JRo’s Notes: Lennar Q3:2024 Earnings

Lennar Q3:2024 Earnings:

Lennar’s third quarter 2024 total revenue increased 7.9%, while homebuilding revenue grew 8.7%. Adjusted EPS was roughly flat with the prior year period at $3.90. Note that the $3.90 in quarterly EPS excludes the mark-to-market gain on its portfolio of public tech investments.

While demand for housing is very strong and supply of homes available for sale very low, homes remain unaffordable for many so Lennar increased incentives to drive sales, which resulted in deliveries growing 16% and new orders increasing 5% year-over-year. Lennar’s average price per home sold (net of incentives) was $422,000, which was down from $448,000 in the third quarter of 2023. The lower sales price per home and higher land prices contributed to a homebuilding gross margin of 22.5%, down from 24.4% last year. Lennar generated a trailing twelve month return on equity (ROE) of 16% and return on invested capital (ROIC) of 11%. Lennar’s margins are below some of its large peers because Lennar is driving volume growth in the 10% range (while peers are slowing down) to meet customer demand is this environment of high input cost inflation, higher land prices, and low affordability (requiring mortgage buydowns and other incentives drive sales). But Lennar’s executive Chairman and co-CEO (and son of the founder) Stuart Miller insists that, “I know that we believe, that our operating margins are going to grow as we go forward.”

Lennar is making real progress on its transition to a “land light”, more efficient, higher inventory turn business model, which should result in higher returns on invested capital and free cash flow conversion over time. It now has options on 81% of its lots, up from 73% last year, and its years supply of owned lots dropped to 1.1 years down from 1.5. These are the “lowest years owned and highest controlled percentage” in Lennar’s corporate history.

Its starts pace and sales pace per community were nearly perfectly aligned at 5.4 and 5.5 (they refer to this matching as “even flow manufacturing”) respectively leaving it with an average of only one unsold completed home per community. Additionally, cycle times declined 23% from Q3:2023 to 140 days (faster cycle times lead to faster inventory turns and higher ROICs), and therefore inventory turns increased to 1.6x compared to 1.3 last year. All of these operational improvements led to a return on inventory of 31.3%, which was 320 basis points higher than same period in the prior year. Lennar thinks that it will be able to further drive down costs and cycle times in 2025 and continue to increase inventory turns over time saying turns “will trend significantly higher than it is right now.” These operating metrics are very encouraging, and further indication that Lennar has taught itself how to become a leaner and meaner, vertically integrated (homebuilding, mortgage financing, title and closing) home building machine!

Here is how Stuart Miller describes their business model transition:

“Against that backdrop, as you can see from our third quarter results, we are adhering to our operating strategy focused on volume, while we are sprinting towards the completion of our 5-year marathon of migrating our operating platform from an asset-heavy model to a land-light, asset-light, just-intime finished homesite delivery model. We have executed that migration without breaking the stride of delivering consistent and growing starts, sales and closings, and while driving the cash flow and bottom line profitability that market conditions enable. We have literally reorganized the company while we have operated day-to-day and quarter-to-quarter with consistent focus on bottom line results. I want to emphasize that our North Star has been exactly this focus: on delivering growing volume with consistent cash flow and bottom line results while migrating to an asset-light model. This predictable volume and growth has been and will be the key to recasting our business model…Since 2020 when we began our financial and operating transformation, the results and comparisons have been rather dramatic and are worthy of some reflection. Since 2020 when we began this journey, we have reduced our year supply of land owned from 3-year supply to an expected 1.1-year at the end of this year. We have increased our controlled homesites from 43% controlled to 81% controlled expected at the end of the year. And we have increased our inventory turn from under a 1x turn to approximately 1.6x turn. While our deliveries have gone from approximately 53,000 to a projected 80,500 to 81,000 for a 53% growth rate, our total owned inventory has actually remained flat. We are clearly doing a lot more with a lot less as our return on inventory has grown from 16% in 2020 to a forecasted 30% plus at year-end this year. But perhaps even more importantly, we have paid down approximately $4.9 billion of debt. By year-end, we will have repurchased approximately 50 million shares of stock for approximately $5.7 billion. And by year-end, we will have distributed approximately $1.9 billion in dividends since 2020. And after all of that, we have a debt-to-total capital ratio of 7.6%, down from approximately 25% in 2020. And currently, we have $4 billion of cash on book.”

In one final effort to become even more “land light” and to complete its 5-year transformation to a fully asset-light business model, Lennar plans to spin off the rest of its land development business into an independent company called Millrose. But the new independent company will provide Lennar with options to purchase finished lots on a just-in-time basis. This spin will remove inventory and capital from Lennar’s balance sheet, and should improve inventory turns (because of “just in time” supply arrangements), ROICs and ROEs even further. Reducing the capex required to own and develop land should also improve FCF conversion. Removing the more cyclical, boom-bust, land business should also further strengthen the balance sheet and lower Lennar’s risk profile, thereby lowering its cost of capital, and increasing its ROIC-to-WACC spread, further justifying Lennar’s higher P/E multiple!

(Note that Lennar is also selling off its multifamily assets and expects to complete the sale of those assets in the fourth quarter. This will result in even more cash on Lennar’s already-strong balance sheet, which is discussed more below).

