Lennar: Margins Too Good Too Soon For Its Own Good?

Lennar ( LEN ) was the first of the big homebuilders to post healthy margins more than a year ago as the housing recovery began to show early signs of a rebound.

And Lennar still has industry-leading margins. But some observers say they're not good enough.

Gross margin dipped slightly in its fiscal first quarter ending Feb. 28 to 22.1% from 23.5% in the prior three months.

Moreover, management kept this year's guidance the same as in the earlier quarter, at 23% to 24%. That disappointed some investors.

"Investors want upside earnings revisions. They didn't hear that," said analyst Will Randow of Citigroup.

Builders trade on momentum, and any sign that a builder is losing momentum is not viewed kindly.

Miami-based Lennar is the third-biggest builder, trailingD.R. Horton ( DHI ) andPulteGroup ( PHM ) in revenue.

Underperforming Year

Though Lennar shares rose 4.8% when it reported what seemed to be excellent first-quarter fiscal results last week, they've since fallen to below 42, about where they were before the release.

Year to date, Lennar's stock "has underperformed peers," Randow said in a phone interview this week. "Most builder stocks are up higher."

Ryland ( RYL ), for example is up 15% year to date. D.R. Horton is up 24% year to date.

"Consensus expectations have been rising more for those two builders," he added.

Since they were later to show margin gains, D.R. Horton, Ryland and other builders will likely show bigger percentage gains than Lennar this year, Randow says.

MKM analyst Megan McGrath calls Lennar's gross margin guidance "somewhat uninspiring" in an environment of rising home prices.

"I thought the gross margin would be higher. Likely, they are absorbing higher input costs," she said.

Lennar said labor and material costs rose 4% in the quarter, but that a 9% rise in the average selling price to $269,000 covered the increases.

"We have been increasing prices probably every couple of weeks in some communities, at least once a month in all communities," said Lennar President Richard Beckwitt in the Q1 conference call.

Lennar reported Q1 net earnings of $57.5 million, or 26 cents a share vs. $15 million, or 8 cents, a year earlier. Revenue rose 37% to $989.9 million.

Orders in the quarter jumped 34% to 4,055 homes. While the backlog of homes was up 82% to 4,922 homes, their dollar value jumped 105% to $1.5 billion.

Analysts polled by Thomson Reuters were expecting 15 cents in earnings on revenue of $898.4 million.

Driving the upside earnings surprise was $25 million for reversal of a deferred tax allowance, Randow noted. Pre-tax income, he added, "missed by a minimal amount."

Rialto Investments, Lennar's subsidiary in distressed real estate investments, was likely one reason for the slight pre-tax miss since it's hard to forecast, Randow says.

Rialto generated operating earnings of $1.7 million in the quarter vs. $9.4 million in the earlier year.

"There is a lot of noise on Lennar's homebuilding operations vs. non-homebuilding operations," Randow said. "The homebuilding metrics are all good."

And on the plus side, Rialto puts Lennar on the inside track to grab good land deals in top locations. Or as Lennar CEO Stuart Miller put it in the latest conference call: It provides "access to off-market home sites."

JPMorgan analysts noted in a report that Lennar's willingness to acquire distressed assets from banks or assets that require financial remediation have enabled it to gain control of attractive and larger land parcels in "A" locations.

Lennar said it spent $472 million in Q1 to buy 9,400 home sites, bringing the total to 135,000 lots owned or controlled.

Miller said the company has "land in hand" to meet projected deliveries through 2014, so current land buying will be for 2015 and beyond.

Beckwitt said the company would probably spend around $500 million on land each quarter for the rest of the fiscal year.

Though land prices have been rising, Lennar is an "astute land buyer," said Wells Fargo analyst Adam Rudiger.

Lennar says it started buying land when prices were at their bottom following the housing crash.

"Right now, they're buying land for 2015 and 2016 when competitors are buying land (at higher prices) for the near term," Rudiger said.

Mothballed Land

But a lot of Lennar's land holdings are mothballed, especially in areas where the housing market has remained moribund. Randow says about 30% of its lots are waiting out the recovery, or abut 20% of the dollar value of inventory.

Plenty of other active communities are making up for the mothballed ones. Selling out quickly are projects in Doral near Miami and various places in California, among others, Randow says.

"They have a lot of good lots in good locations, which will likely manifest itself in improving profits," he said.

Analysts expect earnings to show slower growth this year on a technicality: deferred tax asset allowances, which in effect offset income taxes, won't be nearly as large this year as last year.

Earnings will, for the most part, be fully taxed in future quarters.

Lennar has pushed profits higher through a cost-savings "Everything Included" construction program. It, in effect, abandoned "design studio" customization for a more streamlined construction process.

Other construction cost reductions include unbundling material and labor and reducing floor plan offerings by 60% from the peak. Cost per square foot has fallen 32% from the peak from $60 to $41, Lennar said in a recent presentation.

Meanwhile, a new multifamily apartment operation announced last year is gearing up. But it won't likely affect earnings until 2014 and only then in a small way, McGrath says.

"But it will certainly be a longer term opportunity," she said.

Other longer term drivers involve joint ventures in major projects planned in California, including Hunter's Point and Treasure Island in San Francisco.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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