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Lennar (LEN) to Gain From Acquisitions, Weak Margins Hurt

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Lennar Corporation’s (LEN - Free Report) diversified line of home offerings for first-time, move-up and active adult homebuyers, and positive housing market fundamentals are the driving factors for this leading homebuilder in the United States. Additionally, synergies from its recent acquisitions are also encouraging.

Recently, this leading homebuilder reported stellar first quarter of fiscal 2018 results wherein earnings as well as revenues surpassed the Zacks Consensus Estimate by 20.7% and 3.3%, respectively.

The company reported adjusted earnings of $1.11 per share that exclude integration costs related to the acquisition of CalAtlantic Group, Inc. and one-time non-cash write down of deferred tax assets due to reduction in the federal corporate income tax rate. Including these items, the reported figure came in at 53 cents per share in the quarter, increasing considerably from the year-ago profit level of 16 cents per share. The improvement was primarily attributable to greater demand for homes accompanied with higher prices.

Total revenues of $2.98 billion increased 28% year over year as the Homebuilding, Financial Services and Multifamily segments performed significantly well.

Meanwhile, Lennar’s shares have outperformed its industry year to date. Earnings estimate revisions have been mixed in the past seven days. Earnings estimates for fiscal 2018 have moved down 2.3% but rose 2.5% for 2019, in the said period.



 

Let’s Take a Look at Lennar’s Key Growth Drivers

Prudent Strategic Investments: Lennar is one of the well-positioned homebuilders to capitalize on the housing recovery driven by diverse revenue mix, steady top-line performance, above-average order growth and improving SG&A leverage.

The company offers a diversified line of homes for first-time, move-up and active adult homebuyers. Additionally, it regularly upgrades homes to cater to the changing consumer requirements. For example, it introduced NextGen homes, or a home within a home, to allow homebuyers — who need to accommodate children and parents — to share the cost of their mortgage and other living expenses.

Lennar remains focused on continued improvement in the SG&A line from operating leverage and investments in technology. The company was successful in meeting its target of achieving the lowest SG&A percentage in its history in 2016 and continuing in fiscal 2017 as well. As a percentage of revenues from home sales, SG&A expenses contracted to 9.2% in the fiscal 2017, from 9.4% in the year-ago period.  In the fiscal first quarter, as a percentage of home sales, SG&A expenses declined 60 basis points (bps). Lennar has plans to reduce SG&A expenses to 8.8-9% in fiscal 2018.

Importantly, acquisitions form an integral part of Lennar’s growth strategy. These buyouts have enhanced the company’s product portfolio, and expanded its geographic footprint and market share.

In February 2017, Lennar acquired WCI. With a portfolio of high quality, low-cost land and 51 communities, the integration is expected to produce strong gross margin going forward. Again, in February 2018, Lennar acquired CalAtlantic Group Inc. in a $9.3 billion deal (including debt), which will create one of the country’s top homebuilders. Since the closing of the transaction, Lennar remains confident that the company will exceed its prior $100 million synergy-savings expectations for fiscal 2018 and is on track to meet $365 million synergies for fiscal 2019 as well.

Positive Housing Market: Overall fundamentals of the housing market remained positive through 2016 and 2017, and are expected to improve further in 2018. Steady job and wage growth, a recovering economy, historically low mortgage rates, rising rentals, rapidly increasing household formation and a limited supply of inventory point toward a strong demand in 2018.

Concerns

Rising land and labor costs are threatening margins as they limit homebuilders’ pricing power. The company’s gross margin on home sales decreased 90 bps year over year in fiscal 2017, primarily due to an increase in construction and land costs per home. Although the company’s gross margin expanded 50 bps year over year, it expects gross margins to have a significantly adverse impact from the CalAtlantic acquisition date through the early part of the fiscal third quarter, as a result of the backlog writeup. Over a five-month period after the closing date of the CalAtlantic transaction, Lennar will only recognize a percentage of the gross margin on the homes it delivered during that time.

Nonetheless, we expect this Zacks Rank #3 (Hold) company to benefit in the near term owing to the synergies arising out of the CalAtlantic buyout. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Stocks to Consider

Investors may consider stocks like KB Home (KBH - Free Report) , M.D.C. Holdings, Inc. (MDC - Free Report) and Lyon William Homes (WLH - Free Report) .

KB Home, a Zack Rank #1 stock, surpassed earnings in all of the trailing four quarters with a positive earnings surprise of 19.5%.

M.D.C. Holdings holds a Zack Rank #2 (Buy). Its earnings are expected to grow 15.5% in 2018.

Lyon William Homes carries a Zacks Rank #2. Its earnings are expected to grow 38.1% this year.

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