Chit Chat Stocks - Lennar Corp (LEN) | Not So Deep Dive

Episode Date: September 21, 2021

Lennar Corporation is the largest home construction and real estate company in the United States by revenue. The company acquires land at various stages of development, then hires out contractors to develop the land so it can be ready to sell. Listen closely as Brad, Brett, and Ryan go through the history, financials, and future prospects of Lennar Corporation. Enjoy the show! Our Tuesday Not So Deep Dives are sponsored by Potential Multibaggers. Multis are looking for stocks that have the potential to go up 10x in 10 years. Check-out the service here: https://seekingalpha.com/checkout?service_id=mp_1308 Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney 50% Off Motley Fool's "Stock Advisor" program: https://www.fool.com/chitchat1 Interested in more of Brad’s work? Find his Substack: https://stockmarketnerd.substack.com/ Rather watch us on video? Subscribe to our YouTube channel: https://www.youtube.com/channel/UCG5Ni-SI-jyrEsoNUhqftNQ Contact us: [e-mail] Timestamps Company Background | (4:37) Industry | (9:42) Management & Ownership | (11:52) Valuation | (15:32) Earnings | (17:11) Balance Sheet | (19:39) Our Analysis | (22:40) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, hosts Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or a recommendation. Now, please enjoy this episode. Welcome in. This is the Tuesday Not So Deep Dive episode. We have Brad Freeman on the show. We're in the new format. It's been a few weeks now. I think it's going well.

If the listener uptick per episode is any indication, this is a better pace for everyone. And today we're going to be talking about Lenar Corporation. This is not the sexiest stock. we may be eating our fruits and vegetables today. Dessert comes later. I don't know if Ryan has a good, you know, exciting one. I'll give a sexy intro. I mean, this is, you know, if we're in a housing bubble, we'll get to the bottom of it today. Yeah. Well, we'll see. Brad, I know Ryan and I have not followed this stock at all. Have you looked at it ever before? I have never owned any kind of real estate play or iBuying or anything like that. So no, this is a brand new industry to me. I actually, I start my internships were all in real estate. So I shouldn't say it's

a brand new industry, but it's a brand new public market industry for me. Yes. Hopefully we can learn a bit about the home building market, some of their unit economics today. But first let's talk about our flagship sponsor for the not so deep dives, Potential Multibaggers. You've heard us talk about them before. Potential Multibaggers is trying to find stocks that can go up 10X over the next 10 years or compound at 26% per year. You might think that is a lot, but so far their track record has actually been better than that.

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so you know if you say that i don't know why we are friends with the company yeah we are friends with the company we talk with them all the time but they are offering through our show uh only 99 for their flagship stock picking service called stock advisor that's right so the link will be in the show notes um it's like chit chat money one or something like that it will make it really easy to find for you so if you ever want to think about you know signing up for molly fool they're going to give you a huge discount right now the purpose of the molly fool is to make the world smarter happier and richer and they believe in long-term investing if they do their job right they keep delivering market beating stock picks. I think they're about three X what the market has been

for the past two decades. Most people have probably heard of the stock advisor before. Yes. You've seen the ads. They're a lot, you know, they're a very big service, but if you haven't, you know, if you've ever thought about before, this is a perfect opportunity. $99 for a full year. They have a 30 day money back guarantee. All you have to do is click the link in the show notes and enter your email, help us out a bit, help yourself out, help the Motley Fool out. All right, Ryan, do you want to talk about Lenar Corporation? Yeah, so Lenar, it's not an overly complex model, but there's a lot of moving parts. And home building is sort of an industry we're relatively new to.

So I'm going to try to lay the foundation of really the entire company pretty thoroughly. And so Lenar is the largest home builder in the United States by revenue. They operate in 20 different states throughout the U.S., ranging from coast to coast. uh there's they have different segments they break it into i think five different groups but there's they have texas they have arizona they have the west coast they have the east coast they have florida it's all over the place whereas some home builders are a little niche to specific areas and so the way it works from lenar's side is they acquire land that fits into three different buckets for them the first category is finished land so that is land that's ready for them to

begin the home construction process the second is land under development so in this bucket land is probably a little less than four to five years away from getting ready to start the construction. And then the third is land that's more than four or five years away from being ready. So they still need to gain approval from whatever the jurisdiction or the regulating body is to develop on that land. They might have a whole bunch of planning still to go into preparing that land. And so if it's in the first bucket, that land gets carried on the company's balance sheet. If it's in the second or third bucket, they are actually structured as option agreements with various partners to acquire the land. So that's basically just a way of saying

