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Lennar’s Debt-to-Equity Ratio Seems on the High Side

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Managing debt-to-equity ratio is important

Homebuilding is a very capital-intensive business. For more on that, read Market Realist’s latest homebuilding industry overview series. The business needs continuous availability of capital to run the show at competitive rates. Managing an adequate debt-to-equity ratio is thus very important for the long-term survival of a company.

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Debt level is increasing

Lennar Corporation (LEN) finances its construction and land development activities primarily with cash generated from operations and debt issuances. As of November 2014, the company had consolidated debt of $6.02 billion. Lennar Homebuilding’s average debt outstanding was $4.7 billion with an average interest rate of 5.2% for the year ended November, 2014. In the previous year, it was $4.4 billion with an average rate of 5.1%.

Debt for Lennar Financial jumped from $272 million in 2010 to $704 million in 2014, since it uses Lennar’s facilities to finance its lending activities. The increase in debt level indicates that lending activities are growing at the financial segment.

Lennar is raising funds at competitive rates

In February 2015, Lennar issued $250 million of 4.5% senior notes due 2019, which was below its average rate of 5.2%. This indicates that big builders such as Lennar (LEN), PulteGroup (PHM), D.R. Horton (DHI), and Toll Brothers (TOL) are able to raise funds at competitive rates from the market, while local players struggle and have to rely on bank funding for their capital needs.

Lennar’s debt-to-equity is higher compared to its peers

Lennar’s debt-to-equity ratio was 0.74 in 2007 during the housing crisis. It peaked to 1.68 in 2011 when housing woes seemed to be under control. As the economy gathered steam, it reached 1.25 by the end of fiscal year 2014.

Lennar’s debt-to-equity ratio seems to be on the high side compared to its peers. Toll Brothers (TOL) has a debt-to-equity ratio of 0.85 followed by D.R. Horton (DHI) with 0.71 and PulteGroup (PHM) with the lowest at 0.42.

Companies that are too highly leveraged often find it difficult to grow because of the high cost of servicing the debt. On the other hand, debt does not dilute the owner’s ownership interest in the company.

Debt-to-equity ratio is an important criterion for long-term investors such as the SPDR S&P Homebuilders ETF (XHB) and the iShares Dow Jones U.S. Home Construction Index Fund (ITB).

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