LEN - Lennar Q4 Earnings: What To Expect Amid The Stock Rally

2023-12-11 08:30:00 ET

Summary

• Lennar Corporation stock has rebounded sharply from its October low and just hit a new all-time high of $140.
• LEN is set to announce its fourth quarter earnings on Thursday after the bell.
• In this update, I discuss the reasons for the strong rebound from the October low and share what investors can expect from Lennar's upcoming earnings report.
• I also explain why I have turned very cautious despite LEN stock's strong momentum, improving inflation readings and growing expectations of a Federal Reserve policy reversal in 2024.

Introduction

Homebuilder Lennar Corporation ( LEN , LEN.B) has rebounded massively from its October low - LEN stock is up nearly 40% in less than two months and just hit a new all-time high of $140. I covered the second-largest (by market capitalization) homebuilder in the US in late September in a comparative analysis with KB Home ( KBH ), explaining why I largely ignore the common valuation metrics when timing the purchase of homebuilder stocks and instead focus on book value.

Lennar will release its fiscal 2023 fourth-quarter results on Thursday, Dec. 14 after the bell and hold a conference call on Friday at 11 AM ET. In this brief update, I explain the reasons for the sharp rebound, share what investors can expect from the homebuilder's upcoming report and why I have turned very cautious despite strong momentum , improving inflation readings and growing expectations of a Federal Reserve policy reversal in 2024.

Why Lennar Stock Rebounded Sharply From Its October Low

Quite surprisingly, Lennar stock shows a slightly positive correlation with the yield on long-term bonds, such as the 30-year Treasury note (r = +0.45 since January 2019). However, I think this is a good example of how correlation does not necessarily imply causation. Obviously, it is important to take a closer look (Figure 1). The Federal Reserve began raising interest rates in early 2022 in an effort to curb rising inflation. A somewhat shell-shocked market sold off LEN stock over the course of about six months, pricing in higher mortgage rates, a rising unemployment rate and, as a result, a weakening housing market - correlation was markedly inverse. In the second half of 2022, Lennar stock formed a bottom and began to recover as the long-term interest rate fell slightly.

Finally, in the second half of 2023, as the narrative of a "higher for longer" environment took hold, LEN stock again exhibited a strong inverse correlation with long-term interest rates and sold off sharply when the long-term rate rose to over 5.0% in late October. The ensuing bond rally, which saw the yield on the 30-year Treasury fall by a whopping 80 basis points in less than two months, led to a massive rally in homebuilder stocks.

Understandably, the same characteristics can be seen when plotting LEN's share price against the 30-year mortgage rate (Figure 2). However, the disproportionate rise in the share price suggests that the market now has the "higher for longer" narrative in its rearview mirror and has begun to price in more affordable mortgage rates.

There is, however, a second aspect to keep an eye on - existing home sales. The number of units sold continues to decline, and the October 2023 figure is particularly noteworthy (down 4.1% sequentially, Figure 3). Existing homeowners with a fixed rate mortgage (the percentage of adjustable rate mortgages is very low in the US) are reluctant to sell because they know they have secured very favorable rates. This is somewhat contrary to market expectations (see above), but obviously positive for suppliers of new homes like Lennar.

Finally, a look at the housing inventories registered at month-end indicates a steady improvement in the supply situation (+1.8 % compared to the previous month, 1.15 million units, Figure 4), but it should not be forgotten that we are still almost 6 % below the October 2022 figure (1.22 million units). Evidently, the market remains undersupplied.

What To Expect From Lennar's Q4 Earnings Report?

For the recently concluded fiscal year 2023 (ended Nov. 30), analysts expect adjusted earnings per share ((EPS)) of $13.6, a decrease of 24% compared to the previous year. Quarterly earnings are expected to be $4.6, 8% below the fourth quarter of fiscal 2022. Analysts have become much more optimistic over the last six months and expectations for fiscal 2023 are now almost back to August 2022 levels, but still well below expectations at the start of this rate hike cycle (Figure 5). The long-term outlook for Lennar, however, remains solid and has not really changed over the last two years.

In view of the fact that Lennar has regularly exceeded earnings (and mostly also revenue) estimates for at least the last four years (Figure 6), it is only fair to conclude that analysts were too conservative in their estimates.

As I wrote in my last article, the tailwind resulting from the undersupply in the market for existing homes should not be underestimated (recall Figure 4). The favorable market environment is also underscored by Lennar's historically low cancellation rate (Figure 7) and the number of homes delivered (Figure 8).

As a result of rising interest rates and high inflation, the cancellation rate rose in fiscal 2022, but moderated in the TTM period, despite including the difficult fourth quarter of fiscal 2022 and the first quarter of fiscal 2023. Cancellations declined significantly during 2023. However, I would not necessarily expect the decline in the cancellation rate to continue in the fourth quarter of fiscal 2023, as the 30-year fixed-rate mortgage rose sharply to 7.8% in October before falling back to end-August levels recently (7.2%). Nonetheless, this trend-reversal could bode well for future homebuyer sentiment, especially if inflation readings remain favorable.

Taken together, I expect Lennar to report solid results on Thursday. However, given the recent rally and sharp rebound from the October low, one can assume that the market has already priced in continued solid performance.

Conclusion - Is LEN Stock A Good Stock To Buy Now Before Earnings?

Lennar Corporation will report its fourth-quarter fiscal 2023 results on Thursday. Considering that analysts have been overly conservative in their estimates for at least the last four years and amid still-weak housing inventories and a recently accelerated decline in existing home sales, it's only reasonable to expect another solid quarter from the second-largest homebuilder in the US. The recent sharp decline in cancellation rate - which is now approaching the fiscal 2021 level - also points to a continued robust demand environment.

Therefore, and in light of the recent bond rally and the (temporary?) trend-reversal in mortgage rates, it is no wonder that investors have driven Lennar stock to a new all-time high. Nevertheless, the stock does not look expensive from a historical perspective (Figure 9 and Figure 10).

However, as a cyclical stock, Lennar tends to look cheap (or fairly valued) when the fundamentals are strong. As I explained in my last article, I prefer to - counterintuitively - go long homebuilders when their price-to-book ratios suggest overvaluation. Due to the inventory valuation-driven impairments taken during a downturn, homebuilders' equity ratios shrink, making their stocks appear expensive when in fact the opposite is true.

Therefore, as an investor looking to build a position in Lennar (or any other homebuilder), I think it's better to keep the fear of missing out under control and exercise patience - despite the phenomenal rally, strong momentum, robust balance sheet, a chronically undersupplied housing market, and the interest rate cuts expected in 2024. Let's face it - it's impossible to pinpoint the timing and quantify the magnitude of the Federal Reserve's policy shift. For example, who would have predicted the sharp drop in the Fed Funds Effective Rate in March 2020 in the midst of the COVID-19 pandemic a few months in advance? Similarly, who would have thought at the beginning of 2022 that long-term interest rates would reach the 5% mark in less than 18 months? I always have to chuckle a little when I read headlines from investment bank strategists predicting significant interest rate cuts, with a high degree of precision to suggest accuracy.

Thank you for taking the time to read my latest article. Whether you agree or disagree with my conclusions, I always welcome your opinion and feedback in the comments below. And if there's anything I should improve or expand on in future articles, drop me a line as well. As always, please consider this article only as a first step in your own due diligence.

For further details see: