There were not too many cracks in the foundation of Lennar's (LEN, Financial) Q3 (Aug) report. The homebuilder exceeded top and bottom-line estimates by a wide margin while surpassing its new orders and deliveries forecasts. Much excitement has been mounting over the prospect of lower interest rates. Shares of LEN exploded in early July in connection with broader sector rotation toward more interest-rate sensitive stocks. The stock reached all-time highs yesterday, a +35% run in just over three months after the Federal Reserve announced a surprise 50 bp interest rate cut on Wednesday.
Given this context, LEN was not facing typical expectations. Instead, it needed to deliver an exceptional Q3 performance. With a few minor nitpickings bubbling to the surface, its Q3 report was not perfect, igniting today's sell-the-news response.
- Gross margins on home sales are the primary hang-up today. In Q3, margins edged 190 bps lower yr/yr to 22.5%, missing LEN's prediction of about 23%. Revenue per square foot contracting while land costs increased contributed to the decline. LEN has leaned on incentives to seal the deal with purchasers facing elevated mortgage rates, placing modest pressure on margins. Meanwhile, building costs remain fluid, making it difficult to accurately predict how margins unfold.
- LEN also projected margins to stay flat in Q4 (Nov), translating to a similar yr/yr drop. This is particularly frustrating after management expressed confidence last quarter that its margins in Q4 would begin expanding, potentially hitting around 25%. Seasonality was supposed to help -- the final months of the selling season can create urgency in home buyers. LEN also noted that some margin improvement was embedded in its backlog.
- Aside from margins, LEN's Q3 report was sound. The company delivered adjusted EPS of $3.90, exceeding analyst forecasts by double digits for the 11th consecutive quarter. Revenue expanded by 7.9% yr/yr to $9.42 bln, blowing the roof off analyst expectations. New orders edged 5% higher yr/yr to 20,587, past the midpoint of LEN's 20,500-21,000 prediction. Deliveries increased by 16% to 21,516, toppling LEN's 20,500-21,000 outlook. Again, incentives were leveraged to move homes and spur new orders.
- Looking ahead to Q4, LEN projected a minor dip in new orders sequentially at 19,000-19,300 but an improvement in deliveries at 22,500-23,000. Management touched on the Fed's interest rate cut, commenting that the decision should enhance affordability and boost demand for new and existing homes.
- The latter part is important. Existing home sales have compressed yr/yr in five months this year, reflecting homeowners' unwillingness to give up attractive mortgage rates. Therefore, as rates drop, pent-up demand from existing homeowners could significantly lift LEN's orders over the coming quarters.
While not an awful performance by many metrics, LEN is enduring profit-taking today after its margins failed to keep its record-high stock price trending even higher. That said, several favorable trends remain in the works, particularly the Fed's easing monetary policy. However, profit-taking on minor blemishes could be the theme for other homebuilders following their upcoming reports, including KB Home (KBH, Financial) on September 24, PulteGroup (PHM, Financial) on October 22, and D.R. Horton (DHI, Financial) on October 29.
