Credit Crib Note: Lennar (LEN)
We look at the credit risk and fundamental profile of Lennar, the #2 homebuilder.
Credit Crib Note: Lennar (LEN)
Credit quality trend: Positive. The balance sheet strength rules the credit trend at Lennar despite lower earnings and tighter margins in 2023. While earnings peaked in the 2021-2022 boom, LEN has still posted strong earnings in historical context and boasts cash in excess of homebuilding debt. LEN offers a diverse and well-balanced mix of regional exposure after a decade of expansion and M&A activities. The 2023 trend line in ASPs, gross margin, and net margin by operating region are negative, but the cash generation and balance sheet carry the day.
Operating profile: LEN at a close #2 behind industry leader D.R. Horton (see Credit Crib Notes: D.R. Horton (DHI) 8-29-23, D.R. Horton: Credit Profile 4-4-23) and well ahead of #3 Pulte (see Pulte: Relative Value Meets “Old School” Coupons 11-15-23). LEN arguably possesses the most expansive national footprint across the widest range of price tiers. That scale and breadth was built through acquisitions and organic expansion with the all-stock deal for CalAtlantic (closed Feb 2018) being the pivotal strategic acquisition combining the #2 and #4 builders. CalAtlantic had been created by the Ryland and Standard Pacific merger in 2015 that combined the #8 and #12 builders. LEN’s WCI Communities deal in 2016 enhanced and upgraded LEN’s mix and market position in its home state of Florida.
Financial trends: Cash exceeding total homebuilding debt is clear enough, but the asset coverage of debt based on the ratio of inventory to total debt is also exceptional. That balance sheet advantage leaves LEN many options as the industry remains in an uncertain monetary cycle. The liquidity fundamentals of the homebuilder working capital cycle positions LEN to sustain very high rates of free cash flow generation even if demand weakens in 2024 and drives inventory liquidation.
Revenues, profitability, and cash flow at LEN is dominated by the homebuilding operations with a material earnings contribution from the Financial Services segment (Note: LEN is a November fiscal year).
The flattening of homebuilding revenues 3Q23 YTD and modest declines in 3Q23 came on the other side of weaker pricing and modest growth in volumes.
Lower gross margins and net margins in the four major geographic homebuilding segments are partially countered by strong homebuilding order increases in 3Q23 with all regions higher in orders and 3 of 4 higher in orders YTD 3Q23 (only the East was lower YTD).
Business line operating earnings for YTD 3Q23 are showing the pressure of the tightening cycle and signs of softening volumes and pricing in some homebuilding markets and in multifamily operations.
Unrealized losses in the “Lennar Other” segment were down sharply in 2023 after 2022 saw some payback for soaring valuations in 2021. The YTD 3Q23 unrealized stock losses of -$14.7 mn were down from losses of -$559 mn YTD 3Q22 after gains of +$691 mn in the mini tech bubble of 2021.
Delivery volumes are detailed above for the geographic homebuilding reporting segments. We see the 3Q23 period up +7.6% YoY and for the YTD period (not shown) up by +6.4%. We see 3 of 4 segments higher for the 3Q23 period with only the East segment down slightly.
For the major states underlying the segments, the East includes FL, AL, NJ, PA, and SC (NC is in Central for business line reporting reasons). Central includes GA, IL, IN, MD, MN, NC, TN, and VA. Some of the regional buckets are not intuitive relative to the Atlantic Ocean, but the good news is that Texas includes Texas. The West includes AZ, CA, CO, ID, NV, OR, UT, and WA.
We break out the trends in average sales prices (ASPs) for each geographic reporting segment each quarter of 2023 vs. the prior year.
The range of ASPs across regions can be wide and the same within regions. The West typically is the highest based on California prices, Texas the lowest, and the Central and East markets between the two.
The upward price pressure of FY 2021 into FY 2022 is clear in the table, but we see 3Q23 posting declines in ASPs across the board after a weaker ASP trend in 2Q23 and more mixed picture in 1Q23.
The above chart frames gross margin in % terms and net margin in dollar terms for each of the homebuilding geographic segments for the recent quarter and YTD period while also looking back from FY 2019.
We see the healthy margin growth from 2019 through 2022 and notably in the East, Texas, and West through 2022 before the recent softening YoY with all four major building segments showing narrowing gross margins in % terms in the table and lower net margins generated in dollar terms.
The East gross margins held in the best while the West gross margins weakened the most with the West also showing the biggest dollar drop in net margin.
The total gross margins YTD 3Q23 (not shown) were 22.9% after dropping in modest losses in the “Lennar Other” segment vs. 28.7% YTD 3Q22.
LEN has reduced total homebuilding debt by $4.5 bn since the end of 2019 through the end of 3Q23 or by 57%.
Capital allocation has been prudent and balanced as evident in the gross debt reduction and cash in excess of debt. LEN has been able to balance credit quality with stock buybacks of $841 mn YTD 3Q23 and dividends of $325 mn for $1.16 bn in shareholder rewards over 9 months YTD 3Q23. During FY 2021 and 2022 combined, LEN returned $3.2 bn in cash to shareholders through buybacks and dividends.
The chart details LEN’s exceptionally strong balance sheet with cash exceeding total debt by $567 mn and inventory coverage of total debt of 5.8x without even taking into consideration other asset values.
The cash + inventory coverage of 7.0x is up from 2.4x at the end of 2019.
Total debt % capitalization at 11.5% is a rock-solid balance sheet even before netting cash against the total.
The mortgage loan warehouse facilities in the Financial Services operations are non-recourse to LEN.
Highlights and History
Lennar is the #2 homebuilder behind D.R. Horton with LEN posting more than twice the home sales revenue of #3 Pulte. Like DHI, LEN is important for its scale and breadth with an asset mix and operations serving as a useful microcosm of the bigger macro picture for the housing sector.
The #1 (DHI) and #2 (LEN) builders are more than 3x the #5 ranked builder (NVR) based on the most recent quarterly run rate, underscoring the relative concentration of the major builders while raising the potential for more consolidation ahead.
LEN historically has been the most complex of the builders given the range of its asset management interests and tech-focused venture investments, but it has taken action to shift more towards its core classic homebuilding operations in recent years. The LEN asset mix still makes it one of the most diverse in terms of its investment strategies even though DHI also is being more adventurous by expanding into single family rentals.
LEN’s venture stakes include a range of publicly traded and private companies across various real estate related businesses. Public equities include Blend Labs, Hippo, Opendoor, SmartRent, Sonder, and Sunnova. Investment in equity securities fall under the “Lennar Other” segment and totaled around $397 million in carrying value at 3Q23 with some marked to market and others ($187 mn) not having readily available fair values at interim.
LEN owns a major stake in Five Point Holdings, LLC with a carrying value of $417 mn. That asset has been an underperformer since its IPO at $14.00 in 2017 (ticker FPH, closed at $2.42 on 11-21-23). FPH is a major owner and developer of master planned communities in California.