that's how they get the land to build on. Then once it gets into that group one or that bucket one, that's where Lenar starts the building process. And so they typically hire independent contractors for most aspects of the home construction process. And the homes they are building include first-time homes, move-up homes, active adult luxury, and multi-generational. And so these are all pretty much higher-end homes. For reference, the average selling price of a Lernar home was around $400,000 roughly in 2020. And if that doesn't sound high-end, because maybe you're in California or Washington, there are a lot of homes here in like Texas. So that is a higher-end home. And you can go ahead and look at a lot of the homes they have on their website. Look at that website. You know, those kind of scary, you know, infinite cul-de-sacs of the same looking home.

um i think that's what laura does yeah well they look the you know the exact same and you might you know that's kind of those pictures where they're like oh wow look at this community you're you're on these homes that all look the same uh you know it's a pretty successful business and laura's been doing it for quite a while and they their services actually go well beyond the constructing process too so you've got they they manage the marketing process so they hire consultants for like in-home walkthroughs i think they pay either on commission or on salary stuff like that. And then they advertise through digital channels, different listing sites, all that good stuff. And then once they've got a buyer, they also have a financial services

operation so they can help with the closing of the house. This includes title insurance, closing services, mortgage underwriting. And then just, this is basically a part of their balance sheet, but it's not integral to their core business, which is they have tons of other investments. There's land investments, there's investments in open door, which I'll kind of mentioned later in the earnings. And really, there's just a whole range of different things they're doing. That's not super material to their business, but it's there. And then as far as history goes, Lennar is pretty old. So they were actually started in 1954 in Miami, Florida by Gene Fisher and Arnold Rosen. Originally, it was known as F&R Builders, I believe for Fisher and

Rosen. And then two years later, Leonard Miller joined as a co-owner. I'm assuming he bought out Gene Fisher's stake because on the company's corporate history, they never mentioned Gene Fisher again after the founding part. But so then Leonard Miller and Arnold Rosen were kind of running the show. And after 15 years of building up the business, they changed the name to Len R, which I believe is for Leonard and Arnold, and took the company public in that year. So that was 1971. In 1981, they began expanding into mortgage financing. And in 2000, they acquired us home and doubled in size over the last 20 years they've added a bunch of new products different home types and then in 2018 if you're looking at like the 2017 financials their

deliveries their home deliveries go from like 25 000 to 45 000 that's because they merged with cal atlantic homes to create the world's largest home builder or sorry the us might be the world's largest but uh yeah dr horton can well there was at the time dr horton might have passed them but one of the two yeah all in all lennar seems like a a really good example of what just having a steady culture and steadily doing what you're doing well for a long time what kind of compounding that can create because today uh they're still growing and they've been around for 70 years and pretty good stock returns if i'm not mistaken yeah it's been i don't know what the cagger was but it's been a great return if you've held it for a long, long time. I'll hit industry. This

is a pretty simple one, but I know that this can be a hot topic. So if anyone has any, I don't want to hear any actuallys on this because I know it's all estimates and stuff like that. And there's always that person that's going to say, you know, I don't know. There's a lot of hot takes on this, but there was a good report out from the White House that summed it up clearly. We might link that in the show notes. But what you need to know is, I think from a high level, housing inventory is at really an all-time low for the last decade. It's only at about three months, meaning if there was no new homes built, we'd run out of supply in three months. And that was back in June. Prices are rising 19% year over year right now. That'll probably

cool off a bit. But again, it's a very simple supply and demand thing. There's not enough homes out there. There's a lot of people that want to buy homes. That means the prices are going to get bid up a bit. And that is good news for home builders. And then the estimated total shortage of homes is about 3.8 million. There's a lot of other numbers that fly around out there. Some say like three, four, five, or even six. But I think the takeaway is that there's a big shortage of homes for the next decade or something like that for what the demand is going to be from a demographic level. And the home builders are going to have to build them. For reference, Lennar delivered about 14,500 homes last quarter. So 3.8 million homes is a lot,

even for all the large home builders out there. And there are a ton. So competition includes VR Horton, Pulse Group, NVR, KB Homes, tons more. I don't know if it's necessarily something to focus on, but you can compare all the different companies to see what their margins are like, who's getting the best operating leverage, who's growing the quickest, et cetera, et cetera. Yeah. To paint a picture of this housing shortage that we're having, I believe I saw somewhere that there are more real estate agents than homes for sale. Yeah. I mean, the regulatory stuff has been a bit insane.

