(By Mani) Shares of home builder Lennar Corp. (NYSE:LEN) is expected to climb higher due its ability to make money across the cycle, an improvement in the housing market and potential upside from its Rialto unit.
The stock has enjoyed strong year-to-date performance by increasing 33 percent and outperforming the S&P 500, which grew 9 percent in the same period.
"We believe that LEN offers investors at least 30 percent potential upside during the next two years based on a recovery in core home building earnings and continued growth in the Rialto segment which could eventually be spun-off to shareholders," RBC Capital Markets analyst Robert Wetenhall wrote in a note to clients.
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The gross margin performance and home building unit profitability were sharply affected by lower volumes experienced during the housing downturn but have started to rebound in tandem with a gradual recovery in the housing market.
Increased confidence in a housing recovery provides better visibility into Lennar's earnings power in a normalized demand environment. The company's home building segment, which accounts for 85.1 percent of revenues, could potentially earn about $2.60 per share if the housing market achieves 1.25 million starts in 2015. In fiscal 2012, the segment is expected to earn 48 cents.
Wetenhall expects Lennar could deliver 25,000 homes deliveries compared with 10,746 last year and peak deliveries of 49,568 in 2006. He also expects gross margins to increase from the current 21.6% to 25% in response to slightly better pricing and favorable sales leverage.
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Meanwhile, Lennar investors could get more upside potential returns from the Rialto unit, which focuses on making opportunistic investments in distressed real estate, and accounts for 25 percent of consolidated operating income and continue to grow at a rapid pace.
However, the many moving pieces which comprise Rialto and complications related to mark-to-market accounting, have overshadowed the attractive growth prospects of this segment.
Under the guidance of CEO Jeff Krasnoff and President Jay Mantz, the company is transforming this segment into a traditional private equity business that finances itself with third party capital. Based on other publicly listed private equity managers such as Blackstone, Fortress & KKR, the analyst estimate that Rialto is worth about $2 a share.
Florida-based Lennar sells single-family attached and detached homes in communities marketed towards first-time, move-up and active adult home buyers. The company delivered 11,404 homes during the last twelve months at an average selling price of $248,400 during the last twelve months.
Lennar competes with D.R. Horton (NYSE:DHI); KB Home (NYSE:KBH); PulteGroup (NYSE:PHM); Toll Brothers (NYSE:TOL).