Is Lennar The Best Way to Profit From Homebuilding?

Fiscal cliff? Hard landing in China? Tell that to the American consumer. Alongside generally good confidence and retail sales numbers, housing starts have begun to tick back up and increased 15% between August and September. This corresponds with quarterly reports from large banks, which generally noted positive developments in the housing market. Lennar Corporation (NYSE:LEN), a $7.3 billion market cap homebuilder which also provides mortgage lending and other real estate services, was up about 2% on the day. It is now up about 140% in the last 52 weeks.

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Lennar’s third fiscal quarter, which ended in August, showed an increase in revenue of 34% compared to the third quarter of 2011. This brought top-line growth through the first three quarters of the fiscal year to 29%, suggesting that activity was accelerating even at that time. As a result of this growth, the company pulled what had been low earnings numbers in 2011 up quite substantially: in the third quarter, for example, net income increased from $21 million a year earlier to $87 million. Business was particularly strong in south Florida and Houston. Lennar Corporation trades at 14 times trailing earnings, but with the sell-side expecting business in its next fiscal year to be significantly cooler its forward P/E is a considerably higher 24. That trailing multiple is very reasonable given the company’s growth, and while we are aware that homebuilding is cyclical and the growth trend won’t be continuing for the next ten years it is still an attractive feature.

A number of hedge funds and other notable investors piled into Lennar Corporation during the second quarter of 2012. Billionaire Stanley Druckenmiller initiated a position of 3.3 million shares, which meant that at the end of June he had $100 million invested in the stock; it was his second largest 13F position by market value (see more stock picks from Stanley Druckenmiller). Ken Heebner’s Capital Growth Management had owned a small position in the stock and increased it over the course of the second quarter to a total of 4.2 million shares (research more stocks that Capital Growth Management bought). Citadel Advisors, managed by billionaire Ken Griffin, more than doubled the size of its own stake in the stock (find other stocks that Ken Griffin liked).

We would compare Lennar to fellow homebuilders D.R. Horton, Inc. (NYSE:DHI), Toll Brothers Inc (NYSE:TOL), PulteGroup, Inc. (NYSE:PHM), and KB Home (NYSE:KBH). The latter two of these companies are unprofitable on a trailing basis, but grew their revenues 15-16% in their most recent quarter versus the same period a year ago and Wall Street analysts expect them to be profitable in their next fiscal year: KB Home barely so, and PulteGroup enough to drive a forward P/E of 19. KB Home is also a significantly smaller company in terms of market cap, with its equity valued at $1.3 billion, so perhaps it is not as good a buy. PulteGroup’s discount relative to Lennar on a forward earnings basis is interesting, but it is based on an expectation that it will improve its business while Lennar declines. We’d need to investigate further to check on that assumption.

D.R. Horton looks a bit similar to Lennar: a low trailing P/E, but with consensus implying that it trades at 24 times forward earnings. Its revenue was 15% higher in its most recent quarterly report compared to the same period in 2011, with a large percentage increase in earnings. In this case there’s little on the surface to make one or the other more attractive. Toll Brothers, which concentrates on higher-end residential developments, is high priced at 32 times forward earnings estimates but has seen very high revenue and earnings growth recently. We think it warrants a slightly higher multiple for its higher-priced focus, but probably not to the degree that we see in the market.

Lennar actually seems to be one of the better picks in the homebuilding industry, with D.R. Horton seeming to be at about the same value and PulteGroup requiring further analysis to make a judgment call. It does look a bit expensive on a forward earnings basis, but given the depth of the housing decline the company may be able to prove fairly valued in the event of a sustained recovery.

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