Lennar (NYSE:LEN) is one of the major homebuilding companies in the country. The stock is a few points off its highs, along with the broader market. We have been bullish all year on homebuilding stocks and our members have made profitable trades with us in the space. But what now? With pressure starting to build a bit on the sector, are shares correcting in anticipation of a meaningful slowdown? Or, is this just a healthy breather? Readers, we believe it is a bit of both, but subscribe to the latter option, for now. We think shares are a short to medium-term buy for another run up into next year. Why?
Well the reasons we have been bullish have not really changed. We had a great correction in the massive spike in lumber pricing and other input pricing. We have a long-term home shortage because existing homes just are not being sold. So many homeowners have locked in low mortgage rates, it has killed the inventory available. And so, with many looking to buy homes, despite high mortgage rates, prospective buyers have turned to building their home. We believe this thesis remains in place. However, we think that massive demand has started to cool a bit as evidenced by lower mortgage applications. With that said, we still see homebuilders continuing to do well for the rest of 2023 and into 2024.
We view shares as a buy for the next few quarters. After that however, we think more pressure will mount as soon as the Fed starts to cut rates. Our current thesis is that rates start to be cut in summer of 2024. When that happens, you will start to see demand run up for more existing homes, because mortgage rates will start to recede. The market will in turn anticipate the impact to homebuilders, and likely sell them off with the expectation they will be under pressure as rates come down. But that is a story, in our opinion for a year from now, if not longer. For now, we see the earnings as secure for the next year. This was evidenced by the just reported earnings. Let us discuss.
From a headline perspective, the just reported earnings surpassed the consensus estimates handily on both the top and bottom line. Total revenues were down about 2% from last year to $8.72 billion but beat estimates by $210 million. On the bottom line, we saw EPS of a whopping $3.91, a strong $0.38 beat. These are outstanding results. Let us dig deeper.
Home sales are the massive source of revenue, about 95% of the revenue of course. Revenues from home sales decreased 2% to $8.3 billion from $8.4 billion a year ago. Why the decline? Well, revenues were lower as there was a 9% decrease in average sales price of home deliveries. The slightly lower prices suggests we are seeing the inflation in housing prices taper off which is welcomed news for prospective buyers, but not necessarily great for the company of course. Of course the housing mix impacts this too. The average sales price of homes delivered was $448,000, down from $491,000 a year ago. That said, volumes are strong. There was an 8% increase in the number of home deliveries to 18,559 homes, rising from 17,248 homes last year. Where we did see some concern was in margins.
Gross margins on home sales were $2.0 billion, or 24.4%, down from $2.5 billion, or 29.2%, a year ago. Revenues per square foot decreased year-over-year as the company priced homes to market at a lower entry point. However there were lower material costs, as noted in the open. However, land costs crept up, something to keep an eye on.
Given current market conditions Lennar leaned more on brokers than it did a year ago. This led to a spike in selling, general, and administrative expenses of $583 million in the quarter compared to $486 million a year ago. Should more need of brokers be required, this could hurt the thesis to a degree, but earnings are still very strong, and the valuation of the stock is compelling at 9X FWD EPS.
Some of the other aspects of the business were mixed. The Financial Services segment saw operating earnings more than double, coming in at $148 million compared to $63 million a year ago. However, there was an operating loss for the Multifamily segment. This segment lost $9 million compared to operating earnings of $46 million. And the so-called ‘Other’ segment made $26 million compared to a big operating loss of $118 million a year ago.
Ok, so we are definitely seeing some mixed performance, and there is evidence that while earnings are strong, there are some cracks in the armor. Why buy? Because market conditions are still in the builders’ favor and will be for the foreseeable future.
As we look ahead, we have to note the balance sheet improvement. This is a positive catalyst. During the quarter, Lennar repaid $475 million of debt and repurchased $366 million of its common stock. So this increases shareholder value, and EPS gets a boost as repurchases continue. But the repayment of debt is a major positive. Lennar finished Q3 with debt to total capital of 11.5%. Folks, this is the lowest it has ever been for Lennar in its operational history. The company also has no borrowings on its $2.6 billion revolve. To top it off, the company is sitting on a huge cash pile of $3.9 billion, far more than its debt.
Looking to Q4, Lennar should deliver another 22,000 homes give or take 500, and is looking to see gross margins between 24.4% and 24.6%. You can expect more repurchases, and more debt repayment. This positions the company well for an eventual rate cutting campaign down the road. In terms of earnings for the year, with these results, we are projecting $13.00 in EPS for 2023. With the stock at $117, this puts the stock at precisely 9X FWD estimates. Our early look for 2024 is a bit clouded by possible timing of the first rate cut, but we are projecting a cut in summer of 2024 of 50 basis points. This will not have an immediate impact, but assuming continued strong home pricing, ongoing pressure on existing home sales, and margins that should exceed 25%, we believe EPS will be between $14-$16. It is an early call, and heavily dependent on the back half of 2024, but that is our current view.
Overall, the company is in fantastic shape. The balance sheet is improving monthly. Repurchases will benefit EPS, and home prices while likely to moderate, do not appear in danger of cratering. We rate shares a buy.
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