LENNAR
We strongly believe that Lennar is high quality, well positioned, and well managed. Importantly, Lennar will undergo a very material transformation this quarter with its land spin, Millrose.
Note: All estimates below are pro forma the spin of Lennar’s land assets.
We predict that Lennar’s EPS power will grow at close to a 13-14% CAGR over the next several years, mainly due to continued market share gains (the homebuilding industry is consolidating), benefits of scale and a manufacturing-style model, and accelerated share repurchases.
Our best estimate is that EPS in FY 2027 will be about $20.00. Today, Lennar trades at $134 — before the spin of its land this quarter. The land company, named Millrose, will have a tangible book value of about $22 per Lennar share.
In the spin, Lennar is due to separate off virtually all its land into a REIT called Millrose (NYSE:MRP). Then, Lennar will become truly asset light — and will generate both high returns on shareholders’ equity and large amounts of free cash flow — in spite of fast growth.
The spin of the land is a highly creative step that, in our opinion, totally changes the nature of the company and thus should cause Lennar’s shares to sell at a materially higher PE ratio than in the past. In terms of quality, balance sheet strength (net cash), free cash flows (roughly mirroring earnings), and growth potential, Lennar is an above average company—and the average PE ratio of the S&P 500 Index since 1960 has been 16 X. We additionally note that NVR, an asset light homebuilder that has been growing slower than Lennar, yet has sold at an average PE ratio of roughly 15 X during the past 10 years. At 16 X EPS of $20.00, in 2027 Lennar’s shares would be worth $320 — plus the (taxable) dividend of REIT “Millrose”, which has a $22 tangible book value.
Fifty years ago, most homes were built by very small corporations or by individuals who built only several homes per year. Typically, a builder would purchase some vacant land, have the land permitted to be subdivided into buildable lots, develop the land, and then seek buyers for the houses that would be built. Upon completing and selling the houses, the builder would invest the profits in additional land. The more land a builder owned, the faster he could grow. Builders who wished to grow quickly most often aggressively purchased land, often borrowing heavily from savings and loan banks or commercial banks to finance the purchases and the development of the land. Thus, builders who desired to grow at a fast rate tended to be asset heavy and to be heavily in debt. They also generated poor cash flows.
Over time, the best managed and most aggressive builders grew to a size where they enjoyed substantial cost advantages due to their scale. For example, some advantages that Lennar enjoys by being a scale homebuilder are:
A Change in the Industry: Asset-light
For purposes of analysis, the traditional homebuilding business can be divided into two very different businesses: (1) the construction of homes and (2) the ownership of land. The former is a very good business for the larger builders but the latter is an asset-heavy business. This is because the value of land historically appreciated at only 3-4% per year and the homebuilders that were growing at a high rate needed to invest most or all of their cash flows into the purchase of land (this often necessitated debt). Owning lots of land (and with leverage) also carried impairment risk.
About a dozen years ago, some homebuilders decided to alter their strategy and reduce their investment in land. They commonly accomplished this by purchasing options to take down land at a future date, negotiating deferred payments, or by using “land banks” to hold land to-be purchased at a later date.
Said very simply, the “most” asset-light scenario is where raw land is held by a bank, developed by a third party, and “delivered” to the homebuilder — lot-by-lot and on a “just-in-time” basis. But, land banking and outsourced development is mainly a local business — so historically, it has been difficult for builders to become completely asset light as described on a national scale. In some cases, (again, in general terms) builders may have only been able to outsource the banking of raw land but not its development, or the developer would only accommodate delivering an entire community rather than finished homesites on a lot-by-lot basis.
In the capital intensive model, the builders would require a number of years to turn their assets (raw land needs to be permitted and developed which normally takes at least two years). Under the asset-light model, a builder may only need to invest capital for ~6 months — from taking down the finished lot and through vertical construction (homebuilders hold very little inventory of finished homes). So, the business of the asset light homebuilder marches to a fairly different tune.
In summary, becoming asset light has transitioned Lennar’s homebuilding business from being a fair business to being a very good business—and, conceptually, from being real estate centric to being “manufacturing” centric.
