Leadership

1st-Mover Lennar Continues To Set Pace, Starts As Cash Drivers

Lennar's core strategy to fuse price, pace, and production at a volume level that remains consistent maps the enterprise to fill the present market's dire unmet need, and the future market's most explosive growth opportunity.

Leadership

1st-Mover Lennar Continues To Set Pace, Starts As Cash Drivers

Lennar's core strategy to fuse price, pace, and production at a volume level that remains consistent maps the enterprise to fill the present market's dire unmet need, and the future market's most explosive growth opportunity.

March 15th, 2023
1st-Mover Lennar Continues To Set Pace, Starts As Cash Drivers
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Lennar "beat"  both consensus expectations and its own guidance for what was thought to be the first quarter of the rest of our higher-interest-rate, tougher-rougher-going lives, at least through 2023.

The nation's No. 2-ranked homebuilder by volume clocked in with a tale-of-the-tape better than anyone other than Lennar believers themselves could have expected. Its financial wrap-up reads, briefly:

First quarter net earnings attributable to Lennar in 2023 were $597 million, or $2.06 per diluted share, compared to first quarter net earnings attributable to Lennar in 2022 of $504 million, or $1.69 per diluted share. Excluding mark-to-market losses on technology investments in both years, first quarter net earnings attributable to Lennar in 2023 were $615 million or $2.12 per diluted share, compared to first quarter net earnings attributable to Lennar in 2022 of $800 million or $2.70 per diluted share.

Wolfe Research's homebuilding equity research team notes in a first look analysis that Lennar eclipsed its estimates for Orders, Revenue, Closings, GM [gross margin], SG&A, OM [operating margin], Fin Services, and did especially well to reduce its shortfall on Q1 orders by only 10%, compared with a bumper crop Q1 2022.

That's the good news, and that's not all.

The other really bright spot in the Q1 earnings cycle's bellwether homebuilder has three separate but related plot lines:

1) The quarter's operational and financial performance metrics proved out the Lennar organization's strategic and tactical determination to find market-clearing price-points across its footprint and – temporarily – use its gross margins to "shock absorb" its hellbent plan to drive pace and keep starting new homes.

2) A calendar quarterly period that saw both favorable and unfavorable swings in mortgage interest rate swings showed signs, per Lennar Executive Chairman Stuart Miller, that people have been willing "to stretch their wallets, ... and customers, both primary and institutional are coming to grips with the new normal of higher but acceptable interest rates."

3) Per a tweet from John Burns Real Estate Consulting director of research Rick Palacios Jr.

2023 could be a year where home builders grow market share (new homes are just 11% of total home sales today). Resale housing dynamics tee it up nicely: limited supply, lock-in effect, sellers still reluctant to drop price, and can't really use rate buydown lever like builders."

In other words, Lennar's core strategy to fuse price, pace, and production at a volume level that remains consistent, maps the enterprise to fill the present market's dire unmet need, and the future market's most explosive growth opportunity.

That's the good news, and on the other hand, Executive Chairman Stuart Miller used the term "volatility" 17 times during a 90-minute presentation and Q&A session with Wall Street investment research analysts during this morning's earnings call.

In an example, here, Miller drops the term in twice:

The quarter ended and the past couple of weeks have added new issues and questions that are reflective of a market that is looking for a bottom and looking for stability. With the Federal Reserve and Federal Government trying to reconcile the unintended consequences from aggressive interest rate hikes in order to curb the inflation, there is simply no way to see around corners and anticipate with certainty what comes next.
This is exactly the kind of volatility that our core operating strategy of maintaining volume using incentives and sales price has been built to endure. With volume and production as our constant and margin as our shock absorber, we manage with certainty through volatility and stay focused on our mission. If market conditions deteriorate, we compromise margin through price and/or incentives, but we generate strong cash flow. If conditions improve, we improved margins and bottom line while also generating strong cash flow. Our primary focus is on cash flow."

So, if you're going to take a constructive narrative out of Lennar's execution and commentary, you'd better back it up with as strong and stress-tested a plan as the one Lennar's leaning into in a dicey market. The "core operating strategy" Miller refers to explodes out – as he's articulated in past presentations – in seven distinct areas of focus that he spelled out in the earnings call.

