Will Higher Housing Demand Aid Lennar's (LEN) Q2 Earnings?

Lennar Corporation (NYSE:LEN) is slated to report results for second-quarter fiscal 2018 (ended May 31) before the opening bell on Jun 26.

In the last reported quarter, the company delivered a positive earnings surprise of 20.7%. This Miami-based homebuilder surpassed expectations in three of the trailing four quarters, with the average being 7.1%.

Notably, Lennar’s diversified line of home offerings for first-time, move-up and active adult homebuyers, and positive housing market fundamentals prove favorable for this leading homebuilder in the United States.

Factors at Play

Although higher prices, mortgage rates and supply shortages are taking a toll on the housing industry of late, Lennar has been reporting solid top-line numbers and the trend is expected to continue in the soon-to-be-reported quarter as well, owing to strong demand for homes, favorable job market and impressive economic conditions.

According to the Zacks Consensus Estimate, the company’s Homebuilding segment revenues (comprising almost 89.3% of total revenues) of $4.7 billion are likely to increase from $2.9 billion in the year-ago period and $2.7 billion recorded in the prior reported quarter. This improvement is expected to be driven by higher average selling prices and the delivery of a significant portion of the backlog. The company’s new order trend (in units) also remained solid, growing 30% in the last reported quarter and 11% in fiscal 2017.

The Financial Services segment is also performing well in tandem with its homebuilding operations and innovation of new products such as recently announced creative student-loan program. The company expects the segment’s second-quarter profit to be between $45 million and $48 million for the to-be-reported quarter. Meanwhile, the consensus estimate for the segment’s revenues is pegged at $288 million, reflecting 68.4% sequential growth.

While Lennar’s Homebuilding and Financial Services divisions are the primary drivers of near-term revenues and earnings, its ancillary businesses like Rialto and Multi-Family provide diversification as well as complementary long-term growth opportunities.

On the flip side, Lennar, like other renowned homebuilding companies, has been under considerable pressure owing to rising land and labor costs that are threatening margins. While labor shortages are resulting in higher wages, land prices are increasing due to limited availability.

Lennar’s gross margin on home sales expanded 50 basis points (bps) in the fiscal first quarter but decreased 90 bps year over year in fiscal 2017. The decline was primarily due to an increase in construction and land costs per home. For the second quarter, the company expects gross margin to be in the 21.0-21.6% range compared with 21.1% in the year-ago period. Gross margins are expected to be impacted by 750-800 bps in the second quarter related to the CalAtlantic acquisition.

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Overall, Lennar’s diligent efforts to improve operating efficiency via digital-marketing efforts, dynamic pricing tool and other technology initiatives are expected to offset the headwinds, thereby driving growth for this homebuilder. In this regard, the company is working hard to improve its SG&A expenses via operating leverage and investments in technology. As a percentage of revenues from home sales, SG&A expenses contracted 60 bps to 9.7% in the fiscal first quarter, due to improved operating leverage as a result of an increase in home deliveries. However, the impact of purchase accounting related to CalAtlantic acquisition is expected to hurt margins and thereby the bottom line of the company.

The Zacks Consensus Estimate for second-quarter earnings is pegged at 45 cents, reflecting a decrease of 50.6% year over year. That said, the same for revenues is pegged at $5.23 billion, implying 60.4% growth.