And that White House memo kind of outlines how they hopefully want to fix that. But that's not going to come. I mean, that stuff takes years and years to happen. And one of the solutions will be for someone like Lenar to build more. All right, let's hit management and ownership. Brad seems like he has some interesting things here. For sure. So the executive chairman and Ryan was telling me before the show that he interestingly kind of runs the earnings calls.

It was either Ryan or Brett. Sorry, it was one of the two. But he is the executive chairman currently, but sounds like he has a little bit more active of a role with leadership than most executive chairmen. He's been climbing the ladder with the company for 35 years, three, five years. He's a board member for Alonzo Morning Charities, and he was also the CEO of Lenar for 21 years until 2018. and just running down the list of leadership, you'll see a very clear trend developing that I'll explain afterwards. So Rick Betwitt is the co-CEO and co-president. He's been with the company for 15 years, climbing the ladder. He's the current board of directors for two publicly traded companies, Eagle Materials, which is a building materials company, and Five Point

Holdings, which is a real estate development company. Let me interject there. They own 40% of five point um lenard does uh cool yeah so sorry continue no good interjection thank you so he's a he's a board of director uh he was a bod member at dr horton until 2003 and he was the president at dr horton um until kind of moving on to lenar uh he was the former managing partner at evp evp capital um and he was part of the m&a financing team with lehman brothers but we won't hold that against him. So John Jaffe, co-CEO and co-president. He's been with Lenar for 38 years where he started as a regional president. He's also a board of director at Five Point Holdings, which Brett just told us they have a large stake in. Also Open Door and True Anthem.

The COO, so all I'll say about him is he sold his business to Lenar and then he worked for Lenar for 15 years, climbing the ladder until he was the COO of the company. So this trend that I'm really hitting on is their, their executive team, their management team really sticks around for a very long time. They are extremely loyal. You don't see these kinds of tenures consistently throughout executive teams very often. And it just speaks volumes to that culture aspect that Ryan was talking about before. But ownership, according to their most recent proxy statement, this was in February. So it's about a half year old now. So just keep maybe a little bit of a grain of but it should be pretty accurate. Directors and officers own 1.8% of the Class A common stock.

Keep in mind, this company is 70 years old. They've gone through several large acquisitions and institutions have been accumulating for seven decades. So Stuart Miller, interestingly, however, owns 58% of the Class B common stock with all other directors owning 0.4 combined. And that's according to the proxy statement. And then over 90% of the Class A float today is held by institutions. Exactly who you'd expect at the top of the list, Vanguard with 10.5%, BlackRock with 8.2%, and 1,000 institutional firms with a sizable stake overall. Yeah. And it seems like Lenar's done a great job being able to retain talent. Another interesting point is that a lot of those institutional funds are starting to get into this industry,

or at least pouring capital into it. And so I believe they may have partnered with a lot of these investment funds as well. Um, so it's kind of like this convoluted network of financing. Yeah. Which makes it a little tricky. Don't confuse BlackRock with Blackstone though. I've made that mistake before. Blackstone's the big, the big real estate one, but maybe BlackRock's doing it as well. They're in it. Um, but yeah, that, uh, that management stuff is very interesting. I thought that was a great, um, uh, we always talk about red flags. I don't That's a huge positive, I think, seeing all that. But I'll hit valuation quick.

Pretty simple. Market cap, $30 billion. Enterprise value, $35 billion. Brad will get to the balance sheet to talk about why. You might look at that trailing cash flow number and think that this company is really cheap, but they over-earned on their conversion from earnings to cash flow in the last year. And I bet that is because they weren't building up inventory. Historically, every year before that, their conversion to cash flow has been very low.