MILLROSE
Come Q1, Lennar will spin substantially all its land into an entity named “Millrose Properties” (NYSE: MRP) — which is game changer and a catalyst that officially separates the homebuilding business from the land business. After Millrose’s spin, Lennar will, with few exceptions, only own the land needed at the time that vertical construction commences. Millrose will become a professionally-managed entity and with the greatest national scale (initially, MRP will have $6.6bn of hard assets). It will take down raw land from land bankers, develop the land, and deliver finished lots (lot-by-lot) to Lennar. Conceptually and brilliantly, Lennar wants land to be an input — delivered “just-in-time” like an appliance from Whirlpool or a faucet from Kohler. After the spin, Lennar will no longer be a homebuilder stuck inside an asset-heavy land business (or even a homebuilder dealing with local, and non-JIT, land banks). Instead, it will become a truly asset-light manufacturer and retailer of new homes. In other words, the fundamental nature — and quality — of its business will markedly change come this spin.
More Commentary on Homebuilding
In recent years, most of the larger builders have made another transition that has improved the quality of their business. Instead of building houses one by one as orders are received, most now heavily rely on the mass production of houses, with many houses under construction before they are sold (usually an order is received before construction is complete). A subcontractor might finish constructing the foundation for one house and then immediately start constructing a foundation on the adjoining lot—and, when the second foundation is complete, immediately start working on the next adjoining lot—and so forth. By producing homes on almost an assembly line basis, costs are materially reduced (in some ways, Lennar and the other large builders are doing to homebuilding what Henry Ford did to the production (and costs) of automobiles).
Over the next 10 plus years, Lennar and the other homebuilders should benefit from the underbuilding of new homes that occurred from 2008 until now. Most industry observers believe there is a shortage of 2,000,000-3,000,000 housing units in the United States. About 1,500,000 new housing units are needed each year to satisfy population growth and the tearing down of existing houses due to age, fire, storms, etc. There is a general belief that, due to supply constraints on permitted land and on some materials, the capacity to build new housing units is limited to about 1,700,000 per year. If so and if the industry did produce 1,700,000 per year, it would take 10 -15 years before the existing housing shortage ends. Thus, under normal circumstances, the demand for new homes should be firm. Abnormal circumstances could include softer demand during recessions or during periods when mortgage rates increase sharply. Prospective purchasers of new homes typically spend considerable time (often months) shopping for the right house at the right price. If, during the search, mortgage rates increase sharply, many prospective purchasers will become upset that they missed the opportunity to lock in a mortgage at the previous lower rate—and will defer their purchase. However, and importantly, families need to live somewhere—and many families with young children need extra space and desire a backyard and a good school district. Thus, after becoming acclimated to the higher rates, many families resume their search and purchase a new home (sometimes a less expensive one than originally desired). In the very short term, the demand for new homes is elastic, but in the intermediate term it is quite inelastic. Interestingly, in the twenty-year period 1980-1999, housing completions averaged 5.05 units per 1,000 U.S. persons in spite of mortgage rates averaging 10.4%. Since the population of the U.S. currently is about 340 million, a completion rate of 5.05 units per 1,000 would equate to 1,700,000 completions.
Lennar History
Lennar was founded in 1954. For the next 18 years it remained a tiny but growing company under the leadership of Leonard Miller. Desiring to have the capital to grow rapidly, Leonard Miller took Lennar public in 1972, raising $8.7 million. In 1997, Leonard Miller retired and his son Stuart became CEO. Stuart Miller has been a particularly brilliant and capable leader. Some of his key accomplishments are:
All of the above had made Lennar into a gem of a company that is a low cost producer, that gains market share, that earns a high return on invested capital, that generates large amounts of free cash flow, and that has a pristine balance sheet.
Finance
During the past five years, Lennar has transitioned from a company that owed a substantial amount of debt to a company whose homebuilding operations on November 30, 2024 had about $2.4 billion more cash than debt:
In our opinion, this is a brilliant and important transition. The cash flows behind this transition are as follows:
During the 5-year period, Lennar’s homebuilding revenues increased by 64%, yet the company only needed to invest 11.7% of its earnings to finance this growth.
Looking ahead, with the creation of Millrose, Lennar believes that its free cash flow will become “pretty close” to its net income. Now that the company has no net debt, management has stated that it intends to return more of its free cash flow to shareholders in the form of repurchases.
As indicated above, during the 5-year period that ended on November 30, 2024, Lennar reduced its share count from 316 million to 269 million, which is equal to a 3.2% CAGR. For the sake of having a number to work with, we will project that between FY 2024 and FY 2027 Lennar will reduce its share count at a 3.7% CAGR, calculated as follows:
Based on the above projections,, the average diluted share count in FY 2027 will be about 246 million, down from 275 million in FY 2024.
