As much as people want to believe in the “green shoots” of a recovery, the housing market continues to be a persistent reminder that all is not well. Yesterday the new homes sales data for May came in lower than expected, and the supply of unsold homes would last more than 10 months at the current pace of 342,000 annual sales rate. That being said homebuilders have restrained building over the last few quarters and the number of new homes for sale that are still under construction fell to the lowest level since 1970! Even existing home sales were weaker than expected, although they did show an increase of 2.4% over last year; the existing home supply would last 9.6 months at this sales pace. This tells us a couple of important things, one is that even if there is pent up demand, home buyers there are plenty of existing homes for sale through foreclosures, etc. Also, home construction has necessarily slowed quite a lot, this is what the market needs to chip away at the supply overhang, but we anticipate further difficulty for home builders in the quarters ahead.
On Thursday morning, residential construction company Lennar (LEN) reported dismal results for their fiscal second quarter. Analysts had a wide range of expectations but the consensus called for a quarterly loss of $.64 on revenue of $597.5 million, but although revenue greatly outpaced expectations the bottom line earnings results was a loss of 76 cents. The worse than expected overall results were dragged down in large part by write-downs on land values amounting to about 65 cents.
When you taking away the one-time charges Lennar actually performed quite well given the circumstances, and spurred by the operating performance the stock is up about 13% this morning. However, it seems to be a little bit of a contradictions in the home building industry to call these write-downs a one-time event. The write-downs have been a storyline in each quarter for nearly all homebuilders for the last two years, and many times the write-downs have been severe. The good news is inventories fell drastically by 53% at Lennar, and even though orders were down 19% from a year ago, they were up by 63% from the first quarter. Cancellations also improved from the low 20% to just 15%.
Lennar is starting to show signs of recovery, and on the whole we have the stock’s valuation at current price levels as Fairly Valued. However, we are slightly more positive on this stock than the Residential Construction sector as a group. We are not bullish on the sector yet because of the supply glut that continues to be a major problem in housing, and the fact that all homebuilders have land assets that are continuing to lose value. As of year end 2008 Lennar owned more lots than any homebuilders besides Pulte Homes (PHM) and D.R. Horton (DHI). We are starting to see what could be the beginning of a rebound, but it is too early to tell and these homebuilder stocks are still too risky for our tastes. Write-downs continue to wear on earnings and we are hesitant to recommend any stock that has not turned a profit in 10 of the last 11 quarters, especially when there is a history of profitability as is the case for Lennar.