average is like 60 70 some years it's negative so that's why they get a low multiple go ahead right i would reading the commentary in the conference call it seems they are trying to transition to this low inventory model the just-in-time inventory to buy the land when it's more in that bucket one they i guess we can talk about this in the second half they claim asset light i'm a bit skeptical that they're it's i think it might be like they talk about where an asset like HomeBuilder, I think that's a bit of an oxymoron because how are you ever going to escape this inventory? But maybe they will. They know the industry better than I do. Just some quick things here. EV to EBITDA of 7.4 over the past 12 months. EV to earnings of

about 10.5. Typically, at least myself, I'm kind of anti-net income. I usually like to look at cashflow. But for this company, I think I like using net income better. I think EV to earnings is probably my preferred metric for tracking the valuation here at about 10.5. And then the other thing I would say, dividend yield is about 1%. Not that meaningful. They do buy back a bit of stock, but not too much. Again, because the cash conversion isn't that great. Ryan, do you want to hit earnings? Yeah. So there's some kind of unfamiliar nomenclature in the earnings. So I'll try to break things down. I'm sure people understand it and maybe I'm like dumbing it down more than I have to. But so revenue in the second quarter, which is easy enough to understand was

6.4 billion. That was up 22% from a year ago. The trailing 12-month revenue was around 24 or 25 billion. And then the two factors that are pretty important to pay attention to are the backlog and the deliveries, also average selling price, but that kind of depends on the type of home that they're selling. So deliveries in the second quarter was about 14,500 homes. That's up 14% year-over-year. New orders increased 32% year-over-year with the new order value growing at 56% year over year. So prices are coming up as well. And they've got roughly 25,000 homes in their backlog. Gross margin improved dramatically from 21.6% to 26% in the most recent quarter. And they had $831 million in net earnings. That was growing 61% year over year.

Something that's kind of interesting, they had to knock off $100 million in earnings because of the mark to market losses on their open door investment. So that's the only caveat I'd say to having earnings be the good. Adjust for that. Yeah. If you do sort of adjusted earnings, which I believe they give you, you can kind of find that multiple as well. Because obviously that mark to market, as long as they're not selling, doesn't really affect their cashflow. And then for the fiscal year, 2021. So this year, Lennar expects to deliver 62 to 64,000 homes with an average selling price of 420,000. That's last year, the average selling price was 395,000. I believe they're focusing still on a lot of the same home types. So

that's probably a sign of strong demand. And then that's about, it equates to $26 billion in home sales revenue. Keep in mind, they also garner, I believe it was something around 400 million in operating earnings from their financing segment. And then they're guiding for 26 and a half to 27% gross margins. So it seems like that improvement on the gross margin front is here to stay. Yeah. And that's a good point. The financing part of the business is very important. It's a small part of revenue, but it is highly profitable. If you're really interested in this business, I would research how that works. I would be worried about how that gets affected by interest rates or stuff like that. That is more important than you would look at from revenue at first

glance, but that's something for, you know, not this episode, Brad, do you want to wrap up the first half of the balance sheet for us? Sure. So the company's got $2.6 billion in cash on hand as of this quarter. It's got negative $800 million in net receivables, but that's a pretty consistent theme across these large nationally scaled home builders. They have another $10.4 billion in finished inventory. Ryan was getting into what that bucket kind of means. Another $8 billion in land and developments. And then so the bridge to $30 billion in market cap to $35 billion in enterprise comes from roughly $5.8 billion in senior notes and debt payable. It also has $2.2 billion more in what it calls other liabilities. I dug really deeply to figure out kind of what

that meant and didn't find much. But its interest expense is not really too bad at $94 million as of last quarter, with a 4.9% average rate on that $5.8 billion in debt. It's got another $2.8 billion dollar credit facility. And it's issued roughly $1.5 billion in new stock since November of 2020. Not nothing, but not crazy, not ridiculous, but it could get crazy. It could get ridiculous if that continues and stays consistent going forward. Unsurprisingly, this is a really, really capital intensive business. So the debt on hand and the large credit revolver can kind of be expected. But it also means maybe there's somewhat of a competitive of moat bill because it takes so much capital, so many resources to keep a business like this

up and running. For sure. I agree with that. I guess, or go ahead, Ryan. They've improved their liquidity position too, if I'm not mistaken. They've kind of reduced their debt load. Yeah. So they acquired Atlantic 2018. That's why the share count went up that year, but they financed that. I forget the exact number with some debt and they're trying to get that back down to a more reasonable level. And another note is that the S&P Global just upgraded their credit rating. So hopefully once they get new debt, which I think will be a continuing part, they're going to always want to have some just for the financing part of this business where

the cash flow can be bad for like a year or so sometimes. Hopefully the interest rate on that goes down from that 4.9% because that is a bit high compared to a lot of other companies out there. And I guess one other note I'd say is we're recording this right when Evergrande is collapsing in China. and that was because their assets that they had on there were not there. They weren't not there, they were way too high. What was Evergrande? They were that real estate developer that collapsed in China or is collapsing right now.

They can't pay their interest on their debt. I wouldn't think that's a concern for Lennar. It seems like they're fine. But when you look at that inventory and the land developments, if you're an investor, it's kind of hard. You have to think, okay, these are just estimates on the net worth fear of that um maybe look at some other factors like average selling prices home prices in the united states demand for homes you know if it's something's overbuilt all that stuff um if whether that's worth what that what they're saying uh but let's not ramble too on there or brad you have something nope okay uh let's not ramble on too much there let's hit the ad break and we'll get back and do more analysis on lenore corporation this family is on the brink of civil war on

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Next up, we have anecdotal evidence. Brad, you have nothing written down here, so I'm seeing no for anything on here. hopefully at one, at one point in my life, I will be able to afford a $400,000 house. But at this point, um, I'm, I'm, I'm a little short. Yes, we are not. We ourselves are not liquid enough. Uh, maybe, maybe with the interest rates, we'll be fine, but, uh, 60 year mortgage. Yeah, exactly. Uh, but Ryan looks like you have something. I don't have anything here. Yeah. I looked at some of the houses on the, on their website that they're kind of selling in my area. They look like pretty nice houses um pretty modern uh that's kind of my anecdotal takeaway um they also spoke

which i found interesting on the conference call about the strength that they're seeing in texas florida and arizona um they said that they're seeing a lot of migration out of the coasts into those central states uh especially texas they said their hottest market was austin by far those states well it's the tech boom you had elon and what's the dropbox you know there's hell and joe rogan that's right that's right so uh but those states have really cheap flat land which makes it a little easier to build as opposed to like where we are washington there's a lot of mountain ranges and a lot of barriers that make it a little tough there's a lot of hills it's awful and if you've i mean if you've been to like phoenix lately you can see there's just communities and

housing developments going up everywhere so i imagine migration to those states is probably a good thing for home builders if they're operating in those areas? Could be good for margins. I think that makes sense. But I'll let Brad go to his future growth opportunities. Sure. I'm going with the growth of iBuying. So kind of an indirect beneficiary, I'm thinking maybe cutting down a lot of this red tape that has once existed for somebody building a home could make the process a lot more convenient and could make some people's propensity to spend on a new home a little bit higher. And I mean, with the supply shortage that Brett kind of outlined, I mean, three months of supply remaining, anything making that process more convenient,

I think not only will feed revenue, but it'll probably also directly feed their profit margin, considering how supply constrained the entire industry is at this point in time. Yeah, Lenar was talking about, you know, getting more asset light, reducing those inventory levels that can hurt their cash flow. If open to a red fin in Zillow, uh, just want to take that on. Yeah. That could, that could help them. Uh, but I don't know how much I also impacted. Yeah. I mean, I don't think any of the eye buyers are buying directly from Lennar, but it helps with, and they touched on this in the conference call. It helps with liquidity for like move up, uh, families. So families that are moving into like the second

home or whatever, because I think they called it the fragile dance of selling a home while closing or closing on a new home. And so if they really need that liquidity to sell to an iBuyer, they can get it now. And so it's kind of just making it a little more frictionless in moving up to new houses. But I'll hit on my opportunity. And so this is the single family rental platform or LSFR is what they call it. And here's a quote from the conference call. They said, at the end of the quarter, LSFR formed the Upward American Venture, which was capitalized with $1.25 billion of equity from blue chip institutional investors. And then they piggybacked on it and said just after the second quarter, they acquired more

capital. And so they now said that they have positions to buy $4 billion worth of purpose built communities. What does purpose built mean? I think all homes have a purpose. I'm not sure. I would like to see what a purposeless home looks like. But it seems to be a really big bet on single family rentals. And I think a lot of this is coming from what they call the affordability crisis. There's a lot of families that are getting to the point where they can almost buy a home and they need rentals in the process. And so Lennar's really leveraging that. I believe the way it works is that they're building the, I mean, the funds are essentially financing it, paying them to do it. And they're selling these homes to professional

