AllStarPortfolio Entry- Lennar (LEN)
I've finally stabilized in the 99% rank so here is my official submission for the CAPS AllStarPortfolio portfolio. While I think LEN will do well over the next couple of years it's a long term 5+ years rec.
The two articles above are must reads to understand this recommendation. In particular you need to really understand the history and dynamics of new home construction in the U.S. to understand this recommendation. The chart at the end of the first Morningstar article detailing annual U.S. housing starts over 50 years puts this in context but it stops at 2008. 2009 and 2010 come in at around 0.55M starts per year which is an unprecedented low level only ~33% of the 1.5M/ year long term average and what most consider normal demand. The second article points out that when you offset the excess homes built in the bubble years with the amount under built after the bubble total homes built in the decade of the 00's was essentially the same as the total built in the 90's. That includes a period of low starts in another bubble aftermath in the early 90's.
So the moral of the story so far is yes we built excess housing in the bubble years but it wasn't as bad as hysterical headlines would have you believe and we've already offset it with underproduction in the last couple of years. I should also note that new homes is a small fraction of the overall housing market with existing home sales making up the bulk of the market. New homes only account for ~15% to total home sales in a normal year. Existing home sales average something like $5M-5.5M/ year and were up to ~$6M when the recent tax credit was in effect and fell to something like $4.5M after the credit expired. The point here is existing home sales when you average out during and after the tax credit have been fairly normal but new home sales have been almost non existent. Throughout this downturn the new home builders have been doing the rational thing sitting on the side lines and letting the foreclosure inventory clear out so that they can eventually compete in a rational market. While inventories are high right now they have come down significantly from peak levels in 2008 and sit at something like 10 months supply. Not insurmountable. By definition the dreaded shadow inventory is not coming on market until the market has firmed up and new homes can compete with this inventory they just can't compete with fire sales.
Now that I have hopefully put the housing market in general in context lets look at some numbers for LEN which by the way are similar for all of the large national scale home builders. LEN revenues in 2000 were $4,707 and worked their way up to $16,267 at the height of the market in 2006 or ~350% increase in sales. Go back to the M* chart on housing starts over the same period and they go from ~1.5M/ year to ~2M/ year over the same period or around 33% increase. While some of the difference between LEN's revenue increase and over all housing starts can be explained by average home price increases it's clear the bulk of the difference is market share gains. As I mentioned earlier this is true for all of the large public builders as they were taking share from traditional smaller regional builders. Using LEN's current share count adjusted EPS went from $1.24 in 2000 to $7.32 at the peak in 2005. EPS fell to only $3.21 on higher revenues in 2006 due to home building gross margins falling which I believe was due to over paying for land. So the bubble actually hurt LEN at it's height.
If I annualize LEN's revenues over the first 9 months of 2010 they come to ~$2,430 or roughly 50% of their revenues in 2000. The number of annual housing starts however is at ~33% of what it was in 2000. Assuming current home prices have fallen to roughly the same as 2000 levels it looks like LEN is outperforming the over all market again on the downside. I should also note that LEN is currently profitable with EPS of $0.34 for the first nine months of the year at a time when U.S. housing starts are at 33% of their 50 year average.
If we assume conservatively housing starts in general only get back to the low end of a normal cyclical low or ~ 1.25M/ year over the next couple of years that's ~250% increase in home sales. If LEN just keeps pace with the over all market that would amount to revenues of ~$6M/ year. That's roughly what they did in 2001 and earned ~$2.25 EPS adjusted to current share count. Home building being a traditionally cyclical industry the public builders were getting low multiples in the bubble so give that $2.25 a 10X multiple and you get something like a $22 share price or ~30% higher than current price. So that would make LEN about fair price assuming over all new homes built only come back to a normal cyclical low not their long term average or god forbid better than average. That also assumes LEN only keeps up with the overall market and doesn't outperform it as the market recovers. Again for the skeptics who think we built to many new houses in the bubble and we don't need any more new houses read the two articles again and pay attention to the stats. The total number of houses built in the 00's was the same as was built in the 90's and the early 90's suffered from the overhang of a bubble in the late 80's. Not to mention new homes only account for ~15% of total home sales in a normal market anyway.
Right now new household formation is low as young adults are staying home with parents and couples are putting off divorce due to uncertainty about the economy. There is a decent chance home starts not only get back to normal but maybe a little better than normal early on in the next cycle due to pent up demand. More importantly though looking at LEN's ~350% revenue increase from 00-06 vs ~33% increase in over all home starts and LEN current revenues at ~50% of 00 vs. housing starts at ~33% of 00 they will in all likelihood way outperform the over all market as judged by starts in the new home recovery as they continue to take market share from smaller regional builders a large number of whom didn't even survive this downturn.
I think LEN's revenues could easily do 50%-100% better than over all starts and come in at something like $10M-$12M per year some time in the next couple of years. That would be on par with 04-05 revenues which resulted in EPS of ~$5.00-$6.00. I believe the large public builders share of the total new home market was in the mid teens at the height of the bubble so they have plenty of room to keep taking share. I could see LEN doubling or more that $10M-$12M in revenues by the end of the next decade just on continued market share gains and probably getting a more normal EPS multiple longer term assuming the housing market is fairly rational in the next decade after the turmoil of the past decade. I don't think it would be too much of a stretch to see LEN as something like a 10 bagger in a decade from it's current share price. I really believe this will be one of those stocks people are going to look back on and wish they saw what I see right now.