Revenue Projection
The following table shows Lennar’s deliveries and homebuilding revenues for the past 7 years.
Of importance, during the period 2018-2023, Lennar’s community count declined slightly, partially because the company was focusing on reducing its investment in land and partially due to difficulties of getting land permitted for development. Because Lennar strongly desired to hold its production at a level where its subcontractors could be offered steady work, Lennar resorted to offering larger than normal incentives (discounts) to home buyers in order to increase orders. Recently, Lennar has indicated that it expects its community count to increase by more than 10% per year for at least the next few years. Such an increase should permit the company to provide steady work for its subcontractors without the need to offer particularly high incentives. Thus, Lennar intends to permit its absorption rate to decline—which will result in the growth in deliveries somewhat trailing the growth in community count. Our best guess is that, over the next three years, deliveries will grow at an 8% or so rate, average selling prices will grow at a 2% or so rate (with reduced incentives adding to realized prices), and therefore revenues will grow at a 10% or so rate to about $45 billion in FY 2027.
Projecting Operating Margin
The following table shows Lennar’s operating margins for the past 7 years:
When analyzing the gross margins in the above table, we note that (a) average margins in 2018-2019 were reduced by relatively low margins in former CalAtlantic communities (CalAtlantic was acquired in early 2018), (b) margins in 2021 and 2022 were higher than normal due to the particularly tight housing market coming out of COVID, (c) margins in 2023 were depressed by materially higher than normal incentives, (d) all other things being equal, margins should increase some over time due to efficiencies of scale and due to Lennar’s continuing efforts to reduce construction costs, and (e) fees paid to Millrose for the banking of land will have some negative effect on gross margins.
On balance, our best estimate is that Lennar’s normal gross margins in FY 2027 will be 22%.
When analyzing SG&A (which in our definition includes corporate expense — Lennar breaks out corporate expense seperately), we note that (a) in very recent years, Lennar spent heavily on technology, and (b) in 2023 and 2024, in order to increase sales, Lennar paid higher than normal commissions to outside brokers, and (c) a large percentage of SG&A costs are fixed, so, over the next several years, revenue growth of about 10% should lead to a material decline in SG&A as a percentage of revenues.
Our best estimate is that the percentage of SG&A + corporate costs to revenues in FY 2027 will be 8.5%. Thus, we project that Lennar’s operating margin in a normal environment will be 13.5%.
Projecting EPS
We project that Lennar’s earnings power (which assumes a normal environment) in FY 2027 will be about $20 per share. The calculation is:
Homebuilding operating profit ($45.1 bil revenues X 13.5%) 6,088 mil
Financial services profit 625
Charitable contributions at $1,000 per house (101)
Profits from land sales and other 0
Pre-tax profits 6,612
Taxes at 24.5% effective rate (1,620)
Net income 4,992
EPS (246 million shares outstanding) $20.29
P/E
We strongly believe that Lennar is a materially above average company. In our opinion:
According to our calculations, the average PE ratio of the S&P 500 Index since 1960 has been 16 X. If Lennar’s key attributes are above average, why shouldn’t the company’s shares sell at an above average PE ratio?
Now that Lennar has adopted the asset light strategy of purchasing its land just-in-time (the formation of Millrose is a game changer), the company can be compared to NVR, which has been the poster child for being asset light. NVR is an excellent mid-sized homebuilder, but one whose growth opportunities are limited because it is more of a regional builder. Over the past 7 years, Lennar’s deliveries grew at an 8.4% GAGR while NVR’s only grew at about a 3% CAGR. During the past 10 years, NVR typically has sold at an average PE ratio of 15 X. Given Lennar’s growth opportunities, we believe it deserves to sell at a PE ratio higher than NVR’s.
We conclude that Lennar The Homebuilder is worth at least 16 X earnings—and therefore will be worth at least $320 per share in mid-2027. It is reasonable that, due to the land spin, Lennar’s P/E will have to be re-appraised. It will be a totally changed company in its nature, business quality, and prospects.
And, speaking of the Millrose spin, shareholders will receive the new company, which will be a REIT, in the form of a taxable dividend. The spin will have a book value of $5.97bn which is approximately $22 per Lennar share. Those interested can read Millrose’s recently filed S-3.