buyers who then rent them out. I don't think they're renting them out directly. I imagine the margins are pretty good. Yeah. I don't think Lenar is renting them out, but that could help with inventory too. And Lenar doesn't have to pay the cost for the land if the funds are doing it. I believe Lenar said they're doing some of the financing themselves, but it's a really minuscule amount. Yeah. It makes sense. That comes back to that White House report. They said that the single family rental supply is just drastically low and that's because of regulations in a lot of areas um that really hurt that because uh the bias is towards um oh this might be single family uh but like you know rentals and stuff people have the bias to basically those big houses

with one family um that everyone loves and seems to want but there is a need for these type of rentals and there's just none of them out there right now so that could be a smart move for sure um i'll hit mine and this is an important one but not i don't know if it's a growth opportunity but they're trying to do this to unlock shareholder value and they're spinning off all the non-core businesses so this means none of the residential home building or sorry the only thing that will be left at lenard corporation um and it's a bit vague right now they haven't given out many details and i said it'll be coming in the next few quarters when they you know finalize stuff but what the remaining lenard corporation will be is residential home building and financial

services. That could change. They have talked about moving it around. It hasn't been finalized. All the other stuff, the investments, I guess, they were a bit vague on it. The really only number they gave is that they hope it's about $5 to $6 billion in assets. I think they may have some commercial interest. I think they may have some big apartment communities that they want to get away from? I think they have a partnership with like, they have a lot of things, so it's kind of hard to tell, but the main takeaway is they're trying to get five to $6 billion of these non-core assets separated. I think they want to do that to unlock shareholder value. We'll see if that means anything, but I guess what will be nice is if you're an investor

in this company. We get an insight into how those businesses are running compared to the stuff that's actually meaningful for Lenar as a whole. Let's hit highlights and lowlights though. Brad, what did you like? What did you dislike about this business? Yeah, love going back to management, love the decades of experience and the ladder climbing conducted by pretty much every single person on this executive team. So I'm going to stick with that. So because Ryan, I think our other highlights pretty similar, but low light. So this is, I'm kind of reaching, there's not a lot negative to pick at, but federal house, or the Biden administration announced that they're going to start building a lot of houses. I'm not sure if Lenore will even be involved in that or

not, because they could potentially be. I'm not sure how the White House would build houses without using the help from private builders. But I wonder if, and again, picking, if just supply shortage will eventually be overcorrected and there will be a supply glut. And that's all hypothetical. The other thing I have is interest rates eventually probably will go up and that could dampen affordability, but it could also help if they have any net interest margin income in that financing business, that could be a tailwind to offset it. But yeah, there's not, I have to dig pretty deep to find a low light. It's a pretty flawlessly run company at this point in time that's our good good my low light is really the same it it's uh

basically all just speculation around macro um that ends up being my low light and i guess to some extent my low light is that there's some bit of a macro bet embedded in this that uh real estate demand will stay strong uh and that they have to build their way out of the shortage so i I think, I mean, I think that one's pretty cut and dry, like unless people aren't going to live anywhere or everyone's going to live in eight person homes, I think the real risk is interest rates because that could lower average selling prices. But that's what I was going to interject with earlier. If the financing part benefits from interest rates rising, I am not sure if it does.

I don't think we, I don't think any of us are. So I would look into that if you're going to be an investor, if that can hedge that, that, you know, that can help as well. Yeah. My highlights, simply from everything I've read, there's a housing shortage, and the only way to alleviate that is to build your way out. Demand seems sustainable. They seem like they have a durable runway to keep building more homes and adding incremental deliveries each year. Also, Lenar just checks out on pretty much every account operationally.

I don't think there's any low-eggs from the business, like operations. And then I have one that's kind of pie-in-the-sky speculative thinking, which is competition for land acquisition, which is like there's so many people right now and so many bodies that are trying to just acquire land, whether it is the billionaires that you've heard so much about or the funds or, I mean, just really everyone seems John Malone. Oh, he's been, that was like decades ago. But I guess that's kind of more speculative, but it could drive up the cost of land on Lennar's front. Yeah, Buffett owns a farm, right, out in Nebraska. He owns a small farm. It's a huge part. That's detrimental to Lennar.

