Down 37% YTD, Lennar is a Home Builder Stock Worth Buying
One of the hardest-hit industries in 2022 is the home-building stocks. They’re down more than 40% on the year. Many of them trade at or below book value.
Of the four home builders in the S&P 500, the average decline year-to-date is 34%. Of the four, I like Lennar (LEN). It’s down 35.9% through June 27.
Investors are punishing home-building stocks because of rising interest rates and a possible recession. The home builders themselves continue to generate healthy earnings. Should a recession not come to pass, Lennar’s shares look very cheap today.
Here’s why you might want to put Lennar on your watchlist.
Lennar Trades at Less Than 1x Book
Lennar is the cheapest of the four S&P 500 home-building stocks at 0.98x book value. The other three are D.R. Horton (DHI), NVR (NVR), and PulteGroup (PHM). They trade at 1.43x, 4.88x, and 1.30x book value, respectively.
Suppose you broaden your search for home builder stocks to the homebuilders' segment of the S&P Total Market Index, which increases your possibilities to 35. According to the homepage of the SPDR S&P Homebuilders ETF (XHB), the average price-to-book ratio is 2.0x, almost double Lennar’s.
However, XHB has several companies that are housing-related, in addition to homebuilders, which likely skews the P/B higher.
The iShares U.S. Home Construction ETF (ITB) has greater exposure to homebuilders, with all four of the S&P 500 homebuilder stocks, including Lennar, as its top four holdings. They account for almost 42% of its portfolio. ITB has an average P/B of 1.57x, 60% higher than Lennar’s P/B.
So, from a price-to-book perspective, Lennar is cheap.
What About Free Cash Flow?
One of my favorite financial valuation metrics is free cash flow (FCF) yield. Like P/B, it gives you an idea of how cheap or expensive a stock is. However, it’s not enough to have a high FCF yield. It also needs to demonstrate that it’s growing its free cash. Add a solid balance sheet and healthy revenue growth, and you’ve got the makings of an excellent long-term investment.
How does Lennar stack up in these areas?
In the trailing 12 months ended May 31, it had FCF of $2.01 billion. Based on a market cap of $21.1 billion, its FCF yield is 9.6%. I consider anything above 8% to be in value territory.
As for FCF growth, it gets tricky with homebuilders. That’s because the net cash generated by operating activities is lower in years where it’s spending on land purchases, land development, and homes in construction or finished product.
For example, in 2021, it earned $4.46 billion, but its net cash provided by operating activities was $2.53 billion. In 2020, it earned $2.47 billion, but its net cash provided by operating activities was $4.19 billion. The difference is a $1.96 billion increase in 2021 inventories.
Therefore, more cash is going out the door to deliver the $25.55 billion in homebuilding revenue, that’s then converted into higher profits. With its total inventories up 18% in the first six months of fiscal 2022 to $22.09 billion from the end of 2021, free cash will likely be similar to 2021 levels.
The critical thing to note is that it continues to deliver operating margins that are elevated from historical norms.
The Other Metrics to Consider
In the past five years, Lennar grew its total revenue -- homebuilding, financial services, and multi-family -- by 115% to $27.13 billion in 2021 from $12.65 billion in 2017. On the bottom line, its net earnings grew 450% from $810.48 million in 2017 to $4.46 billion in 2021.
Over those five years, Lennar’s annualized total return was 7.92%, 350 basis points less than the U.S. market. It seems odd that Lennar’s top and bottom lines would grow by such an amount without getting a little love from the markets. Its performance in 2022 hasn’t helped the cause.
It’s trading at the same price it did in October 2020, 21 months ago.
As for Lennar’s balance sheet, it’s excellent. Here’s what Co-CEO Rick Beckwitt had to say about its financial position at the end of the second quarter:
“[We] are laser focused on traffic, affordability, the quality of our backlog, along with cancellation rates and completed, unsold inventory levels which, to date, are both at low levels,” Beckwitt stated on June 21.
“Additionally, we are focused on balance sheet strength as we ended the quarter with $1.3 billion in cash, no borrowings on our $2.6 billion revolver and homebuilding debt to capital of 17.7%. Our balance sheet has never been in a stronger position than it is today.”
Why Buy Lennar?
The company was very cautious in its guidance for the remainder of 2022. However, on a positive note, it left its projection for home deliveries in 2022 at 68,000. It’s more than ready to handle whatever comes down the pike due to increased interest rates.
To a certain extent, the interest rate hikes for the rest of 2022 and into 2023 are already baked into its stock price.
In the $60s, LEN is a bargain, in my opinion.
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