Seeking Alpha
Long/short equity, research analyst, portfolio strategy, newsletter provider
Profile| Send Message| ()  

by David Urani

For its fourth quarter earnings report, homebuilder Lennar (LEN) posted net income of $32.0 million, or $0.17 per share. In a market where most of the competition is struggling just to turn a profit, Lennar was able to do just that, and more. That's surprising given that ever since the nationwide homebuyers' tax credit expired in April, the housing market has sunk back to new depths, and most indicators are showing a resumed decline in prices. As it turns out, Lennar's fourth quarter victory had little to do with market trends, and a whole lot to do with the Company's strategy. Lennar changed up its game plan to avoid the weak fundamentals in homebuilding and in the fourth quarter, management's changes yielded progress.

The most glaring change to Lennar's business model came from the addition of its Rialto Investments arm which it started up at the beginning of fiscal 2010. Rialto is not involved in homebuilding, but instead it does real estate investments such as buying up packages of distressed mortgages from the FDIC or foreclosed homes, which it then turns for a profit. In the fourth quarter Rialto contributed $12.4 million to the bottom line, including $19.7 million of revenue. Distressed assets at deep discounts appear to be easy to come by for Rialto, and this excursion into the investment business was a smart move for Lennar to offset some of the damage in the homebuilding sector.

That being said, Lennar's homebuilding operations were nicely profitable as well, which was an eyebrow raiser. One item to note is that home sales generally take at least couple of months to complete, especially built-to-order homes, so sales in the fourth quarter (which spanned September through November) largely represents sales made earlier in the year. In that sense, fourth quarter homebuilding results aren't yet reflecting the full brunt of home price declines that have been sweeping over the housing market lately. That being said, Lennar's homebuilding results were still impressive. Excluding adjustments, gross margin went up to 20.8% from 20.3% in the previous quarter and from 17.8% a year ago. The main contributors to the improved gross margin were a greater mix of new higher margin product, focus on cost controls, and fewer incentives.

With respect to the newer product, Lennar has made a concerted effort to sell more "efficient" homes. These designs include elements such as smaller floor plans, redesigned utilities, and less expensive materials. Overall, there are fewer design options now to accommodate the changes. As an end result, the average direct cost per home is down 25%. In the current environment, the demand for these re-designed homes is quite strong. More streamlined homes like these are more readily able to compete with foreclosures and other existing homes, with the additional benefit of selling for a higher profit than previous blueprints. We could even see this becoming a sustained change in the housing market over the long term, assuming consumers have readjusted their tastes following the collapse of the housing bubble. Consequentially, Lennar's home sales results were stronger than expected, although they were still down 12.6% year over year.

Source: Lennar Evolves to Counter Depressing Housing Market