Lennar Earnings Call Nuggets: Gross Margins Outlook, Demand & Pricing

Lennar Corporation (NYSE:LEN) recently reported its third quarter earnings and discussed the following topics in its earnings conference call.

Gross Margins Outlook

Robert Wetenhall – RBC Capital Markets: I wanted to ask, it was a strong quarter in terms of gross margin performance and incremental operating leverage. Could you help give us a sense of where you see gross margins going in the next two or three years if volumes continue to recover?

Stuart A. Miller – CEO: So, Bob, looking forward, as we think about gross margins, there are several opportunities still for gross margins to grow. We think we have the opportunity for margins to exceed our past peak, which was around the 26% to 27% range, if everything goes according to plan, and that’s based on the following. It’s based on average sales prices continuing to grow as there is still room and affordability. Sales incentives still have room to go down from the current 6% level over time to what’s more normal at 3%. We have more of our new communities that would come on line that have a higher gross margin than the Company average. Currently, 61% of our deliveries, as I mentioned, were coming from new communities. So that should be helpful as well. Then as absorption increases and gets back to normalized levels, we have the ability to amortize fixed cost over more deliveries. So, if everything happens according to plan, there is room for upward mobility in the margins over time. We think the next quarter, however, will probably be somewhere close to the level that you saw in the third quarter that we just reported.

Rick Beckwitt – President: Bob, this is Rick. Just one other thing I’d point out is, as we had typically discussed in the past, we’re more focused on our operating margin than the gross margin. We’re very focused on leveraging the overhead, the infrastructure of the Company. We will within any quarter adjust pricing and pace to maximize the underlying value of the asset. So, gross margins will move up and down, but the real thing you should focus on is the operating margin line…

Robert Wetenhall – RBC Capital Markets: That’s really informative. I appreciate the granular detail. On a follow-up, Stuart had said that interest rates are probably having an impact on order growth, but you characterized the impact as being temporary and mild and touched on the production deficit. If rates stay in the current context for 30-year fixed, how do you think the recovery looks from here on out during the next 12 months?

Rick Beckwitt – President: Bob, it’s our view that the recovery, it just continues forward. I think that the first move in both sales pace and pricing has been stronger than people anticipated, in large part because it’s a reversion as opposed to just a straight-line recovery. When I say reversion, we had a very, very unusual downturn. It was much more severe than we’ve seen historically. And I think there’s been somewhat of a snapback. The fact that the rate of growth in sales and sales price will and should moderate; does not derail the recovery, we think that the recovery will be more orderly and slower in nature. But we think that over the next three to five years, we’re likely to be in a steady recovery mode.

Demand & Pricing

Stephen East – ISI Group: Stuart, you talked about what you were seeing with demand a little bit. If you could talk a little bit more just what you all were seeing as you went through the quarter and post-quarter for demand and pricing; and then, as you go through this a bit slower time, what’s your strategy, or how is your strategy change a little bit to navigate through this period?

Stuart A. Miller – CEO: Yeah, let me turn that over to Rick and then to Jon. They have a real close – they’re in close touch with the people in the field, and you’ll get a better answer from them…

Rick Beckwitt – President: As we look at the quarter, Steve, I would tell you that July was the slowest month for us, and we saw August actually being the strongest month on both in nominal and year-over-year basis. That was pretty much consistent with both number of sales and dollar pricing power. There was that a little bit of sticker shock associated with the rate increase so dramatically, put a little pause on the market, and we saw buyers starting to come back to the market. As Stuart said in his opening comments and in his talk about the economy, we see just strong viable fundamental demand out there. But it’s cooled a little bit. As a result of that, we have, from a pricing standpoint, we’ve selected some of our inventory, select inventory and have increased some incentives associated with that inventory. But blended across the overall pool, it’s had a relatively modest impact on pricing and net sales price. Varies dramatically by market. The A communities are performing extremely well. But we’re really focused on discounting, if there was a discounting on stuff that was ready to close and it was just the best way for us to focus on return on investment. Jon, any further comments?

Jonathan M. Jaffe – VP and COO: I would just add, as we manage through what is appearing to be more of a normal season, as Bruce highlighted, we’ve focused on our unsold inventory, which is about one home per community, and we’ll manage the levers of price and pace to make sure those homes are delivered, they are sold and they close; and that will create some fluctuations from community to community. But as I look at our backlog and look at the end of third quarter sequentially compared to the second quarter, I feel very comfortable that we are managing our average sales price in a level or upward trend and same with our gross margin. So, I think we’ll manage through this somewhat bumpier time because our inventory is under control; we’re not under pressure to incentivize any greater than the market needs to keep that pace.

Stuart A. Miller – CEO: Just a final thought on that, Steve. I think this is at the top of the mind of the market right now. What we’re hearing from customers in the field, clearly there’s a little bit of sticker shock relative to interest rates moving at the same time that prices have been moving up. We saw across the country in the Case-Shiller report this morning that prices are up in a healthy way. So as interest rates have moved, people have had to confront the fact that the price they were looking at few weeks ago might be different than the price or the monthly payment might be different than today. But by and large they still have to measure their decision on where they’re going to live against rental rates. They still have the opportunity to look at reasonably low interest rates that are going to hold them in good stead for years to come. The attitude of the consumer in the field still seems to be positively oriented towards finding a way to purchase and making it through the mortgage maze right now, and finding their way into homeownership…

Stephen East – ISI Group: Then if we look, you know you can grow one or two ways; you can buy the lots and the land or you can buy the company. There are – both are pretty fluid right now. On the M&A side, we’re seeing some small deals, but then we also have the two big ones that are sitting out there, and the land environment itself looks like it’s getting a bit more rational. Can you talk about those two and how you all view your appetite for potential M&A? Then, what’s actually going on in the land market?

Bruce E. Gross – VP and CFO: As has been the case with our Company for a very long time, there is nothing that we don’t look at and consider. We look at M&A the same way that we look at organic growth. It’s all about competing capital. And we measure the returns on capital that we can generate from a company acquisition against comparably deployed capital in a well-constructed organic program, and wherever the best returns for our Company are going to lie, that’s where we act. So, there is nothing off the table as it relates to Lennar. We are focused on and have reviewed every M&A transaction that’s out there, and we are looking at just about every organic opportunity to purchase new land position. It’s all about returns on the invested capital.

Stephen East – ISI Group: Has land market changed?

Rick Beckwitt – President: Steve, this is Rick. The land market has been going through a state of evolution. As we’ve discussed in the past, the more ready-to-go finished homesites out there have been priced up. That’s not to say that you can invest in communities that produce a good return and a decent gross margin, but clearly not the margins that we’ve seen in current deliveries. And as a result of that, as Stuart mentioned, most of our land acquisition activity or contracting activity — and I want to really focus on that – things that we’ve been putting under contract are things that will probably be closing on in 2015, 2016, 2017. We benefit from the fact that we were early in, aggressive, and you can see that reflected in the gross margins.

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