Yeah, it's a huge part of his portfolio. But that is a good point. It might not matter, but it's something probably to research if you're looking into this further. I think there's probably enough land to go around. Yeah, U.S. is pretty big. I guess my highlights here are the same as you. you know, I would also though, a good run home builders are, excuse me, the good run home builders over the decades have been decent investments. There's some tough times because

of the macro, but through the cycles over, I guess, multi-cycle periods, if that's the right way to put it, I think you understand what I mean. They've been really strong. I'll just look at the returns for all those. So they're clearly solid businesses. Obviously I struggle low white, same as you guys, a struggle where the business can be affected by interest rates because there's a ton of things here that could be outside of their control. And that is unpredictable, like we've highlighted before. But other than that, I agree with you guys, no low lights from the business operationally. Let's move on to the bull case though. Brad, what do you have for us? Yeah, I think the micro bull case has pretty much been proven. The management team seems really

capable of delivering, like we're saying, in a macro environment that continues to be favorable. So the bull case for me, kind of continuing on with this theme of macro, is that this housing shortage persists and that we struggle to build our way out of it, which means Lenar and D.R. Horton and all these companies are just going to keep building as much as they possibly can in the years to come. That doesn't seem that far-fetched, but it doesn't seem like guarantee either. Yeah. Ryan? Yeah. My bull case is that they have sustained demand, which drives, I put 10% cashflow growth for the next 10 years. So 10% annual cashflow growth, which seems very reasonable. In that case, they would be generating about 20% of their current market cap in free

cashflow by 2025 or whatever, 2026, I guess at that point. That seems like it'd be a really good investment it typically trades around 10 times earnings from the store yeah well they bumped up it could have just been some one-time thing but it bumped up in like 2017 2016 to about 20 but yeah i wouldn't expect multiple expansion here um i mean just look at the cash conversion over time it's been pretty poor and that's because of the inventory stuff can they fix that like they say they're going to maybe and that could be a part of the bulk case but one thing i think i would be concerned about with the, you know, 10% compounded cashflow growth is that I don't think it'll be just a straight line. There could be some concerns there on inventory buildups, stuff

like that. And that's, that's why these trade at 10,000 rings. I mean, yeah. Aren't home builders just notoriously cyclical? Yes. Yes. I don't think we're, that's what I've heard. I mean, I looked at the stock chart. It looks pretty cyclical, but that doesn't. Yeah. That's what I was trying to, you know, the good run ones, it seems that there's quite a few that have been around since like the seventies and eighties, at least publicly traded. And all of them have done quite well. I bet total returns have been strong as well because they all seem to pay out dividends. But your business can be affected by, you know, just the housing market. My bull case is similar to you guys. They keep doing what they're doing operationally. I don't

think you should want any changes there. And the spinoff, you know, is successful and I guess unlocks the shareholder value quote unquote like they've been saying and then on a macro front you know the american consumer stays in good shape like they are right now with um a lot of uh i guess the stimulus checks kind of helped a bit where you know savings are at all-time rates or at least they were back in the spring the last time i checked and then housing prices stay elevated that is it feels unpredictable for the housing prices um i i feels like it would be tough for them to drop like 30%. But a lot of their growth has been from average selling price going up. So that is just a variable that you'll have to think about.

Let's move on to bear case though. Brad, what do you think could go wrong here? Sure. And I'll preface this with the likelihood of this happening is extremely low. But the bear case to me is the cyclicality and the really, really ample liquidity we have in the system, very low rates and stimulus checks and all of this fun stuff leads eventually to another housing bubble where we have to significantly pull back on some of the practices of building and financing and getting far less aggressive. So history doesn't repeat itself. That happened 13 years ago. I like to think the Federal Reserve has put itself in a position to avoid this exact same issue in the future. But because the company is so well run, that's kind of where I see it.

Yeah, I think they were down like 75% in the housing crisis. Yeah, I think GFC 2.0 seems unlikely. But if it happens, go look what happened to their business or their stock at the time. It was pretty detrimental. um my my bear case is that uh i mean there isn't a there isn't a huge bear case for me honestly the i guess maybe supply or demand dries up um the and they get back to around like pre-pandemic home deliveries of around 40 to 50 000 um average selling price i think is big for me i think that i mean what if this is a one-time bump you know an average selling price

and that comes down could they more margin because there's well maybe but there's operating leverage on the average selling price i think that is a big reason why margins are going up so i think there could be partly they talk about technology investments i don't necessarily how it's affecting the cost of wood um but maybe it there was there was a quote from a book that i was reading yesterday uh and it was like cyclical you gotta give the listeners you gotta quality investing by lawrence cunningham and i think it's it said something along the lines of cyclicals are the most dangerous when they look the most sustainable um and so that's the only thing that like i fear underwriting here is that it looks like this is going to just be sustained

