Homebuilders: Lennar's Loss Deepens the Pain

The company's hefty third quarter loss came amid sagging sales and big writedowns, and signals more trouble ahead for the rest of the industry

The latest numbers from Lennar Corp. (LEN), the first of the homebuilders to report financial results for the third quarter, exceeded Wall Street's worst expectations and didn't bode well for the rest of the battered homebuilding industry.

The nation's second-largest homebuilder said on Sept. 25 that its results swung to a net loss of $513.9 million, or $3.25 a share, for the three months ending Aug. 31 from a profit of $206.7 million, or $1.30 a share, a year ago. Revenues from home sales fell 44% -- mostly on a 41% drop in the number of home deliveries and a 6% decline in the average sales price of homes sold.

Lennar had to suck it up financially to move a lower number of houses. Gross margins fell to 14.0% from 19.5% a year ago due to a $10,100 hike in sales incentives to $46,000 per home, which was responsible for the lower average sales price.

And sagging home sales weren't the only nightmare for Lennar. The Miami-based company took an $847.5 million pretax impairment charge to write down the value of its assets. That included a $344.7 million loss on land sales, of which $242.5 million was for write-offs of deposits and pre-acquisition costs related to 15,000 home sites under options that Lennar decided not to buy.

This was the biggest writeoff Lennar has taken since the housing slump began and added to the $1.05 billion in write-offs the company has taken since 2006, Banc of America Securities said in a research note (BAS does investment banking with Lennar.)

Excluding the $847.5 million charge, which equates to $3.33 a share, the company earned a profit of eight cents a share in the latest quarter.

The consensus estimate among analysts polled by Thomson Financial was a net loss of 55 cents a share.

On Sept. 25, Lennar shares logged a new 52-week low of $22.53 before rebounding a bit to trade 3.5% lower at $23.34.

The Lennar news was only one of a number of downbeat developments for the housing sector on Sept. 25. Reports released that date showed a big decline in existing home sales for August and a slide in a nationwide home-price index in July.

Lennar was hurt "because of the magnitude of the write-offs. They are the first company to report and give some indication of what August looks like," said Paul Puryear, an analyst at Raymond James & Associates. "Everybody is stepping back and saying how bad is this? How long and how deep is this downturn?" (Raymond James received non-securities-related compensation from Lennar within the past 12 months.)

The fact that Lennar's stock wasn't getting hammered as badly as some of its rivals like Standard Pacific (SPF), which was down 11.1% on Sept. 25, was only because Lennar was ahead of the curve when it began to aggressively price its homes to market to early in 2006 in order to dispose of inventory.

The company has kept its focus on inventory, by holding off to some extent from building new homes before contracts are signed. Construction starts were down 62% in the third quarter from a year ago, CEO Stuart Miller said on a conference call to discuss the latest results.

Because of the efforts it's already made to reduce inventory and its stronger balance sheet – it has a total debt-to-capital ratio of 33,.5% -- Lennar doesn't need to join in the fire-sales that some of its competitors have opted for recently, Miller said.

Lennar's new orders fell 48% from the prior-year period to 5,804 homes, while cancellations rose three percentage points from the second quarter to 32%.

New orders deteriorated from a 31% year-over-year decline in the second quarter and were worse than the 22% drop that BAS had expected, probably due to more challenging market conditions overall and tough comparisons with the high sales volume Lennar maintained throughout 2006, the BAS note said.

BAS cut its estimate for fiscal 2007 to a net loss of $4.77 a share from an earlier forecast of a $1.90 loss and reduced its fiscal 2008 estimate to a $1.95 loss from a $1.80 loss.

"To the extent that we see pricing go down further, we're going to see more writeoffs," Puryear at Raymond James said.

The homebuilder's negative operating margin improved to -2.1% in the third quarter from -2.9% in the second quarter, most likely due to the company's aggressive strategy of pricing to market, Deutsche Bank Securities said in a research note. Consequently, once the housing downturn has run its course, Lennar's margins could rebound sooner than those of its peers, the note said. (Deutsche Bank doe and seeks to do investment banking with the companies it covers in its reports.)

But the recovery will probably occur by geography, with certain markets coming back earlier than others. And it will also vary by price point of homes. Those two characteristics will determine which homebuilders bounce back first, Puryear said.

"We always thought Toll Brothers (TOL) at a high price point has a more durable buyer, a buyer who could come back to the market quicker," he said. "We haven't seen that yet. They're also the shrewdest buyers and most likely to play the market and could come back later."

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