Is Lennar a Dangerous Investment?

With shares of Lennar (NYSE:LEN) trading at around $36.72, is LEN an OUTPERFORM, WAIT AND SEE or STAY AWAY? Let’s analyze the stock with the relevant sections of our CHEAT SHEET investing framework:

C = Catalyst for the Stock’s Movement

Lennar CEO Stuart Miller recently stated that a gradual rise in interest rates won’t stop the housing recovery. He might be right, but let’s play devil’s advocate.

There’s a lot of talk that consumers will be able to afford homes even if rates continue to increase. Once again, while this is possible, it’s important to remember that investors always want to be ahead of the curve. In other words, it’s not that rates are still low; it’s that the direction of rates is up. Therefore, investors (and traders) are likely to shy away from such a play. That said, there is no guarantee that rates will continue to increase. If rates stay where they are or come back down, then longs are well-positioned.

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Instead of attempting to predict the direction of interest rates, let’s instead attempt to answer the question whether or not interest rates and home prices can increase at the same time in this economic environment. In other words, will there be enough demand to push up home prices even if interest rates are higher and monthly mortgages become more expensive?

Most analysts are saying that this is a likelihood. Perhaps that’s the case, but Generation X isn’t exactly the wealthiest generation of all time, and Generation X is a major player when it comes to home buying. Headwinds include unemployment, underemployment, and debt. A lot of the strong performance in housing has come from investment firms and speculation. But to be fair, mortgage applications have been on the rise over the past year. The problem is that they declined in May. If rates are now higher – a 30-year fixed is at 3.91 percent – is it likely for there to be a sustainable increase in mortgage applications if rates continue to increase?

Lennar has significantly improved its efficiency since the real estate bust in 2006. However, while earnings have consistently improved on an annual basis and revenue has improved over the past three years, the last quarter saw significant declines in revenue and earnings on a sequential basis.

Lennar is trading at 16 times forward earnings, which is in-line with peers Toll Brothers (NYSE:TOL) and PulteGroup (NYSE:PHM), which are trading at 21 times forward earnings, and 12 times forward earnings, respectively. In regards to profit margin, Lennar is impressive at 16.51 percent. Toll Brothers is even more impressive at 23.60 percent. However, PulteGroup sports a profit margin of just 5.87 percent. Lennar’s operating cash flow is -$613.70, which is a negative.

Lennar does offer a 0.40 percent yield whereas its aforementioned peers don’t offer any yield. However, this isn’t a large enough yield to make a difference in an investor’s decision-making process.

The company culture at Lennar is average at best. According to Glassdoor.com, employees have rated their employer a 3.1 of 5, and only 45 percent of employees would recommend the company to a friend. In regards to leadership, it’s also average as 50 percent of employees approve of CEO Stuart Miller. All that said, this is by far and away an industry trade, not a company-specific trade.

Let’s take a look at some important numbers prior to forming an opinion on this stock.

T = Technicals Have Weakened

Lennar had been performing extremely well for years, but momentum has shifted to the downside.

1 Month Year-To-Date 1 Year 3 Year
LEN -13.99% -4.88% 45.50% 141.3%
TOL -12.76% -1.78% 27.74% 68.55%
PHM -13.78% 10.24% 138.0% 109.6%

At $36.72, Lennar is trading below its averages. Even if after the recent selloff, this is a rarity throughout the broader market.

50-Day SMA 41.30
200-Day SMA 40.21
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E = Equity to Debt Ratio Is Normal

The debt-to-equity ratio for Lennar is close to the industry average of 1.10.

Debt-To-Equity Cash Long-Term Debt
LEN 1.25 1.18B 5.09B
TOL 0.78 936.00M 2.48B
PHM 1.14 1.60B 2.60B

E = Earnings Have Been Strong

Earnings have consistently improved on an annual basis, and revenue has improved for three consecutive years.

Fiscal Year 2008 2009 2010 2011 2012
Revenue ($) in millions 4,575 3,119 3,074 3,095 4,105
Diluted EPS ($) -7.00 -2.45 0.51 0.48 3.11

Looking at the last quarter on a sequential basis, revenue and earnings both declined.

Quarter May. 31, 2012 Aug. 31, 2012 Nov. 30, 2012 Feb. 28, 2013
Revenue ($) in millions 930.16 1,099.76 1,349.94 989.95
Diluted EPS ($) 2.06 0.40 0.56 0.26

Now let’s take a look at the next page for the Conclusion. Is this stock an OUTPERFORM, a WAIT AND SEE, or a STAY AWAY?

Conclusion

Lennar’s stock-price momentum has shifted in the wrong direction as interest rates have slowly headed higher. To simplify the future potential of Lennar, if interest rates head back down, then Lennar is a great investment. If interest rates continue to increase, then Lennar is a bad investment. And if interest rates gradually move higher (a realistic possibility), then nobody really knows the answer. However, if interest rates gradually move higher, then they will eventually reach a point where most consumers (not investors) won’t be able to afford a home (see weak consumer). That being the case, how can Lennar possibly be a winning long-term investment? Lennar would be a winning long-term investment if rates were already at reasonable levels and the consumer was strong. However, that isn’t the environment we’re currently living in.

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The bottom line is that Lennar could bounce back and make for a good trade. It might even make a good one-year or two-year trade. This isn’t likely, but it’s possible. That said, Lennar isn’t going to make for a good long-term investment. Even in the current environment, downside risks outweigh upside potential.

Lennar is a STAY AWAY.

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All content posted should not be considered professional advice. Please do your own research and consult with a professional financial advisor before making any investment decisions. I don’t have any positions in this stock.

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