Lennar’s Price Concessions Have Bolstered Demand and Protected Its Backlog

As the U.S. housing market softens, Lennar LEN has proactively offered a combination of base price reductions and sale incentives (for example, mortgage rate buydowns) to persuade more-skittish consumers to purchase its homes and prevent order cancellations. This strategy appears to be working as intended as fiscal first-quarter orders declined 10% year over year, outperforming management’s guidance for a 14%-24% decline. The average selling price of new orders declined 9% to $452,000.

While the first-quarter cancellation rate was still elevated at 21.5% (compared to 10.2% last year), it was a marked improvement from last quarter’s 26%. Of course, lower profit margin is a consequence of this pricing strategy. Indeed, first-quarter home sale gross margin of 21.2% contracted 570 basis points year over year. While Lennar’s profit margins will suffer this year (we model a 21.3% full-year gross margin compared with 27.7% in 2022), we expect Lennar will generate outsize cash flow as it converts its $9 billion backlog and reduces land acquisition spending. Strong cash flow generation in 2023 will further strengthen its excellent balance sheet, which finished the quarter with more homebuilding cash than debt (its net homebuilding debt/total capital ratio was negative 0.1%). As such, we believe Lennar is very well positioned to resume its growth engine when stronger housing demand returns in 2024-25.

We’ve increased our fair value estimate 2% to $120 per share, primarily due to the time value of money since our last update. Lennar’s stock currently trades about a 15% discount to our new fair value estimate. We continue to see favorable longer-term housing dynamics, but we think the market is more focused on the challenging near-term environment.

Considering elevated market uncertainty, management continues to offer only full-year delivery guidance, which is now 62,000-66,000 homes (versus 66,399 in 2022) modestly better than previous guidance of 60,000-65,000 homes.