demand for the next five years and it won't uh but still it's so sound operationally that they're they're not going to get to the i don't think they're going to be losing money anytime soon yeah well i think that negative cash flow through a few years like 2013 2014 i can't remember exactly but gosh i don't know yeah it's tough now it's tough well that's the that's the bulk cases that they've helped improve operationally. Yeah, I don't know. My bear case is very similar to you guys. It's really hard to put any predictions on it because you really have no idea if housing is going to cool off. There's just too many variables. I think that's the bear case is there's a lot of uncertainty around that part. But again, I have no bear case on their

execution. Let's move to wrap things up. More or less interested, Brad, what do you conclude here? Yeah. If this was for a retirement account and I was at maybe a different point in my life, I would enthusiastically say more interested. But this doesn't really fit the type of company I generally invest in. It also would require me to take more of a macro lens than I usually like to take when I'm investing in a company because they are not so reliable, but because interest rates and liquidity are really, really large drivers of their business. And I like to take an extremely narrow view of one company at a time, extremely micro, and I don't think I can do that with this. So just pairing that with the fact that it really doesn't fit the high growth disruptor company that I'm looking for, less interested, but just admiring that the results of this team is delivered for the past few decades. Yep, track record speaks for itself there. Ryan, what do you got? i'm okay if you have any grasp on where you think the housing market is going and where you think uh housing supply is going then i think you have to be more interested because it seems like the

best home builder to own right now i'm a little surprised there's nbr too people love nbr i haven't looked at that but maybe that too okay uh i guess i should say it's the largest home builder and the culture seems to check out the big i i just don't feel well equipped enough uh or i don't feel like i've learned enough about the macro environment to make any sort of stance here so i'm gonna go right on the fence i'm just as interested as i was yeah i'm gonna the uh hot take the uh we have this episode uh is not the again it won't be this is not the sexiest one right now you know home builders not a not that not the clickbait one but i'll go more interested but not at these levels i or sorry excuse me at these at this valuation really the only reason i get

excited about something that i believe could potentially be like a cyclical capital intensive something like that, is if it's at a really, really cheap multiple. And those don't come around that often. But I don't think this is at a below market multiple. I don't know if I have any good insights into this business. And like Ryan outlined above, you're not going to get all your cash back within five years. I think one of the things I've learned in the past year or so is that if you're going to go for something that has a little bit more of a macro risk, maybe you want more of that cash back available to shareholders within like five years or three years or something like that. I would really want like, you know, at least like 50% of the market cap back. And that

is not nearly where we're trading right now. So at that point, I'm like, I'm less interested, but the business itself, I think it would move to my watch list, but it's not a high enough quality business that I think deserves a trade at a higher multiple where, you know, you look at a 10 times PE. That's not the same as, I don't know, what's a good example? Costco is probably the easiest example at 30. I think that's not too different. All right. That's going to be- Yeah. It's not necessarily idiosyncratic. It's not unique, I guess, in comparison to other home builders. Yeah. Maybe a basket bet makes sense. But yeah, the industry is not as exciting. I feel like the valuation is not as compelling as it may look at first glance, but we're going

and go to stock for next week. Ryan, it is your turn. What do you have for us? Yeah. For two weeks, too. I forgot that it was my turn, so I'm digging through the email. Well, I texted you.

We get recommended. Did you not see that? No, I must have missed it. We'll look at it right now and see if you love this company. All right. I texted you this morning. All right.

We've got our stock for next week, then it's Dutch Bros. I think they filed their S1. I don't know if they've gone public yet, though. I think they... Yeah, it's up like 40% today or something ridiculous like that. So they're valued at like 5 million per shack, uh, which, you know,

maybe if it value valuation might be high, but I know Ryan's been there before. I am. Uh, yes, I, I have plenty of anecdotal evidence. Yeah, exactly. So that should be a fun one. Uh, but that's going to do it for this episode. Thank you all for listening. Like we said before, uh, if you like this and excuse me, if you're interested in the Motley Fool, check out that link, it'll be in the show notes. It'll walk you through it. Use their email, help, help them out, help, uh, help yourself out and help us out.

But remember, we are not financial advisors. Anything we say on this episode is not formal advice or recommendation. Ryan and I are general partners at Arch Capital. Arch Capital clients may hold securities discussed in this podcast. Thank you all for listening. We'll see you next time. this family is on the brink of civil war on september 18th mob land the hit original series is back on paramount plus from the underworld of guy ritchie do you want to step

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