National home construction giant Lennar (NYSE:LEN) finished 2020 on quite a roll. The company’s fiscal fourth-quarter 2020 earnings report, released in mid-December, revealed a healthy advance in net income in an environment characterized by strong housing demand. Shares rose nearly 30% last year, and the company has entered 2021 positioned to capitalize on a robust order book and favorable residential home-buying trends that have received a boost during the COVID-19 pandemic.
Let’s review Lennar’s recent performance and related implications for the current year, and one reason why Lennar is presently one of the most attractive stocks in the home construction sector.
Recent results bode well for 2021
In Lennar’s fourth quarter of 2020, revenue dipped by 2% year over year to $6.3 billion, due to a decreased number of home deliveries completed during the quarter versus the prior year. Like its home construction peers, Lennar continues to catch up from production that was lost during the spring, at the peak of COVID-19-related shutdowns.
Orders for the fourth quarter, however, improved by 16% to 15,214 homes, while the value of these new orders jumped by 22% against the comparable quarter, to $6.3 billion. In Lennar’s fourth-quarter earnings conference call, executive chairman Stuart Miller discussed a number of factors pushing demand for new home construction, from millennials who are just beginning to start their families, to the pandemic’s acceleration of a trend of homeownership among those who previously rented.
For investors wary about the home construction industry’s tendency toward cyclical ups and downs, Miller also noted that “[t]he underproduction of homes for the past 10 years has created a housing shortage.” The effects of insufficient construction in the years following the Great Recession have become obvious to many observers. As my colleague Jason Hall recently pointed out, the housing industry may be in for no less than a decade of sustained demand.
Leaner, lighter, and more profitable
An eye-opening metric from Lennar’s fourth-quarter report was its homebuilding gross margin of 25%, which rose 3.5 percentage points above the fourth quarter of 2019. Management attributed this partly to pricing power due to brisk demand. But it’s also due to the company’s effort to trim construction costs over the last several quarters.
Alongside productivity gains, management has also focused on keeping overhead expenses in check, specifically, reducing selling, general, and administrative (SG&A) spend as a percentage of revenue. SG&A hit an all-time low of 7.5% of revenue during the fourth quarter.
Gross profit and operating profit improvement are occurring because Lennar seeks to be one of the most capital-light and efficient businesses in the industry. Its drive to squeeze increasingly efficient returns from its capital base is a great reason to buy this stock in 2021, and to hold Lennar shares for the long term, irrespective of the cyclicality of the construction industry.
For example, throughout 2020, Lennar continued to pursue its strategy of reducing owned land inventory in favor of “controlled homesites.” In the fourth quarter, Lennar’s percentage of controlled homesites increased by 600 basis points year over year to 39%, while its years-owned supply of homesites dipped from 4.1 years (in Q4 2019) to 3.5 years. Reducing the amount of owned sites lowers the various carrying costs associated with land inventory, including taxes, insurance, and interest expense.
Management has supplemented the company’s leaner cost structure and lighter land investments with a debt reduction push. Lennar reduced its long-term debt by $1.8 billion in 2020, leaving $6 billion in debt on its balance sheet. It also fully paid down its revolving credit line during the year.
When we take into account the company’s rising margins, capital-light strategy, and trimmed borrowings, it’s no wonder that Lennar’s net income soared by 39% to $2.5 billion in 2020. The organization is generating higher profits at a time when it can barely keep up with demand.
And yet, due to perennial investor skepticism regarding the home building industry, Lennar’s shares are trading at only eight times projected 2021 earnings (a price-to-earnings ratio that’s in line with many of its rivals). Even after its run-up in 2020, Lennar’s stock is relatively cheap given its improving bottom line and forward potential. Patient investors can capitalize on this bargain price by picking up shares in 2021 and holding them for a multi-year period.
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