Analyzing Lennar (LEN)

By Yaser Anwar, CSC of Equity Investment Ideas

LEN reported that net income fell 73% to $68.6 million, 43 cents a share vs. $258.1 million $1.58 a share in 06, on revenue of $2.79 billion vs. $3.24 billion last year. Its becoming increasingly tough to sell homes, resulting in big inventory overhang.

For LEN, California’s the key to early recovery success. Excluding land related charges, Q1 earnings missed estimate by $0.10-12 as a lower gross margin, higher SG&A expenses, and lower financial services income more than offset a higher than expected LandSource JV gain (which added $0.7 after tax to Q1 EPS).

With continued weakening market conditions driven by huge re-sale inventory across the country and increasing mortgage financing problems in the market, orders were down 27% YoY in units.

The Street expects prices on orders fell roughly 13%, driving the dollar value of orders down by 40%. LEN’s unsold inventory remains high at 7K homes, about half of the 13.9K under construction. The Street expects additional margin headwind from increased incentives offload the inventory.

Keep in mind, that fundamentals have yet to show any signs of stabilization. Even with the incentives, the inventory remain high, the decline in order growth accelerated, and the backlog declined more than 50%.
Recall, management provided an overly optimistic 07 EPS goal just two months ago. Now, management doesn’t expect to achieve its target of flat earnings in 07 and did not feel "comfortable" providing updated guidance.
LEN’s management laid out its 4 step program to rebuilding margins, consisting of salesmanship, re-bidding construction costs, re-negotiating land deals, and rightsizing overhead.
While these initiatives, along with impairment benefits, should ease sequential margin pressure from reduced sales prices and increased land cost, investors shouldn’t expect a robust recovery this year.
LEN had been the most aggressive in the industry at price discounting to move inventory over the past 18 months but has now cleaned out much of its less desirable land. Management is now focused on improving profitability in the future through a combination of improved land mix, lower operating costs, and lower construction and materials costs. Of great importance to LEN’s future success will be its strong land position in California, as eluded to in my opening statements.
Is there nothing positive? Well, If the Fed signals a rate cut (Bernanke speaks today), LEN and the other homebuilder stocks will likely rally. Recall, last year, when Fed paused, homebuilders bottomed out. Keep an eye on management comments.
Last year, I was able to pick a near-term bottom in TOL because its CEO Rob Toll was saying "its the worst market in 50 years!!". Hence, severe comments by management, fed cuts and positions taken by institutions could be the key (look for rising On Balance Volume).
Also, so far LEN has not utilized its $2.7 billion line of credit and recently received $700 million in the refinancing of LandSource. As the market weakens, with home and land prices falling, LEN would be in a better position than some of its peers to take advantage of other homebuilders troubles as the market tries to bottom out, but don’t hold your breadth.

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