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Will Higher Costs Weigh Down Lennar's (LEN) Q2 Earnings?

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Lennar Corporation (LEN - Free Report) is scheduled to announce second-quarter fiscal 2018 results on Jun 26, before the opening bell. Lennar has been showcasing solid top-line performances and the trend is supposed to continue in the soon-to-be-reported quarter as well, courtesy of robust demand for homes, favorable job market and impressive economic conditions.

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

Lennar Corporation Gross Margin (TTM)


Lennar Corporation Gross Margin (TTM) | Lennar Corporation Quote

Gross Margin: Despite 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 one hand, labor shortages are leading to higher wages and on the other, land prices are inflating due to limited availability.

That said, Lennar has managed to boost its margin in the last reported quarter, courtesy of an increase in the average sales price of homes delivered and increased volume. Adjusted gross margin on home sales expanded 50 basis points (bps) to 21.6%.

Meanwhile, in February 2018, Lennar acquired CalAtlantic Group Inc. in a $9.3-billion deal (including debt), which is expected to position Lennar among one of the country’s top three homebuilders in 24 of the top 30 U.S. markets.

Now, as part of the CalAtlantic acquisition, the company needs to evaluate the assets and liabilities acquired, and record them at fair value on the acquisition date. These adjustments will include, but not be limited to, adjustments to inventory, investments in unconsolidated entities, other assets, goodwill and debt. The company had earlier warned that some of these adjustments will impact gross margins, going forward. There will be a more significant impact on gross margins from the acquisition date through the early part of fiscal third quarter, as a result of the backlog writeup that is required for homes that have already been sold.

In the first quarter, the adjustments had negatively impacted gross margin by 210 bps, thereby bringing down gross margin from 21.6% to 19.5%. The company expects gross margin to be impacted by approximately 750-800 bps in the second quarter and 100-150 bps in the third quarter, as a result of the adjustments.

SG&A Expenses: Meanwhile, Lennar remains focused on continued improvement in the SG&A line via operating leverage and investments in technology. Notably, in the last reported quarter, SG&A expenses, as a percentage of revenues from home sales, came in at 9.7%, improving 60 bps year over year. The trend is likely to continue in the to-be-reported quarter as well.

Operating Margin: Lennar anticipates full-year operating margin to be in the range of 12.5-13.25%. Overall, the increase in volume is expected to have a positive impact on operating margin. However, lower gross margin owing to the CalAtlantic deal will likely have a negative impact on operating margin.

Overall, this Zacks Rank #3 (Hold) company is expected to witness lower gross margin and earnings in the fiscal second quarter, owing to merger-related costs. Nonetheless, Lennar’s diligent efforts to improve operating efficiency via digital marketing strategies, dynamic pricing tool and other technology initiatives are expected to offset the headwinds to some extent.

Overall Earnings & Revenue Expectations

Overall, the Zacks Consensus Estimate of 45 cents for second-quarter earnings reflects 50.6% decrease from the prior-year period’s profit of 91 cents per share. Meanwhile, the consensus mark for revenues of $5.23 billion represents a 60.4% increase on a year-over-year basis.

(Read More: Will Higher Housing Demand Aid Lennar's Q2 Earnings?).

Lennar’s shares have declined 13.5% in the past three months, comparing unfavorably with the industry’s 11% decline. Earnings estimates for the fiscal second quarter and 2018 have remained stable in the past 60 days, limiting the stock’s upside potential for future earnings.


Key Picks

Some better-ranked stocks in the Zacks Construction sector are M.D.C. Holdings, Inc. (MDC - Free Report) , sporting a Zacks Rank #1 (Strong Buy), while Beazer Homes USA, Inc. (BZH - Free Report) and Meritage Homes Corporation (MTH - Free Report) , both carry a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Current-year earnings for M.D.C. Holdings, Beazer Homes and Meritage Homes are expected to grow 33.3%, 6.5% and 42.5%, respectively.

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