Lennar Corp /New/ Q3 FY2021 Earnings Call

Welcome to Lennar's Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. After the presentation, we will conduct a question-and-answer session. Today's conference is being recorded. If you have any objections, you may disconnect at this time. I will now turn the call over to Alexandra Lumpkin for the reading of the forward-looking statement.

Thank you, and good morning. Today's conference call may include forward-looking statements, including statements regarding Lennar's business, financial condition, results of operations, cash flows, strategies and prospects. Forward-looking statements represent only Lennar's estimates on the date of this conference call and are not intended to give any assurance as to actual future results. Because forward-looking statements relate to matters that have not yet occurred, these statements are inherently subject to risks and uncertainties. Many factors could affect future results and may cause Lennar's actual activities or results to differ materially from the activities and results anticipated in forward-looking statements. These factors include those described in yesterday's press release and our SEC filings, including those under the caption Risk Factors contained in Lennar's annual report on Form 10-K most recently filed with the SEC. Please note that Lennar assumes no obligation to update any forward-looking statements.

I would like to introduce your host, Mr. Stuart Miller, Executive Chairman. Sir, you may begin.

Thank you, and good morning, everyone. This morning, I'm here in Miami and I'm joined by our Co-President and CEO Jon Jaffe, and it happens to be his birthday today as well. Happy Birthday, Jon. Diane Bessette is here, our Chief Financial Officer; David Collins, our Controller; Bruce Gross, CEO of Lennar Financial Services; and of course, Alex, who you just heard from. We also have Richard Beckwitt, who's on the road, I believe in Dallas today. And Rick will be joining and contributing as well. So listen, today's call is pretty straightforward. We will try to keep our remarks brief so we have plenty of time for your questions. As usual, I'll give a macro and strategic Lennar overview. Rick is going to talk about market strength, land and community count. Jon will update on the supply chain, production, and construction costs. And as usual, Diane will give detailed financial highlights and additional guidance, and then we'll answer as many questions as we can. Please limit questions to one question and one follow-up. Let me begin with a low note. As you saw in our press release, we missed the low end of our third quarter delivery guidance by 600 homes, delivering 15,199 homes. While at Lennar, we are certainly not immune to supply chain disruption, we are simply not used to missing either. Our entire team feels the pain of this miss; it is not for lack of effort or focus but instead a reflection of current market conditions. The supply chain for both land and construction is significantly stressed, and that will continue into the fourth quarter and beyond. Accordingly, we expect our community count at the end of the year to be up only approximately 7% versus the 10% we previously guided, and our deliveries will be approximately 18,000 versus the 19,000 to 21,000 range we previously guided. While we're not giving specific guidance for 2022, we fully expect double-digit growth in sales, starts, closings, and community count next year. After my introductory remarks, Rick will further address land, supply chain, and our performance and expectations. Jon will give color on labor and materials and the effects on production. Except for the miss on deliveries, our third-quarter results were very strong and quite extraordinary. Despite the supply chain constraint, we still grew our deliveries 10% year-over-year, while our revenues from home sales grew 19% to over $6.5 billion. By remaining focused on orderly targeted growth with our sales pace tightly matched with our pace of production, we drove a 420 basis point gross margin improvement from 23.1% last year to 27.3% this year. Alongside gross margin, we recorded significant improvement in operating efficiency as our SG&A decreased 100 basis points to 7% this year versus 8% last year, and that’s without the embedded leverage of missed closings. Our net margin increased 520 basis points year-over-year from 15.1% last year to a company all-time high of 20.3% in our third quarter. This drove a 54% after-tax and before extraordinary items bottom-line improvement in net earnings from approximately $667 million last year to over $1 billion this year. With our focus on bottom-line over top-line improvement, 19% revenue growth drove 54% bottom-line growth. Our net new orders grew 5% year-over-year, even as we matched our sales pace with production pace in this constrained environment in spite of a difficult comparison to last year's strong recovery of fourth-quarter numbers. Additionally, our Financial Services Group continued to perform exceptionally, adding $112 million of earnings while supporting the orderly closing of our homes and making the closing process as joyful as possible in the current environment. With the strong performance of our core operating divisions, our balance sheet and returns continue to improve. Even after the purchase of 2.5 million shares of stock and the reduction of $350 million of debt in the quarter, we reported a cash balance of over $2.6 billion and a 21.2% debt-to-total capital ratio, while our return on equity grew 800 basis points to 21.9%. All in all, our core operating numbers are very strong, and we expect this strength to continue into the fourth quarter and beyond. In addition to our core, we have generated additional upside this quarter by some of our LENx investments which entered the public markets. While market conditions resulted in lower valuations for these companies by our quarter end, including Doma, Title, Hippo home insurance, Blend mortgage processing, and SmartRent automated entry systems, we still recorded just under $500 million of profit from those investments. Even though we are guiding down our deliveries for the next quarter, we are decidedly guiding the prospects for Lennar’s continued success up as we continue to build on the core strategies that define our business. Diane will give more detailed guidance for the fourth quarter, but our expectations reflect overall strength in the market and optimism for our future. From a macro perspective, the housing market remains strong, and these continue to be the best of times. Demand has been consistently strong, while the supply of new and existing homes remains limited. Since new home construction cannot rent quickly enough to fill the void of the production deficit that persisted over the last decade, short supply is likely to remain for some time. Even though home prices have moved much higher, overall affordability remains strong. Interest rates are still lower than they were a year ago and personal savings for deposits are strong. Wages for the average family seem to be rising faster than monthly payments. While inflation numbers might seem to tell a different story, this is the story that we're hearing from our customers as they come to visit our field offices. The primary driver of demand continues to be an upward spiral of housing consumer needs. Millennials are forming families. Apartment dwellers are purchasing first-time homes. Yesterday's first-time homes are selling at higher prices and anticipated equity is enabling first-time move-ups. All this while supply is limited for everyone. Additionally, the iBuyer and single-family-for-rent participants are providing additional liquidity to the marketplace, becoming more essential as the coordination of closing new homes is complicated by supply chain disruptions. Professional ownership of homes enables renters to access a single-family lifestyle while they build the credentials to own. Better housing for families produces better outcomes for families, and the industry is rewiring to provide those solutions. As noted, changes will also act as circuit breakers for the cyclicality in the housing market in the future. But for now, the housing market is very strong, and we, the builders, just have to get the homes built. Before I conclude, let me briefly talk about our SpinCo. We have adequate and even excess capacity to spin our well-established ancillary businesses. These businesses do not meaningfully contribute to our core earnings in their current ownership configuration right now. Time has been our friend, as the Lennar core business, cash flow, and balance sheet have continued to improve, providing greater opportunity and flexibility. We are pushing to make SpinCo happen, engaging Matt Zames as a Senior Advisor to focus on our SpinCo strategy. Matt's expertise in operations, execution, and detailed financial modeling will help quickly advance the timeline for SpinCo and bring it to market. We are working on the structure and organization of the new company which meets regularly to map the structure, model expected growth, and review progress. We are standing up a new company backbone with leaders from the projected SpinCo verticals. I would wrap up by saying that despite the miss of deliveries and supply chain disruption, we have never been better positioned financially, organizationally, and technologically to thrive and grow in this evolving housing market. Demand and the market in general remain very strong as we begin to look to 2022, we see continued strength and double-digit growth for Lennar. The story remains that supply is short and demand is strong. Some are concerned that demand is slowing as prices move higher; it seems to us that sales are slowing because many sales were made early and the industry is building through those sales slower than expected. We believe that home production has been constrained for a decade, and we are making up the deficit now, which should keep the housing market thriving for some time. With that, let me turn it over to Rick.