Stuart Miller concluded his prepared remarks by emphasizing, “We are, in fact, nearing the end of a 5-year marathon that will have restructured our entire operating platform for long-term success and greater returns on capital and equity…Perhaps most importantly, our strong balance sheet affords us flexibility and opportunity to consider and execute upon thoughtful growth for our future. In that regard, we will focus on our manufacturing model and continue to use our land partnerships to grow with a focus on high returns on capital and equity. We will also continue to focus on our pure-play business model and reduce exposure to non-core assets. We’ll continue to drive just-in-time homesite delivery and an asset-light balance sheet, and we’ll continue to allocate capital to growth, debt repayment and stock repurchases as appropriate.”

Lennar has $3 billion of net cash and a homebuilding debt-to-capital of only 7.6%. It spent $519 million (at an average price of $154.77) on buybacks in the quarter compared to $603 million in Q2:2024 and $506 million in Q1:2024. The company expects to buy back more than $2 billion of stock this year, which equates to more than 4% of the market cap (with the market cap at $45.5 billion). Additionally, the company expects that its higher FCF conversion (FCF-to-net income) will allow it to increase divendeds and buybacks even further over time. Lennar’s CFO said, “the goal really is to have our cash flow generation equal our net earnings. And as you think about the usage of that cash, our debt maturity ladder, that’s definitely been reducing with our paydown and not refinancing. So that leaves a fair amount of cash to be deployed back into shareholders.”

Homebuilders, including Lennar, should benefit from lower interest rates. Miller said, “This week, the Fed decreased interest rates which should start to enhance affordability and accelerate the already strong demand for both new and existing homes. While strong demand, enabled by incentives and mortgage rate buydowns, has driven the new home market over the past two years, we fully expect an even stronger, and more broad-based demand cycle, as rates move lower.”

Here are some other quotes from Stuart Miller and the Lennar management team from the earnings call on the state of the homebuilding industry in the U.S.:

“Overall, the economic environment remains very constructive for homebuilders. Demand remains very strong and the migration to lower interest rates will further activate that demand. Lower interest rates will enhance affordability, which will enable many more families to access and attain homeownership at the entry level, while growing families will be able to unlock value from existing homes, enabling them to move up to more bedrooms and more living space…The dynamic of lower interest rates is likely to accelerate demand for both new and existing homes while expanding access to homeownership.”

“Of course, affordability has been a limiting factor for demand and access to homeownership to date. Inflation and interest rates have hindered the ability of average families to accumulate a down payment or to qualify for mortgage. Higher interest rates have also locked households in lower interest rate mortgages and curtailed the natural move up as families expand and need more space. Rate buydowns and incentives have enabled demand to access the market to date.”

“Consumers remain employed, they are generally confident that they will remain employed, and they generally believe that their compensation will rise. This is most often the foundation of a very strong housing market, and we believe that, while confidence will ebb and flow, lower rates will stabilize confidence and the consumer will prioritize shelter and purchase as affordability enables them to do so. We firmly believe that lower rates and controlled inflation will build affordability, enabling more households to access either first-time home ownership or move-up purchase. While strong demand enabled by incentives and mortgage rate buydowns has driven the new home market over the past 2 years, we fully expect an even stronger and more broad-based demand cycle as rates move lower.”

“While demand has been and should remain strong, the supply of homes remains constrained. The well-documented chronic housing shortage is a result of years of underproduction. This shortage has been exacerbated by continuing shortfalls in production driven by restrictive land permitting and higher impact fees at local levels and higher construction costs across the housing landscape…Greater supply and greater access to home ownership enables the upward mobility and generational wealth building that has long been associated with building the middle class through home ownership.”

“Remember that nationally, we’re supply constrained. At local markets, there’s supply constraint. And the market is going to need additional supply of homes, particularly as interest rates drift down, particularly as, at the local and at the national level, the world focuses on greater volume and greater supply to accommodate the population as it sits right now…And I don’t know what new normal is. The print more recently was 1.36 million. That seems light and it doesn’t seem like we’re catching up on the supply side.”

“We utilize incentives and interest rate buydowns as needed to enable us to address affordability and consumer confidence challenges in order to achieve the desired sales pace. This process, against the backdrop of higher interest rates and the impact on consumer from inflation, informed us as to where we needed to buydown of interest rates and/or other incentives to achieve the desired pace. As noted, our third quarter sales pace of 5.5 homes per community per month matched our start pace of 5.4. Achieving the sales pace also resulted in ending the quarter with an average of just more than 1 unsold completed home per community.”

“Inflation has been a difficult component in enabling our customer base to accumulate a down payment. And there’s no question that the down payment is a hurdle and has been and continues to be a hurdle for customers looking to acquire specifically a first home, whether it’s attainable housing or affordable housing, the down payment is definitely a hurdle. I think that the — there are a lot of thoughts and programs out there. We’ll see where they shake out. I think there’s a tightrope that has to be walked. Number one, we’ve got to remember back to the Great Recession, we certainly don’t want to get to that no down payment kind of programming. It might feel good for a short period of time, but we want a durable housing market.”

Official press release: https://investors.lennar.com/press-releases/2024/09-19-2024-213050023