Score one for the home builders!
On a day when the Dow dropped more than 170 points, shares of Lennar Corporation (NYSE:LEN) added more than $2.00 per share, rising 4.2%. Investors cheered the company’s second quarter earnings release which handily beat analyst expectations.
For the quarter, Lennar booked profits of $0.79 per share, compared to estimates for a 69-cent profit. Revenue for the quarter was $2.39 billion, up 31% from last quarter.
Lennar’s backlog of homes will lead to strong performance for the rest of the year.
If the past quarter was bright for Lennar, the rest of the year looks even better…
Lennar’s backlog of homes under contract rose by 18% to a total of 7,271 homes. And selling prices for these homes rose by 8% to an average of 348,000.
With a strong spring quarter in the books, and plenty of demand for the rest of the year, Lennar is in position to continue to increase profits. As the company successfully executes its growth plan, shareholders should gain confidence and the stock price should continue to trade higher.
Key Themes For the Homebuildng Industry
During the earnings conference call, CEO Stuart Miller discussed a few key themes that are having a material effect on the home construction industry:
Tight Inventory – The financial crisis put a lot of home builders out of business and caused the surviving companies to be much more cautious. As a result, the number of new homes built dropped and today there is a shortage of inventory for new homes. Naturally, prices for new homes are rising, a trend that is helping to push home builder stocks higher.
Millennials prefer to rent – A larger portion of people born in the ’80’s and ’90’s prefer to rent rather than own their homes. This has led to low vacancies and higher rental rates. Lennar has been taking advantage of this trend by building a single family home rental community in Nevada. The assumption is that if this community is successful, the model will be rolled out in other locations as well.
Credit conditions are slowly improving – While mortgage companies are still managing their risk carefully, restrictions on new loans are slowly relaxing. This is an important factor for first time home buyers who typically have less equity to invest in their first real estate purchase.
Perhaps the most important theme Miller discussed was the competitive shift in the home construction industry.
Show Me the Money!
Since 2007, the number of active home construction companies (as measured by memberships in the national home builders association) has dropped by 43%. But even among the companies that managed to survive the financial crisis, there is a huge difference between the “have’s” and the “have not’s”
What dictates success for individual home builders?
In today’s market it is all about access to capital. Large builders with the ability to issue bonds, sell shares of stock, or sign mega bank loans are the winners. Niche home builders looking to borrow money to develop a few small lots are more likely to get turned down when applying for a bank loan.
Blue-chip home builders with access to capital will dominate today’s housing market.
According to Miller, this dynamic clearly favors the established blue-chip home builders who have strong relationships with institutional lenders or investment bankers.
“A slow, steady recovery with limited land supply and limited access to capital constrains the number of smaller, less capitalized home builders… This has enabled the larger, better capitalized builders to pick up a larger portion of the smaller pie.”
The positive earnings report and encouraging conference call had a bullish effect on the entire home builder sector. Shares of Toll Brothers rose by 0.9%, D.R. Horton added 1.1% as did Pulte Homes. This is especially impressive given the bearish overall market action.
Given the resilient price action for this group, we’ll be looking for opportunities to add bullish exposure to home builder stocks in our model portfolios. As other home builders announce earnings, and real estate reports confirm the strong market, these stocks should continue to advance.
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