Lennar: Plus As Mortgage Rates Begin To Fall (NYSE:LEN)

Introduction

Lennar (NYSE:LEN) has significantly outperformed the iShares US Consumer Discretionary (IYC) ETF so far in 2024, delivering a total return of around 23% versus ~11% gain for the benchmark ETF:

I think the company has additional upside, driven in part by a sector-wide tailwind that will come from lower mortgage rates as the Fed normalizes policy, but also by a P/ That’s an unassuming ~13x and a net cash position that provides a significant margin of safety if reported results don’t improve as expected.

Company overview

You can access all company results here. Lennar is the second largest homebuilder in the US, trailing only DR Horton (DHI). The company reports results in three primary operating segments, namely Home Construction, Financial Services and Multifamily, with the remainder of results recorded in Lennar Other. House construction is the most important segment for Lennar, representing 95.6% of Q2 2024 revenue and 90% of EBIT:

Operational overview

The company has a fiscal year that ends in November, therefore the Q2 2024 results cover the period that ended in May 2024.

In Q2 2024, Lennar reported increase in income by 9% A/A, led by the Residential Construction segment. Home sales gross margin was 22.6%, up 0.1% y/y to manage construction spending, while net margin was 15.1%, down 0.7% y/y due to higher sales, general and administrative expenses.

The combined effect was earnings of $3.45/shareup 14.6% y/y, also helped by a lower share count of 3.9% y/y.

Outlook for Q3 2024

In Q3 2024, the company expects to deliver approximately 20,750 homes at a gross margin of 23%, putting it on track to meet its full-year target of 80,000 homes, as well as a gross margin in line with 2023:

Analyst consensus estimates set Q3 2024 EPS at about $3.62/share, which seems reasonable to me. Compared to Q2 2024, we expect to see marginally stronger gross margin and lower SG&A impact (down 0.1% Q/Q). In addition, EPS will benefit from share repurchases, which I expect to have continued throughout Q3 2024.

We should note that Q2 2024 EPS included a benefit of $0.07/share from the gain on the sale of a technology investment; therefore, I expect Lennar to show strong Q/Q EPS growth, although Y/Y comparisons will suffer from higher margins in the prior year quarter.

Capital structure

Lennar has an extremely conservative capital structure, the company ends Q2 2024 with a the net cash position of ~$1.4 billion, allowing it to focus on share buybacks – in Q2 2024, the company allocated $603 million to repurchases and $554 million to repaying debt principal (the company still has $2.2 billion in debt gross).

Outlook and assessment

Even before factoring in the significant benefits from the Fed’s rate cuts, I think it’s reasonable to assume that Lennar can generate earnings of around $14/share annually, which would put P/E multiple at 13x – a very undemanding valuation for a company with a net cash position. When factoring in 2% inflation over the long term, it’s possible to be looking at a high single digit return in the current economic climate.

I expect the company to benefit from lower mortgage rates going forward, with data from Bankrate showing the national average Fixed mortgage for 30 years at 6.44%well below the >7% values ​​we were used to. You can clearly see the trend of lower mortgage rates over the last six months:

While there is no guarantee that we will see a return to the sub-5% mortgages that characterized the post-2010 period until the recent cycle of Fed rate hikes, I would fully expect mortgage rates to fall further, potentially during 5%- 6% range, which was the norm between the Dotcom bubble and the global financial crisis of 2008:

That, in turn, is likely to provide a marginal boost to homebuilders, with Lennar one of the key beneficiaries. The company also stands to benefit from federal home care programs, which could be strengthened regardless of who wins the November 2024 presidential election.

risks

The primary risk facing Lennar is a the continued increase in the unemployment rate, which would severely limit people’s inclination to buy new homes, cutting into Lennar’s profits. That risk would be mitigated to a degree by larger-than-current Fed funds rate cuts as the Federal Reserve becomes increasingly wary of labor market weakness.

July 2024 Pending Home Sales data was also weak, underscoring that although mortgage rates have eased from >7% levels in May/June 2024, the housing market boost may take longer to it materializes. As such, while there is a correlation between the housing market and mortgage rates, it is not 1 to 1; therefore, there is no guarantee that lower mortgage rates will translate into more construction activity for Lennar.

Conclusion

Lennar reported strong revenue and EPS growth in Q2 2024, driven by its core homebuilding segment. I expect the robust performance to continue into Q3 2024.

Lennar has an extremely conservative net cash capital structure, limiting the company’s sensitivity to the ever-changing operating dynamics of the real estate market. With mortgage rates on a clear downward trajectory, I expect the 30-year fixed mortgage to decline to at least 5%-6% over the medium term as the Fed normalizes policy.

Given my forecasts for a sector-wide tailwind from lower mortgage rates and a P/E multiple of only 13x, I think Lennar deserves a buy rating even after the company’s strong performance so far in 2024 .

Thank you for reading.