  • Leveraging a secret-sauce dynamic pricing model and a proprietary Digits – Microsoft-backed – marketing platform to detect and act on a "market-clearing" price that stays in constant real-time motion, driving matches between homes and buyers on a fine-tuned, constant-forward-moving level.
  • Right-size cost structure, leveraging scale, volume visibility, local market heft, to forcibly ratchet down trade, land, and vendor expense so that everybody in Lennar's system bears some measure of the weight of more adverse
  • In the same vein, Lennar's ongoing dynamic plans call for resets on what it pays and will pay for land and lots, ensuring that deltas between lot price and vertical development and sale prices re-hitch in 2023's new realities.
  • Internally, Lennar's focus on its corporate GS&A overheads and operating costs will mean additional corporate-level cost cuts, even as cost-of-sales that fund incentives rise, will be in the plan.
  • Evenflow, Lennar's discipline around controlling a precise balance between starts, sales, and closings – i.e. currently a reported 1,300 completed unsold homes are in Lennar's inventory pipeline, roughly one home per actively selling community. This ties to balance sheet impacts of Lennar's inventory turns that have been bloated over the past couple of years due to supply chain and construction cycle time delays.
  • Focus on driving cash flow to bottom line profits, improving cash position and balance sheet to sustain resiliency and optionality.
  • A freshly added, "core" strategy, Miller notes, is continuous improvement, with accountability measures and benchmarks that peg compensation and bonuses to key performance metrics.

On these bedrock operating foundations, Lennar's strategic team views the company as both a first-mover and a market maker, capable of carrying on a self-determined course despite conditions and uncertainties that may batter and bruise others.

Here's seven highlight verbatim insights that came out of the call's question and answer segment:

Banking Crisis Fallout

Stuart Miller - Executive Chairman

I don't think there's a clean clear answer. And I was very intentional in my comments, I use the words unintended consequences. There are so many of them just swirling around out there. And I'm not sure how they're going to shake out. You're absolutely right that the community banking and regional banking system is a support structure for the broader housing market, whether it's the smaller builders or all the way through the system. The SFR buyers are going to feel the ripple of not only cost of capital but also capitalization rates. There's going to be moving upward. There's going to be movement downward. And how it shakes out is going to be something that we'll be very tuned to.

But the landscape is going to shift. Unintended consequences are not -- we're not going to be able to see around those corners. And I think we've seen that in many ways over just the past few days, the unexpected has happened, and we just had to think about how we deal with it, whether it's over the weekend or whether it's over last night. So it's important to daylight that there are these things out there that are going to have some ripple effects, and we'll all have to just sit and see how we deal with them. I hope that I laid out well in our commentary that our strategic focus is taking into account the volatility, the unexpected and recognizing that we're going to stay very close to the market on a community-by-community basis and use our dynamic pricing model digital marketing platform to keep the production machine moving, and that will impact both sales prices and margins.

Volume Vs. Margins

Stuart Miller - Executive Chairman

Your question as to whether if demand is stronger, [are we going] to see that reflected in higher volume numbers or higher margins. And it's really the answer to that is really going to be about optimizing to both. We will, with greater demand see some greater volume but additionally, that greater demand will express itself through our dynamic pricing model and the ability to garner a higher sales price and margin."

Jon Jaffe – Co-CEO and Co-President

One more important thought on that. And that is, as you know, we really have a very well-controlled inventory position, not a lot of unsold homes in front of us are current. So we're very disciplined about not getting too far ahead in sales. We could potentially open it up some more. But we find very effective use of mortgage rate buy- downs, which tend to lend to a shorter cycle duration in in terms of how far out we're selling."

The Strength Of Spec Homes

Rick Beckwitt - Co-CEO and Co-President

We have seen that our homes as they're getting close to completion -- or being completed -- that they get premium pricing. That's why we continued with our production strategy to keep homes coming off of the conveyor belt, if you will... That's reflective of the lowering of incentives on a monthly basis, really on a weekly basis since for the last six, eight, 10 weeks. We've been able to lower the amount of the incentive. That's why we're keeping our start cadence going. And just going back to your sales pace question, the sales pace for the Q2 is really in the mid-4s. And if the market improves, we can definitely push that. But that's sort of the middle of the fairway type of projection."

