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On Sep 30, we reverted to a Neutral recommendation on Lennar Corporation (LEN - Analyst Report) from Outperform as we believe that the recent spike in interest rates is slightly slowing down the housing recovery.

Why Back to Neutral?

Though Lennar announced strong fiscal third-quarter results on Sep 24, it witnessed a slowdown in order growth.

Lennar beat the Zacks Consensus Estimate for both earnings and revenues on the back of the strong momentum in the housing market. Adjusted earnings of 54 cents per share grew 35% year over year driven by double-digit growth in homebuilding revenues and solid margins.

However, even though homebuilding revenues grew 53% in the quarter, net order pace slowed down. Though new home order grew 14% year over year, it declined sequentially.

The recent increase in interest/mortgage rates has slowed order pace and traffic. With the recent improvement in economic conditions and the housing market in general, mortgage rates are edging upwards to more normalized levels since May. High interest rates dilute the demand for new homes, as mortgage loans become expensive; thus lowering a buyer’s purchasing power. Accordingly, the sharp increase in interest rates shocked many customers and a few put off their purchase decisions.

Management is optimistic that the moderating sales pace is only temporary and is confident of seeing strong demand in future quarters as buyers adjust to the rising interest rates and increasing home prices and return to the market. Moreover, easing credit standards and limited supply (arising from low home inventories of both for new and existing homes) is expected to drive demand growth.

However, we prefer to remain on the sidelines until we actually see a rebound in order growth.

Other Stocks to Consider

Lennar carries a Zacks Rank #3 (Hold). Other homebuilders which are currently doing well include Standard Pacific Corp. (SPF - Snapshot Report) and Beazer Homes USA Inc. (BZH - Snapshot Report). Both the companies carry a Zacks Rank #1 (Strong Buy). Among the building products companies, Masco Corporation (MAS - Analyst Report) is worth mentioning which carries a Zacks Rank #2 (Buy).

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