Wednesday, January 03, 2007

Color on news: Lennar (NYSE:LEN)

Several firms are commenting on Lennar (NYSE:LEN) after the country's 3rd largest homebuilder warned for Q4:

- Deutsche Bank notes Lennar's preliminary 4Q06 results reveal an impact from worsening housing market conditions similar to other builders, but they also continue to show the different strategy that Lennar is pursuing. As the firm has written previously, Lennar's strategy of aggressively matching pricing with current market conditions should allow its earnings to
rebound sooner than other builders.

4Q06 orders are down only -6% (vs. -35-40% for other builders in 3Q), illustrating Lennar's strategy of adjusting pricing to maintain a steady sales and delivery pace. Closings of 14,006 reflect an impressive turnover rate of roughly 90%, up from 68% in 4Q05. Write-downs of $400-$500mm in 4Q06 will bring the total for the year to roughly $525-$625mm, or 6-7% of equity after-tax. Firm notes that as they have written previously, builders' year-end write-downs should continue to be higher than investors' expect. In contrast to Toll and Hovnanian, Lennar sees no signs of imminent housing market bottoming. DB reduces their estimates--4Q06 to $0.74 (excluding write-downs) and FY07 to $2.10.

- UBS on the other hand notes that while many builders were caught off guard by the severity & speed of the correction, they believe Lennar's strategy of building 'even flow' to match the delivery pace, vs building to order, is disappointing. In their opinion, aggressive discounting, necessitated by elevated cancellation rates & spec building, leads to a vicious circle of further price reductions and falling margins. The returns generated on the Newhall project underscore the co's land expertise, which unfortunately was overshadowed in 06 by poor execution in the HB business.

UBS is not all that pessimistic regarding the co saying that as capital for private builders becomes increasingly constrained, they expect opportunities for well-financed public builders to unfold. Historically, Lennar has had success in expanding through acquisitions during downturns, as demonstrated by the acquisition of U.S. Homes in 2000 and Pacific Greystone in 1997. The financial flexibility created by Lennar's conservative balance sheet, combined with its land expertise, should limit downside potential during this slowdown. Through its F3Q (Aug), Lennar's net debt to capital was 37%, well below the 48% group average, reflecting management's efforts to limit balance sheet leverage to govern growth and reduce risk.

The firm is reducing their F06E EPS to $5.55 (-32% YOY) from $5.85, vs mgmt's revised guidance of ~$5.60. Further, F07E goes to $2.20 (-60% YOY) from $2.40. TgtT remains $52 and rating at Neutral.

- JP Morgan comments that while LEN noted that market conditions continued to weaken, they note that 4Q orders (w/JVs) of down 6% nearly matched 3Q's -5%, against a similar comp of 25% vs. 4Q's 24%. Moreover, the firm note that while pricing has likely weakened, aside from this possibly being exacerbated by LEN's evenflow/spec model, they believe weaker pricing is necessary to reduce today's excess inventory. Lastly, contrary to LEN's comments, new and existing home sales, the MBA Purchase index, and other builders' comments on some regions all point to signs of stabilization.

While LEN's 4Q charges of $400-$500 mil. are on top of YTD charges of $98 mil., JPM notes
these are only slightly more than KBH's $395-$445 mil., HOV's $326 mil., PHM's expected $300 mil., and DHI's $260 mil (all YTD). Moreover, at 4.8% of equity (after-tax), they continue to believe book value remains reliable.

Overall, they believe this newsflow in total is a neutral event, and continue to believe stable to improving trends in inventory, orders, and can rates will be positive catalysts for the sector, and reiterate their positive stance.

At 1.41x book value, LEN's is trading roughly in-line with its large-cap peers' 1.39x, which the firm believes appropriately reflects the outlook for a roughly in-line FY07 EPS decline. Hence, the firm maintains Neutral rating.

Notablecalls: As I have noted before, housing downturns have historically lasted between 26 and 52 months with new home unit sales averaging around a 50% decline. New home sales topped at close to 1.4 mln units in 2005 and have declined to around 1 mln units currently. Add a highly leveraged consumer to the mix and you'll likely see a prolonged downturn. While several firms expect this downturn to last no more than next couple of qtrs I suspect they will be disappointed.

While I have very little or no feel for the homies I suspect LEN will not get hit in any substantial way following the news. Buying it down 5-6% may provide a nice st bounce entry.


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Would you please drop me a line?

Mick Weinstein
Seeking Alpha

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