Lennar: A Safe Investment In A Risky Housing Market

| About: Lennar Corporation (LEN)

The news of the Fed's decision to begin the QE taper has probably done unimaginable rounds of global media and analysts have already written at great length about its implications. While there are definitely a good number of consequences of this decision, one of the important things that clearly catches my attention is the fact that the Fed is seeing signs of sustainable improvement in the American economy.

Lennar: A Strong Player

There is no denying the fact that the forerunner of this improvement has been the recovery in the housing sector. The recently announced results of Lennar Corp. (NYSE:LEN) show that this recovery is here to stay and will bring in big money for the homebuilders. The company's revenue for the fourth quarter was up by 42% y-o-y and the average sales price advanced to $307,000, an 18% increase year-over-year because of a spurt in the overall economy.

While, the overall numbers looked great, Lennar's gross margin also picked up in the quarter. This number saw an improvement of 330 basis points on a y-o-y basis because of an increase in the sale prices along with prudent cost containment.

Better placed for the future

The management pointed out the huge magnitude of investment that the company is making in land acquisition and development in order to prepare itself for the upcoming spring buying season. There have been concerns over the fact that the housing recovery is not as extensive as conveyed by the homebuilders and that fluctuating mortgage rates as a result of the Fed's taper decision will slow down the recovery. In my opinion, however, the current results and future investment plans of Lennar give a much better picture about its sustainability.

The limited supply of land and high demand for homes has definitely led to an increase in average selling prices but it would not be prudent to assume a bubble building up at this stage. Lennar's management presented an optimistic view around the housing recovery at its earnings call and also focused on the purchase of new communities at viable locations. The order book for new homes saw a reasonable growth of 13% in Q4 and dollar value up by 34% y-o-y.

A word of caution

While everything sounds great with the company, it is important to sound off a note of caution for investors because the housing sector is experiencing quite an uncertain trajectory as of now and entails higher comparative risk. Lennar's financial services business also did quite well in the quarter and complemented the performance of its homebuilding segment. The growth was comparatively lower as the refinancing business has encountered a slowdown due to an increase in the mortgage rates. However, the results were stable and in line with the expectations of the management.

Other segments are doing well

Besides a reasonable performance from the financial services segment, the Rialto segment also put up a good show. It generated operating earnings of $13.9 million as compared to $4.6 million in the prior year period, which is a healthy sign of increasing momentum. The star of this division was Rialto Mortgage finance operations that contributed around $10.2 million during its first full quarter of operations. However, investors need to watch out for the performance of this particular division as the gradually rising mortgage rates will hamper loan origination. As of now, the Rialto investment is paying-off well considering the short tenure for which it has been operational.

Final words

Since the beginning of this article, I have laid a lot of emphasis on the recovery in the housing sector and the implications of the Fed's taper decision on homebuilders. As said earlier, the recovery is sustainable and though the markets are not in a similar spot as pre-crisis, there has been a considerable level of rebound. That being said, the sector is going to face some hiccups because of fluctuating mortgage rates and demand-supply mismatch.

Thus, Lennar is an ideal candidate under such circumstances because of its credible investment plans and good market positioning, which puts it in a favourable spot for the expected spurt in demand during the spring selling season.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.