Thanks, Stuart. As you can tell from Stuart's opening comments, the housing market is very strong. Our team is extremely well-coordinated, and our financial results continue to benefit from solid execution of our core operating strategies. Key to that has been running a finely tuned homebuilding machine where we carefully match homebuilding production with sales on a community-by-community basis. In this appreciated market with slightly longer cycle times caused by supply chain issues, we are strategically selling homes later in the production cycle to maximize prices and offset potential cost increases. Our third-quarter results prove the success of this strategy as we achieved gross margin increases of 420 basis points year-over-year and 120 basis points sequentially. During the third quarter, we started 4.9 homes per community, sold 4.5 homes per community, and we ended the quarter with fewer than 200 completed unsold homes across our entire footprint. This production, margin-driven, and sales-focused program will continue to improve margin and lead to increased deliveries in fiscal 2022. In the third quarter, new orders, deliveries, and gross margins were strong across all operating regions, with August being the strongest month. We saw strength in all product categories, from entry-level to move-up to active adult. This strength was reflected in a historically low cancellation rate, which was 10% in the quarter, down 470 basis points from last year. In the third quarter, we continued to achieve price increases, although at a lower rate than earlier in the year. In general, the market has moderated from being extremely hot to a strong market that is returning to normal seasonal trends. Florida continues to benefit from core local demand as well as in-migration from the Northeast and the West Coast, driving sales pace and price. Inventory is extremely limited, and buyers are moving fast to close. The hottest markets in Florida continue to be Naples and Sarasota in the Southwest; Miami, Dade, and Broward in the Southeast, and Tampa. We are also seeing a strong recovery in Orlando with increased tourism. Raleigh, Charlotte, and Charleston remain strong markets benefiting from limited inventory, job growth, and quality of living. Texas continues to be the strongest state in the country, driven by in-migration and a pro-business economy. Even with out-migration from parts of California, the markets remain strong due to severe housing shortages. Phoenix and Las Vegas continue to thrive due to business-friendly environments and real job growth. Overall, we're witnessing strength and depth throughout the market across the country. I'd like to briefly address community count. While our community count is up slightly from the beginning of the year, we ended the quarter flat year-over-year. This was driven by a faster sales pace in certain existing communities, which caused some communities to close out sooner than expected. Challenges related to supply chain disruptions have impacted our ability to get new communities open on time. Despite these delays, we expect to end the year with a 7% increase in community count versus the 10% targeted at the year’s beginning. We maintain confidence in our robust land pipeline, with plenty of land queued to meet our growth goals over the next few years. We're pleased with the excellent progress made on our land-light strategy, as evidenced by our years owned supply of homesites improving to 3.3 years at the end of the third quarter from 3.8 years last year, and our controlled homesite percentage increasing to 53% from 35% for the same periods. Thank you to all our associates for their tireless efforts in navigating these supply chain challenges. Now I'd like to turn it over to Jon.

