We all know how hot the US real estate market is right now. It is estimated that there are only three months of housing supply and a housing shortage of 5.2 million across the country. This is good news for everyone who builds homes, that is, home builders. Coupled with soaring housing prices, there is a huge economic tailwind for the housing industry that could continue over the next decade.
The easiest way to follow this trend is to own a great home builder like Lennar Corporation (NYSE: LEN). Does this real estate trend make Lennar’s stock a buy?
One of the oldest home builders in the country
With a history dating back to 1954, Lennar is one of the oldest home builders in the country. It has acquired many different businesses over the years including a mortgage finance unit and many residential construction competitors. Most recently, in 2018, it completed a major merger with CalAtlantic Homes for $ 5.7 billion. The combined company is the largest home builder in the United States. She also looked at various businesses, including title insurance, multi-family properties and rental complexes. Finally, it has a portfolio of investments linked to housing, such as a participation in Open Door Technologies.
With house prices rising and supply declining rapidly over the past 18 months, Lennar’s business has been boosted significantly. In the second quarter, which ended in May, Lennar’s revenue was $ 6.4 billion, up 22% year-over-year, thanks to an increase of 14% of the number of homes delivered and a 6% increase in the average sale price to $ 414,000.
Due to its scale, rising home prices and technological improvements, Lennar has significantly improved its gross margin over the past year. In the second quarter, the gross margin was 26.1%, compared to 21.6% a year ago. Additionally, Lennar was able to reduce operating expenses as a percentage of revenue from 8.3% last year to 7.6% this year. All this is in addition to the net margin for housing construction, which stands at 18.5%, which shows the strong operating leverage of this activity. These margin improvements are expected to remain in place if Lennar is able to increase revenue in line with aggregate demand from potential and existing owners.
A spin-off is coming
Over 90% of Lennar’s income comes from home construction, but its mortgage origination business accounts for a large portion of its profits due to its high margins. In the second quarter, Lennar’s financial services segment contributed $ 121 million to operating income, and in 2020, the segment achieved operating income of $ 480 million. With a market capitalization of $ 30 billion, this segment of financial services contributes immensely to Lennar’s business value.
Outside of building residential homes and providing mortgages (which fall under financial services), management believes there is hidden value in Lennar’s business and investment merger. To try and realize that value, he plans to part with all of these non-essential operations. The new entity will have assets of $ 5 billion to $ 6 billion. The remaining Lennar Corporation will focus solely on housing construction and financial services, which management believes it does best. No further details have been released, but any investor or potential investor should watch what will be included in this spin-off.
it is not without risks
Lennar Corporation made about $ 2.5 billion in profit last year and is poised to do a lot more this year. Compared to its market cap of $ 30 billion, this gives it a fairly low price-to-earnings (P / E) ratio of 8.9 based on the last 12 months of earnings, and an estimated forecast P / E of 7. , 1 based on the next 12 months.
With housing demand so high, investors might think this makes Lennar a catastrophic investment opportunity. However, there are many economic variables that can affect Lennar’s growth and profitability. These include procurement costs (such as timber) and interest rates. If the Federal Reserve raises interest rates significantly, it will trickle down to mortgages, making it more expensive to buy a home. This would likely affect the demand for Lennar’s products.
Over the past five years, Lennar’s P / E has only been above 20 for a short time, and has historically hovered around 10. Although it is now below these levels, investors should not be swayed. ‘expect a lot of multiple expansion when they own shares of this stock.
LEN PE ratio data by YCharts
So is it a purchase?
Considering all of these factors, Lennar Corporation appears to be a solid bet for conservative investors with a long-term time horizon. The company has been around for decades, is enjoying a strong tailwind in the industry, and trading at a very cheap multiple of earnings. Don’t expect this to be a 100 bagger, but this combination of factors makes Lennar a good bet against other US home builders at this time.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.