(By Kevin Donovan) Back on May 29, we recommended buying home builders D.R. Horton (DHI) and PulteGroup (PHM) and standing neutral on Lennar (LEN) and Toll Brothers (TOL). Our recommendations were based on relative valuation and whiffs of a housing recovery in the air.
We were a tad early but got the sector right: stock price performance of the four home builders we looked at has been basically flat since that call. The stocks have surged this week on fresh signs that housing has bottomed and is resurrecting.
Our bullish stance on home builders remains. If anything, our conviction has grown and we're adding Lennar to our buy list in the group, mainly because we always grow more confident on evidence that the companies themselves are confident.
We got that signal from Lennar yesterday with its announcement it was buying a 40-acre residential parcel in San Jose, Calif.
"We are bullish on the prospects for recovery and growth in the Bay Area in particular and are eager to purchase more land in this economy," said Dale Billy, division president, in a statement announcing the purchase.
Lennar said in the statement that the master planned community will consist of more than 800 homes and will offer "a variety of product types including single-family townhomes and flats designed specifically to meet the needs of the most discerning buyers and suit all types of lifestyles." The community will include a main street park, pedestrian paths and greenbelt, which should add to the appeal of the community, Lennar said.
Known as a "McMansion" builder, Miami-based Lennar operates in 18 states and offers what it calls "affordable, move-up and retirement homes in communities that cater to almost any lifestyle – such as urban, golf course, Active Adult or suburban communities.
First-quarter results, reported Wednesday, easily beating analysts' estimates. Revenue came in at $930.2 million compared with the mean estimate of $906.8 million. Earnings per share EPS came in at $0.21 vs. the $0.17 estimate.
Those numbers and CEO Stuart Miller's rosy outlook boosted the shares of Lennar and other home builders higher.
"Evidence from the field suggests that the 'for sale' housing market has, in fact, bottomed and that we have commenced a slow and steady recovery process. And while the housing downturn was broad-based and national, the recovery process continues to be very localized. Although highly conservative mortgage lending practices and challenging appraisals remain a constant headwind, we are experiencing net positive price and volume trends in most of our markets."
And Lennar is benefiting from operating leverage that pushed the operating margin to 9.2& in the quarter, the highest since 2006. Deliveries increased 20%, new orders were up 40% and the backlog rose 61%. Leverage was driven by increased sales per community, higher prices and lower incentives.
Miller added that Lennar was prepared to take advantage of the housing market's better footing. "Looking ahead, our strong balance sheet and significant liquidity, which was enhanced this quarter by our new $525 million unsecured revolving credit facility, continue to position us to capitalize on future strategic opportunities," he said.
We think Lennar remains undervalued on a price to earnings growth basis (PEG). Trading at a PEG of 2.18 on next year's earnings expectation, it lags both D.R. Horton and Toll Brothers at 4.14 and 3.80, respectively.
We are buyers of Lennar, D.R. Horton and PulteGroup.