily due to an increase in construction and land costs per home.

So far this year, Lennar’s shares have gained 44.8% compared with 64.6% growth of the industry. Earnings estimates for the fourth quarter and fiscal 2017 have remained stable in the past 30 days.

Nonetheless, we expect this Zacks Rank #3 (Hold) company to outperform in the near term owing to the synergies arising out of the CalAtlantic buyout. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Other Stocks to Consider

Investors may also consider stocks like NVR, Inc. (NYSE:NVR) and D.R. Horton, Inc. (NYSE:DHI) .

NVR sports a Zacks Rank #1 and is likely to witness a rise of 42.5% in earnings for the current year.

D.R. Horton, a Zacks Rank #2 (Buy) stock, is expected to witness 17.4% earnings growth this year.

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