Thanks, Rick. I will now briefly address how we are managing through the supply chain disruptions impacting Lennar and the industry. Our closing miss for Q3 was driven by supply chain disruptions that led to a general increase in our cycle time to build homes, along with intermittent shortages that stalled production beyond cycle time, causing some closings to be delayed into our fourth quarter. Disruptions are affecting different trades at different times and in different geographies. They are intermittent and ongoing. In many ways, it's truly a game of whack-a-mole, creating a traffic jam. Like cars, the construction process is backed up, creating a chain reaction of delays that cascade from one trade to the next. Fortunately, we have extraordinary supply chain, purchasing, and construction teams managing scheduling on a day-to-day basis with our trade partners. We work with our partners to solve issues in real time and plan for future demand. All our investments and initiatives in everything's included have minimized the impact of supply chain shortages. Lead times have materially expanded for most manufacturers. Categories most impacted currently are engineered wood, windows, garage doors, paint, and vinyl siding. We expect to feel the effects of this supply chain backup for the next few quarters. We anticipate stabilization in our cycle times by Q2 of 2022. Overall, the management team is focused daily on navigating through the current supply chain disruptions. It's truly an all-hands-on-deck effort with our regional presidents, supply chain team, and myself supporting our suppliers and partners. We look ahead to increased starts, and with well-coordinated cooperation from our trade partners, we are positioning ourselves for solid growth in deliveries in 2022. Thank you. I'll now turn it over to Diane.

