Lennar Reports Its 3rd Consecutive Drop in Gross Margins in 2Q15



Lennar’s days of increasing gross margins are over

In the second quarter, Lennar’s (LEN) gross margins sequentially increased by 70 basis points to 23.8%. Last year, however, second-quarter gross margins were 25.5%, which was a drop of 170 basis points. That said, last year’s gross margins were boosted 60 basis points due to non-recurring items, so the year-over-year comparisons aren’t as bad as they initially appear.

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.

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Lennar has found a profitable way to wait for the first-time homebuyer to return

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. An alternative way to invest in the homebuilding sector is through the SPDR S&P Homebuilders ETF (XHB) or the iShares U.S. Home Construction ETF (ITB).

Focus on the high-end first-time homebuyer

Lennar is focusing on the high-end first-time homebuyer and the move-up market, which is why its average selling prices remain higher than either D.R. Horton or Pulte.

Given the difficult situation many Millennials find themselves in, many have become renters. Lennar has been building out its apartment strategy, which has benefited from good timing as rents are soaring and vacancies remain at historic lows. It’s a good way for the company to take advantage of current conditions and wait for the first-time homebuyer to return.


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