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Solid Housing Market Fundamentals Aid Lennar Amid High Costs

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Lennar Corporation (LEN - Free Report) has been benefiting from improved housing market fundamentals, strategic land investments and improving SG&A leverage.

Notably, shares of this leading homebuilder have gained 26.2% over the past six-month period, outperforming its industry’s 18.9% rally. Also, it has outperformed the S&P 500’s 9% rise in the said period. Earnings estimates for fiscal 2020 have moved 1.3% upward over the past seven days to $6.11 per share. The company’s price performance was mainly driven by a solid earnings surprise history, having surpassed the Zacks Consensus Estimate in 12 of the trailing 14 quarters.

Recently, Lennar came up with solid fourth-quarter fiscal 2019 results, wherein earnings and revenues jumped 15.8% and 7.9% year over year, respectively. The upside was mainly driven by higher deliveries and continued operating leverage, backed by technological efforts.

However, rising land and labor costs remain significant headwinds.

Let’s delve deeper into the factors supporting the company’s Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Substantial Growth Drivers

Improved Housing Market Fundamentals Bode Well: A combination of lower interest rates and slower price appreciation have positively impacted affordability, thereby helping Lennar to generate higher revenues in fiscal 2019. During the period, its total revenues grew 8% year over year. Precisely, homebuilding operation registered 9% revenue growth, driven by higher number of homes delivered (up 13% year over year). Lennar’s core homebuilding results remain consistent with slow and steady housing recovery. In fiscal 2019, the company’s new orders jumped 12% from a year ago to 51,439 homes.

Focus on Asset Light Strategy: Lennar has maintained its relentless focus on a land lighter strategy. The company continues to migrate toward a significantly smaller land-owned inventory, driving business and cash flow.

Strong operating results and focus on asset base increased its cash flow in fiscal 2019 to $1.6 billion. Lennar’s annual cash flow for fiscal 2020 is expected to reach the $2-billion mark.

Active Management of Cash Flows: Lennar has been actively managing cash flows via returning much of its free cash to investors through share repurchases and dividends. During fiscal 2019, it generated strong homebuilding cash flow of $1.6 billion and repurchased 9.8 million shares for a total purchase price of $492.9 million. The company expects to continue generating strong cash flow in fiscal 2020, and intends to utilize the cash to pay down debt and return capital to its shareholders while improving balance sheet, as it continues to improve shareholder return. On Jan 2020, the company more than tripled (approximately 212.5%) quarterly dividend to 12.5 cents per share (50 cents annually) from 4 cents (16 cents annually).

Major Headwinds

Rising Labor, Land and Material Costs: Rising land and labor costs are threatening margins as they limit homebuilders’ pricing power. Labor shortages are resulting in higher wages, while land prices are inflating due to limited availability. This is somewhat denting homebuilders’ margins.

Although Lennar’s fiscal 2019 gross and operating margins improved, the adverse effect of labor shortage in the construction industry is the strongest headwind faced by Lennar. Notably, labor cost represents 43% of its direct costs. Also, higher construction costs are a cause of concern.

Key Picks

Some better-ranked stocks in the same space are M/I Homes, Inc. (MHO - Free Report) , D.R. Horton, Inc. (DHI - Free Report) and M.D.C. Holdings, Inc. (MDC - Free Report) , each carrying a Zacks Rank #2 (Buy).

M/I Homes’ earnings for 2020 are expected to increase 13%.

D.R. Horton and M.D.C. Holdings have a three-five year EPS growth rate of 11.4% and 9.6%, respectively.

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