Thank you, Jon, and good morning, everyone. Stuart, Rick, and Jon have provided great insights regarding our homebuilding performance. I'll spend a few minutes on the results of our other business segments and our balance sheet, and then provide detailed guidance for Q4 of 2021. Starting with Financial Services, our Financial Services team reported $112 million of operating earnings for the third quarter. Mortgage operating earnings decreased to $80 million compared to $113 million in the prior year. The mortgage market has become more competitive with purchase business as refi volumes have declined. Title operating earnings increased to $26 million compared to $21 million in the prior year due to growth in both volume and profit per transaction. Our Title team has focused on technology, automation, and efficiencies to drive higher productivity. Regarding our Lennar Other segment, we had operating earnings of $492 million. The driver of these earnings was LENx, our growing technology investment business, with mark-to-market gains recognized on our various investments totaling $494 million in this quarter. In terms of our balance sheet, we ended the quarter with $2.6 billion of cash after deploying almost $600 million to retire debt early and buy back stock. At quarter-end, we had no borrowings outstanding on our $2.5 billion revolving credit facility. We continue to execute on our asset-light strategy by generating significant homebuilding cash flow and improving returns. As of the end of the third quarter, we owned 190,000 homesites and controlled 216,000 homesites, resulting in a decrease in our year supply owned to 3.3 years from 3.8 years in the prior year and an increase in our homesites controlled percentage to 53% from 35%. During the quarter, we paid dividends totaling $78 million and repurchased 2.5 million shares totaling $246 million, bringing our year-to-date repurchase amount to 4 million shares for $388 million. We retired early our $300 million senior notes due in December 2021, reducing our debt balance and saving about $9 million in interest. Our homebuilding debt to total capital was 21.2%, down from 29.5% in the prior year. Our stockholders' equity increased to approximately $21 billion from $17 billion in the prior year, and our book value per share increased to $66.73 from $54.91 in the prior year. We were upgraded to investment grade by S&P and are now investment grade with all three rating agencies. This reflects the successful execution of our operating strategy and our very strong balance sheet. Now turning to guidance for Q4, we expect new orders in the range of 15,200 to 15,400 homes as we return to more seasonal patterns, and we expect our deliveries to be about 18,000. Our Q4 average sales price should be about $445,000 as we continue to see price appreciation. We expect our gross margin to be about 28% and SG&A to be about 6.7%. In terms of our Financial Services earnings for Q4, we believe they'll be in the range of $95 million to $105 million as market competition for purchased business continues. We expect our multifamily operations to be about breakeven, and for the Lennar Other category, earnings are expected to be in the range of $5 million to $10 million. We expect Q4 corporate G&A to be about 1.2% of total revenue. Our tax rate will be approximately 23.8%, and we expect the weighted average share count for the quarter to be around 306 million shares. When you put all this together, this guidance should produce an EPS range of $4.12 to $4.16 per share for the fourth quarter. We are focused on executing our core operating strategies, maintaining a strong balance sheet, and remain optimistic about our position heading into the end of fiscal 2021. With that, let me turn it over to the operator for questions.

Our first question will come from Stephen Kim with Evercore ISI.

Appreciate all the detail. I want to talk about the homebuilding business specifically. Stuart, three months ago, we talked about how it might be more accurate to describe the move in home prices that the industry, including you, have seen over the past year as a correction upward since home prices rose to reduce demand down to the depressed level of supply; there was a gap between supply and demand. And so this quarter, you've mentioned in your remarks about demand being at a more normal seasonal level. However, it's fair to say that supply constraints have worsened too. My question is, would you say that demand is still above supply, and are home prices still generally rising? Specifically, how did demand respond to pricing actions you took over the summer, and how would you say things are trending thus far in September?

That's an interesting question, Steve. I would clearly say that demand is above supply, and therein lies pricing power. However, the conflict you're highlighting is that if you think about the sales pattern of last year, it stalled around COVID and then picked up sharply in the third and fourth quarters. So your comparisons are relative to a catch-up that was embedded in sales numbers. Yes, you have strong demand and sales, but you are not catching up anymore. Due to short supply and a production system slowed by the supply chain, demand is clearly outstripping supply, which continues to give us pricing power. Pricing over the summer has moderated our sales, so you see pricing power holding back sales a bit as we try to keep our sales in check with actual production.

Yes, absolutely. It's important to call out, as you did, the unusual seasonality last year. My next question gets to 2022 and beyond. Jon, you mentioned a cost increase of $5.40 per square foot, with lumber making up 95% of that. You conveyed a belief that costs would normalize by Q2 of next year, and that the decline in lumber costs would outweigh other inflationary pressures impacting your structure. I want to confirm that I'm accurately understanding your remark. As a follow-up to that, I'd like to get your outlook on gross margins, which is a major point of disagreement with investors. Are we likely to see margins return to historical norms quickly, or will there be a lag as demand and supply find balance?

Yes, you heard me correctly. Lumber is down about 70% from its peak, and our starts in September are now incorporating that lower price. By Q2, we will see benefits flowing through from that, exceeding the increases in other categories combined and resulting in lower costs per square foot on homes we deliver starting in Q2.

Looking ahead to 2022, we certainly see margin strength. The big ticket item, lumber, has seen declines and will start flowing through the production cycle. While labor and materials are increasing, we're experiencing margin protection, and we believe our margins will remain strong as we progress into 2022.

We have not seen any indication of downward adjustments in margins. Our land deals are underwritten with the same intensity and confidence as before. Visibility is strong, particularly for our 2022 pipeline.

Our next question comes from Truman Patterson with Wolfe Research.

