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Will Higher Costs Weigh on Lennar's (LEN) Q4 Gross Margin?

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Lennar Corporation (LEN - Free Report) is set to report fourth-quarter fiscal 2017 results on Jan 10, before market open. As discussed in an earlier article, Lennar has been exhibiting solid top-line performances and the trend is expected to continue in the soon-to-be-reported quarter as well, thanks to the strong demand for homes, favorable job market and impressive economic conditions (read more: Will Higher Housing Demand Drive Lennar's Q4 Revenues?).

Let’s take a look at how the company's margin is shaping up for this earnings season.

Unlike an impressive revenue performance, Lennar and a number of renowned homebuilders have been under pressure owing to rising land and labor costs that are threatening margins. On the one hand labor shortages are leading to higher wages and on the other hand land prices are inflating due to limited availability.

Lennar’s gross margin on home sales decreased 90 basis points or bps year over year in the first nine months of fiscal 2017, primarily due to an increase in construction and land costs per home. This trend is unlikely to change in the to-be-reported quarter.

Even the company expects gross margin in the range of 22-22.25% for the fourth quarter. This reflects a decline of approximately 130-105 bps from the year-ago level of 23.3%. The downside will be largely due to higher input costs as well as less sales conversion due to weather-related issues.

Lennar Corporation Gross Margin (TTM)


Lennar Corporation Gross Margin (TTM) | Lennar Corporation Quote

Meanwhile, Lennar remains focused on continued improvement in the SG&A line from operating leverage and investments in technology. SG&A expenses, as a percentage of home sales, are expected to be between 8.5% and 8.6% for the quarter, compared with 8.7% a year ago. The company has been working on the SG&A front and was successful in meeting its target of achieving the lowest SG&A percentage in its history in 2016. The trend continued in the first nine months of 2017 too. As a percentage of revenues from home sales, SG&A expenses contracted to 9.5% in the first nine months of fiscal 2017, from 9.7% in the year-ago period due to improved operating leverage as a result of an increase in home deliveries.

Overall, this Zacks Rank #3 (Hold) company is expected to see lower gross margin in the fourth quarter, owing to higher construction costs. Nonetheless, Lennar’s diligent effort to improve its operating efficiency via digital marketing efforts, dynamic pricing tool and other technology initiatives are expected to offset the headwinds, thereby driving growth for this homebuilder.

Lennar’s shares have gained 29% in the last six months, underperforming the 38.3% growth of its industry. That said, earnings estimates for fiscal 2018 have been trending upward, increasing 1.7% in the last seven days. This reflects analysts’ optimism about the stock’s prospect in the near term.

Key Picks

A few better-ranked stocks in the Zacks Construction sector are Century Communities, Inc. (CCS - Free Report) , with a Zacks Rank #1 (Strong Buy), and Cementos Pacasmayo S.A.A. (CPAC - Free Report) and NVR, Inc. (NVR - Free Report) , carrying a Zacks Rank #2 (Buy).

Full-year 2018 earnings for Century Communities is likely to rise 66%, while that of Cementos Pacasmayo are expected to increase 41.9%.

NVR is expected to witness 16.8% growth in 2018 earnings.

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