Lennar: Doing Well in a Tough Market, But Not a Buy (NYSE:LEN)

Introduction

Investors looking for a large-cap proxy to play the US homebuilding market can take a look at Lennar Corporation, which ranks among the nation’s top homebuilders by shipments, revenue and earnings.

Lennar can be pursued either through its Class A common stock (NYSE:LEN) or class B ordinary shares (NYSE: LEN.B). The latter offers superior voting rights of 10 votes for 1 share (as opposed to LEN’s one vote per share), but suffers from liquidity challenges due to a small float and strong concentration in the hands of the Chairman and Co-CEO . ..

Yet over the past year, when housing affordability reports have been out in force, Lennar has been a shining light, generating returns of 53% and nearly doubling the returns seen by the prime equity bellwether.

Lennar- Some things to like

As mentioned earlier, LEN is one of the largest home builders in the country, but its scale and presence is not limited to certain pockets. Although it has its roots in the Miami market, it has since expanded to other eastern regions (Florida, Alabama, New Jersey, Pennsylvania, etc.), while reaching the western regions (California, Utah, Washington, etc.), the Center land (Georgia, Virginia, Illinois, Minnesota) and the massive Texas market. This degree of geographic diversification makes it less vulnerable to headwinds that could develop in specific markets.

Also note that at a time when high interest rates have caused many of the smaller builders to go slow and take a step back, LEN has strengthened its presence in these markets and taken shares. Investors should note that LEN has increasingly followed an asset reduction strategy, where they hold very little land, but rather increase land exposure either through flexible option contracts or JVs (for context, over three-quarters of their locations are controlled through options with land banks or JVs). This period has also allowed them to build deeper relationships with even more strategic land banks across the country that will serve them well in the future.

Because they’re not committing huge capital to building land assets on their balance sheet, it leaves them plenty of room to pursue sales incentives that help support volumes in a market where affordability is a key theme. As captured in the image below, sales incentives for S1 accounted for over 10% of sales, a change of nearly 100 bps from a year ago.

Meanwhile, also note in a difficult housing market, Lennar’s cancellation rates have also declined over time.

With interest rates expected to fall this year, the popular theory is that sales stimulus in the industry could be coming, but we’re not entirely convinced that’s the case, as home prices are still 50% above levels before the pandemic and are still expected to grow by 5.4% this year. Besides an interesting study by M&G Investments showed that interest rate pass-throughs are not as effective in stimulating the economy even in an easing phase and mortgage rates should fall quite substantially (potentially to levels of 3.4 % from current levels of 6.3). %) to stimulate demand. In light of these heady conditions, we believe homebuilders such as LEN, which have the capital strength to support sales volume (LEN is on track to deliver 80,000 homes this year) through incentives could receive positive attention.

Just to highlight their capital position, this is a debt-to-equity business of just 7.7% and $3.6 billion in excess cash. In addition, LEN management is concerned with maintaining a lean inventory in compliance with Just-In-Time home delivery, where the gap between production and sales is minimized. This also means that working capital commitments exert less pressure on the cash flow position. Notice how LEN’s working capital turnover rate has generally increased over the past decade.

As a result, LEN’s business model is also fine-tuned to convert net income into cash flow, which in turn is very close to covering total debt (currently at 88%). Before the pandemic, LEN’s FCF levels were not even a quarter of the level of total debt.

Why LEN stock might not be a good buy right now

Even though Lennar has some relatively favorable sub-plots, we’re not convinced it makes much sense to rush out and buy the stock at this stage.

First, we have some concerns about forward valuations. LEN currently trades at a one-year forward price of 11.2x, which represents a nearly 60% premium to its long-term rolling average of 7.13x.

We could probably give some leeway to shedding that double-digit P/E if we got double-digit earnings growth over the next couple of years, but that doesn’t seem to be the case here. The image below shows consensus EPS estimates for FY24 and FY25 (LEN follows November end), and using last year’s annualized EPS of $14.25 as a base, we’re looking at just 7% earnings CAGR over the next two years.

Then again, LEN has been paying dividends for 34 years and has been particularly generous in its dividend increases (the last increase earlier this year was a massive 33%). However, despite the steep rise, note that such has been the ferocity of the price appreciation that the current dividend yield is still only on par with its five-year average. This is another reason to stay away.

Then we have the relative strength chart using the house builders as a base, which helps identify some of the beaten pockets that could benefit from mean reversion. LEN will definitely not be on this list; on the contrary, the current relatively steep resistance ratio of 1.55 is 23% higher than the long-term average and risks reversion to the mean.

Finally, note the developments on a chart showing weekly LEN price prints over the past two years. What we can see is that the price has broadly risen within the limits of the two black lines (in other words, the LEN has formed an ascending channel). If you want to buy LEN, it makes sense to buy when the price drops closer to the lower limit, not where it is now (almost a few percentage points away from the upper limit, which is just under $200). Additionally, the overextended price face is also reiterated by the stock trading at the upper Bollinger band (which is 2 standard deviations from the 20-period moving average).

At these high levels, it’s also questionable whether Lennar will maintain its determined share buyback activity (February’s tremors and May saw buyback spending of $600 million in the quarter versus $358 million in the last two quarters), which supported the price. LEN’s target buyback spending for the year is only about $2 billion, and since they’ve already done $1.2 billion, that would imply a much slower cadence in the second half.

Bottom line, LEN is a HOLD.