Good morning, everyone, and happy birthday, Jon. I apologize, I did get disconnected during the opening comments from the call. You increased starts by 16% year-over-year, mentioning supply chain issues. My question is on materials availability and discussions with your suppliers. Do you think they'll have enough capacity to support a double-digit growth rate in 2022? Our hope is the manufacturers will improve inventory during the winter months, but we haven’t seen much evidence yet. What's your take on how next year unfolds? You mentioned easing constraints by Q2.

Yes, that's correct. Capacity constraints still exist on the supply chain. However, lead times have expanded, which could allow manufacturers to catch up. As we get into Q2 of next year, we expect those constraints to stabilize. This is a calculated approach with visibility on planned starts to ensure ongoing support for double-digit growth.

We will be very hands-on with our trade partners to ensure alignment on production needs while maintaining appropriate expectations. We're diligent about setting achievable expectations ourselves and coordinating proactively with our partners.

From my perspective, smaller regional builders will have a harder time increasing their community count. Larger builders like us can effectively address challenges arising from the market, and we are anticipating double-digit growth in community counts for 2022. We have ample land in place to ensure growth materially.

Indeed, we have plenty of land ready to convert into community count. The challenge lies in finalizing entitlements and approvals, which have reduced our pace temporarily. Community production has been steady, but some local aspects hinder swift implementation.

Next, we will hear from Carl Reichardt with BTIG.

Stuart, what are the critical early signs we should look out for to tell if we're on the path to stabilization in build times? Would it be product availability or process normalization? Additionally, in the long run, how does the current environment impact strategies or tactics the industry might use to gain better control over the supply chain?

Critical signs include our manufacturers' planning processes and aligning production productivity, which is essential to managing build times effectively. We also plan to onboard additional trade partners to meet demand.

Carl, it’s likely you won't see stabilization signals until they're reflected in our numbers. We'll share updates as these developments occur.

Our Everything’s Included program enables better communications with suppliers and a structured approach in planning. This provides flexibility during volatile times.

My next question is on single-family build rent. What percentage of your deliveries are to non-owner occupants, whether to institutions or mom-and-pop operators? Additionally, are you concerned that well-funded build-to-rent players are impacting land availability in the long term?

We do not keep track of deliveries to final users versus non-traditional users. Many households simply benefit from the availability of single-family rentals in areas with high demand.

We see limited competition for land from other players. Developers want dependable execution, and the market is favoring established builders like us. Our competitive advantage lies in our cost structures.

Our next question will come from Alan Ratner with Zelman.

You’ve discussed material challenges. Your starts were up year-over-year, but down about 2,000 homes sequentially. What drove that, and was that a response to labor tightness or a more strategic decision?

The sequential decline aligns with the normal planning process based on seasonal cyclicality. Starts in the second quarter generally feed into our largest delivery quarter in the fourth, while the third quarter starts contribute to the beginning of the following year.

Understood. Would demand surpassing supply affect your ability to adjust for seasonality from a production perspective?

Though demand is edging ahead, along with our belief in a stronger production pace, we still respect natural seasonality while responding to market conditions.

As our demand remains strong, we continue to execute plans effectively and grow our starts.

Can you clarify your production capacity? Your starts are around 5 per community, but will you achieve that sustainably in 2022 without easing supply constraints?

We need the supply chain to stabilize and adapt to the complexities that will affect outputs early in the year. Although we won’t provide specific guidance yet, we will offer updates in our upcoming quarters.

Looking at sales pace, the East region saw an increase. What’s different about that market, allowing you to maintain a high sales pace?

Florida notably benefits from our competitive position. We have significant control over the trade base, particularly around concrete block construction, which contributes to our strong sales performance.

Our next question will come from Susan Maklari with Goldman Sachs.

Can you elaborate on how your option versus owned strategy is materializing and its implications for next year?

We're focused on transitioning towards a greater optioning model, improving efficiencies in this area, and we anticipate positive outcomes. This strategy involves managing our land delivery pipeline more effectively.

You’ve made progress in lowering SG&A. Can you share the key initiatives behind this and what lies ahead?

Our SG&A improvements stem from numerous small initiatives across departments aimed at enhancing efficiency. We’re also facilitating quicker quarter-end closes. All elements matter significantly to our margins over time. Thank you all for your questions. We look forward to providing further updates in our fourth-quarter report, where we will discuss supply chain developments and market positions. Thank you for your participation.

That does conclude today's conference. Thank you for participating. You may disconnect at this time.