How Lennar's (LEN) Margins Are Shaping Up for Q1 Earnings?

Lennar Corporation LEN is set to report first-quarter fiscal 2018 results on Apr 4, before market open. Lennar has been exhibiting solid top-line performances and the trend is expected to continue in the soon-to-be-reported quarter as well, thanks to the strong demand for homes, favorable job market and impressive economic conditions.

Let’s take a look at how the company's margin is shaping up for this earnings season.

Gross Margin: Unlike an impressive revenue performance, Lennar and a number of renowned homebuilders have been under pressure owing to rising land and labor costs that are threatening margins. On the one hand, labor shortages are leading to higher wages and on the other, land prices are inflating due to limited availability.

Lennar’s gross margin on home sales decreased 90 basis points or bps year over year in the fourth quarter as well as fiscal 2017, primarily due to an increase in construction and land costs per home. This trend is unlikely to change in the to-be-reported quarter.

Meanwhile, in February 2018, Lennar acquired CalAtlantic Group Inc. in a $9.3 billion deal (including debt), which is expected to put Lennar among one of the country’s top three home builders in 24 of the top 30 U.S. markets.

Now, as part of the CalAtlantic acquisition, the company needs to evaluate the assets and liabilities acquired and record them at fair value on the acquisition date. These adjustments will include, but not be limited to, adjustments to inventory, investments in unconsolidated entities, other assets, goodwill and debt. The company had earlier warned that some of these adjustments will impact its gross margins going forward. There will be a more significant impact to gross margins from the acquisition date through the early part of fiscal third quarter, as a result of the backlog writeup that is required for homes that have already been sold.

Lennar Corporation Gross Margin (TTM)

 

Lennar Corporation Gross Margin (TTM) | Lennar Corporation Quote

SG&A Expenses: Meanwhile, Lennar remains focused on continued improvement in the SG&A line from operating leverage and investments in technology. As a percentage of revenues from home sales, SG&A expenses contracted to 9.2% in the fiscal 2017 from 9.4% in the year-ago period, due to improved operating leverage as a result of an increase in home deliveries. Notably, in the last reported quarter, SG&A expenses came in at 8.4%, marking the lowest fourth quarter in the company's history. The trend is expected to continue in the to-be-reported quarter as well.

Operating Margin: Lennar anticipates full-year operating margins to match the fiscal 2017 level of 12.9%. Seasonality will impact operating margin in the upcoming quarters, with the first quarter being the lowest. However, with the increase in volumes throughout the year, operating margin is expected to show improvement. Overall, Lennar expects operating margin to be fairly consistent with the prior year in each quarter of fiscal 2018.

Meanwhile, the synergies of CalAtlantic combination will lower direct construction costs, reduce cycle times, leverage SG&A and increase sales base, all of which are expected to boost profitability and internal rate of return on invested capital.

Overall, this Zacks Rank #3 (Hold) company is expected to witness lower gross margin in the fiscal first quarter, owing to higher construction costs. Nonetheless, Lennar’s diligent efforts to improve its operating efficiency via digital marketing strategies, dynamic pricing tool and other technology initiatives are expected to offset the headwinds, thereby driving growth for this homebuilder.

Overall Earnings & Revenue Expectations

Overall, the Zacks Consensus Estimate of 82 cents for first-quarter earnings reflects 39% growth from the prior-year period’s profit of 59 cents per share. Also, the consensus mark for revenues of $2.65 billion represents a 13.5% increase on a year-over-year basis.

(Read More: Lennar to Report Q1 Earnings: What's in the Cards?).

Lennar’s shares have gained 6.5% in the last six months, outperforming 1.8% growth of its industry. That said, earnings estimates for the fiscal first quarter and fiscal 2018 have been trending upward, increasing 2.5% each for both the periods in the last 60 days. This reflects analysts’ confidence in the company’s future earnings.

 

Key Picks

A few better-ranked stocks in the Zacks Construction sector are Beazer Homes USA, Inc. BZH, with a Zacks Rank #1 (Strong Buy), KB Home KBH and Meritage Homes Corporation MTH, both carrying a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Beazer Homes is expected to witness 112.5% growth in earnings this quarter.

KB Home and Meritage Homes are expected to witness 45.4% and 30.4% increase in 2018 earnings.

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