Description

Executive Summary

This is essentially a follow-up to the LEN write-up I authored on 1/24/20.  The stock is up >60% since then, so it’s been a successful investment.  However, I believe the stock is about to take another leg up and thus presents a very compelling investment opportunities at current levels.

Specifically, two main catalysts should drive the stock upward from here:

• The Company is current directing its excess cash flow toward repurchasing stock
• The Company is scheduled to spin out its non-homebuilding businesses in 2Q22 or 3Q22

As calculated below, my price target for LEN is $170, up >55% from current levels.  This is based on $152/share in value for the RemainCo entity and $18/share in value for the SpinCo.

Quick Recap

Additional detail and background on the Company and stock is contained in my write-up from 1/24/20 – I won’t repeat things here to keep this write-up brief.  The main macro factors which have helped propel the stock upward remain in place and should provide tailwinds for the stock.  These include:

• Significant supply/demand imbalance for homes in the US driven by the prevailing spread between US household formations and US housing starts
• Low interest rates
• Low unemployment
• Wage growth
• High consumer confidence

As far as LEN-specific factors, the Company has accomplished a lot over the past few years.  Specifically, the Company has:

• Transitioned to a “land lighter” strategy through which the Company (i) reduced its years of owned supply of homesites and (ii) increased the percentage of land controlled through options.  To provide quantitative amounts for this change, in 2Q19 (May), the Company had 4.5 years of supply of owned homesites.  By 4Q21 (Nov), the LEN had reduced this supply to its stated goal of 3.0 years.
• Used the proceeds from its “land lighter” strategy and associated reduction in asset base to pay down debt.  As noted in the Supplemental Data in its earnings releases, LEN reduced its “Net Homebuilding Debt to Total Capital” from 36.2% in 2Q19 (May) to 8.4% in 4Q21 (Nov).

Investment Thesis

Now that LEN has reduced its leverage to its target level, the Company is directing its excess cash flow toward share repurchases.  In 4Q21, the Company repurchased $977mm worth of stock.  This is a sizeable step-up from repurchasing activity for the first 3 quarters of 2021:  1Q21 - $69mm, 2Q21 - $104mm and 3Q21 - $246mm.  Internal estimates indicate that the Company could easily repurchase $2bn worth of stock in each of the next two years without causing real change to its balance sheet.  This should provide not only upward pressure on LEN’s stock price but also enhanced EPS growth.

Further, in conjunction with reporting 1Q21 earnings, LEN management announced on the earnings call their intent to spin-off the Company’s non-homebuilding businesses.  These businesses include: (i) Lennar Multifamily (LMC), (ii) single-family for rent (SFR), (iii) LEN’s land program and land management business, (iv) Lennar Mortgage Finance (LMF), and (v) LEN’s growing technology investment business, part of LENx.  Management noted at the time that they were exploring a tax-free spin-off of these businesses but was unable to provide much in the way of detail as the plans were still in early stages.  Importantly, management noted that LEN RemainCo would “see almost no loss of operating income from the spin-off”.

Then, in conjunction with reporting 4Q21 earnings, LEN management was able to provide a lot more detail on the proposed spin-off transaction.  Management noted that in November 2021, they formally filed a request for a private letter ruling from the IRS for the tax-free spin.  They also noted that they expect to file a Form 10 by the end of January or beginning of February, at which time they will have a name for the SpinCo and a management team in place.  Further, management commented that the SpinCo would be an asset-light management business that will have a limited balance sheet.  The book value of SpinCo’s assets will be $5-6bn.  LEN expects to complete the spin in 2Q22 or 3Q22 which should serve as a value-unlocking catalyst for the stock.

Financial Analysis and Price Target

Internal projections are relatively comparable with consensus estimates as far as revenues, gross margin, operating income, etc.  However, internal estimates are much greater than consensus estimates which surprisingly don’t seem to take into account the Company’s forward share repurchasing activity.

The current consensus 2023E EPS for LEN is $16.87.  Internal estimates project the Company repurchasing a total of $4bn worth of stock ($2bn/year) over the next two years, leading to 2023E EPS of $19.00.  Applying a reasonable 8.0x PE multiple (where LEN has historically traded) on this $19.00 in EPS equates to $152 in value.

Assuming the SpinCo has $5.5bn in assets, trades at book, and doesn’t cause any decline in LEN’s operating income (as management stated on the 1Q21 earnings call), the SpinCo should have a value of ~$18/share, based on 301.2mm shares outstanding.

Adding everything together, LEN shareholders should look forward to their stock trading to $152 and receiving ~$18/share in value through the SpinCo.  This is a total of $170, up >55% from current levels.

Key Risks

The key risks for LEN’s stock going forward are:

• Supply chain challenges – The Company has been very open in the supply chain challenges that they are facing in constructing homes, from procuring windows to garage doors.  Thus far, management has been able to navigate these supply chain difficulties, but they acknowledge that they could cause future disruption to their business.
• Interest Rates – Currently, mortgage rates are at historical lows, increasing the affordability of homes for buyers.  The Fed has indicated they are prepared to start raise interest rates over the course of 2022 to dampen inflation, as necessary.  To see how this would affect affordability, it’s best to walk through a quick example for a single family looking to purchase a $400,000 home with 20% down payment and financed with a $320,000 30-year fixed mortgage at a rate of 3.0%.  The monthly payment on that mortgage would be $1,349.  A 25bp rise in rates increases the mortgage payment to $1,393 and a 50bp rise in rates increases the monthly mortgage payment to $1,437.  So, a 50bp increase in mortgage rates is an $88 increase in monthly payments, or $1,056 annually.  That’s a meaningful increase.  However, there’s been some sell-side studies which have shown that it takes at least 75bps of rate increase to really start causing housing demand destruction due to decreased affordability.

Catalyst

Key catalysts are:

• Company continuing to repurchase shares which should place upward pressure on LEN's stock price
• Spin-off of non-homebuilding businesses in 2Q22 or 3Q22