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Lennar’s Gross Margins Have Peaked

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Jan. 16 2015, Published 3:31 p.m. ET

Lennar’s days of increasing gross margins are over

For the fourth quarter, gross margins increased 40 basis points sequentially, to 25.6%. Last year, however, fourth quarter gross margins were 26.6%, which means a drop of 120 basis points. During the latest conference call, Lennar guided 2015 gross margins of 24%, which disappointed Wall Street and sent the stock down over 7%. Gross margins are a function of pricing power and costs. While lower oil prices are making materials like asphalt shingles cheaper, skilled labor is scarce and expensive. With buyers balking at higher prices, margins are compressing.

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Not all of the decrease is due to bad news, however

Part of the reason for the decrease in margins is a new focus on the first-time homebuyer and an expectation of more entry-level communities. While starter homes may have lower margins, there’s a tremendous need for affordable housing. This means you can sell a lot of homes and push through more volume than a luxury builder like Toll Brothers (TOL) can.

Lennar is not the only builder looking at increasing its focus on the first-time homebuyer. D.R. Horton (DHI) has launched a new brand targeting entry-level buyers, and KB Home (KBH) has exposure there as well. We’ll hear soon from PulteGroup (PHM), which is a large diversified builder with exposure at the lower price points.

The first-time homebuyer has been targeted by the Obama administration, and the FHFA has made some changes in order to make credit more available. On Lennar’s conference call, CEO Stuart Miller sounded hopeful that this would help drive traffic at the lower price points, but this requires lenders to make credit more available.

An alternative way to invest in the homebuilding sector is through the S&P SPDR Homebuilder ETF (XHB).

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