Data, Rates & Sales Pace

Stuart Miller - Executive Chairman

We're looking at pricing on an everyday basis in each community. It's a very granular assessment. To reconcile what I said about the end of February, at the end of February, interest rates started moving dramatically in a different direction, and we definitely saw direct impact in traffic levels. We were intrigued to sit, watch as we went from February into March that our sales pace remained relatively strong. There are a number of ways to read that information. But we -- a big part of our read is the fact that we have kind of entered into a world of a new normal relative to interest rates, the sticker shock of the rapid change is subsiding. It doesn't mean it's gone away.
But at the same time, interest rate movements are not disrupting sales as they might have 6 months or nine months ago. And we are able to find and keep in touch in step with interest rate movements and that intersection between the discounting that we might have to do, the incentives we might have to get and the consumers' affordability assessment. So all of those are in play on a regular basis. And as we came to the end of February, we definitely saw an impact on traffic but not really much of an impact on sales."

Pricing To Market, Predicting Volume

Jon Jaffe – Co-CEO and Co-President

Our dynamic pricing model really gives us a very clear view of the different elements that go into pricing home and associated incentives, mortgage buydowns, base pricing premiums, et cetera. So we've evolved that product through these market conditions. We've developed additional tools within dynamic pricing that give our operators that view of what's happening on a plan-by-plan community-by- community basis where they can track week over week changes in base pricing, incentives, et cetera, and stay very much on top of sales pace, what's needed and what is having the biggest impact on driving results."

Stuart Miller – Executive Chairman

All of the components of what's happening in the market is being ingested into our dynamic pricing model, and it is giving in graphic form our operators a clear view of what's happening in their market, backward-looking and forward expected. And it's really the ingestion of data, the backward testing and the ability to accumulate more information that is dependable that we -- where we build and understanding as to what it means that helps us come up with pricing that is actionable in the field on a market- by-market basis.
And probably the most interesting thing that has taken place over the last six months is a better understanding of how to look at our underperforming assets, meaning the communities that are not performing up to par. It's easy to focus on the communities that are doing quite well and harder to focus on the ones that might be lagging and across a platform that's 1,300 communities coast-to-coast. It's important to zero-in on those that are underperforming and see what it takes to get them moving in the right direction. That's what our dynamic pricing model is all about.

Cost Savings: Now $14,000-per Home Vs. '22

Stuart Miller – Executive Chairman

The general volatility that is sending up the caution flag. We are working every day on expanding that number to a larger number, and it is not static. And if you just look at numbers, your assessment is correct. But with that said, we're leaving room for volatility to run its course. We recognize that even things within the cost numbers are moving around. Whether it's lumber costs moving down and then moving back up, whether it's other components. So the answer is yes, we're leaving some room for other elements of volatility to express themselves as well."

Jon Jaffe – Co-CEO and Co-President

So for Q2, you're just seeing the very beginnings of that because there is a time lag that Stuart addressed a moment ago. We put something under contract today, it affects homes we start tomorrow, which deliver, call it six months from now. So you have that timing cycle. You do have a likelihood that lumber does move up some. We are battling, for example, in aggregates and concrete as a headwind. There is a constant energy efficiency battle that goes on that affects our manufacturers. So it's give and take in that, and that's why I said we feel comfortable with what we have put under contract so far."

Will Land Disinflate?

Stuart Miller – Executive Chairman

Land value is a residual of what it can be used for. And the residual land value off of residential land is relative to the price or sales price of the home. What makes land value somewhat sticky is the expectation that perhaps home prices have come down, but they'll bounce back up. And therefore, the old residual might come back into play and landholders will sometimes wait.
At the end of the day, we're finding that we're coming into a new sense of normal. And I have to believe that if landholders [and]  land owners want to generate cash and sell products, ultimately, the valuation is going to have to revert to kind of that new normal of home pricing and the end use of the land, and there will be that rational relationship between land cost and ultimate home price.
We are patiently waiting for that to reconcile and we're doing it because we're simply not going to buy the land that's going to put us underwater or to buy the next impaired margin. And so we are going to bide our time. If the market corrects to the upside, we'll pay a little bit more. But if it stays kind of situated where it is, quite sure that land sellers will come around to understanding that there is a new valuation that has to come into play."

ABOUT THE AUTHOR

John McManus

John McManus

President and Founder

John McManus, founder and president of The Builder’s Daily, is an award-winning editorial, programming, and digital content strategist. TBD's purpose is a community capable of constant improvement.

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