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Lennar InsovlentLennar Insovlent
This 18% combined with the relatively heavy debt load Lennar carries put's roughly 10.2% past the level of insolvency. Now, I truly believe that the 18% mark is definitively on the low side, but it is more than enough to surpass the 8% needed to make Lennar insovent. Included in the calculations is:
An 18% FAS 144 impairment factor to bring inventory mark to makret as a result of inventory valuations available from the recent asset sales. We have provided this factor instead of a one time charge, but included both for the sake of comparison and chose the one that would have the least impact according to GAAP rules, to be as conservative as possible. I obviouslydon't feel this woud be either one time or extraordinary, hence probably belongs in FAS 144 category.
During 4Q2007, Lennar sold properties at sales price of $525 million with a net book value of approximately $1.3 billion. As a result I expect Lennar to write-down a minimum loss of $775 million in 4Q2007.
During 4Q2007, Lennar has sold 8,300 homesites to Metro Development Group and 11,000 sites to a strategic land investor. As a result, total home sites have been reduced by 31,108 to include the effects of these 2 transactions.
Thus, not only is Lennar currently insolvent, but according to Alman's Z score analysis, they are nearly assured to be heading into bankruptcy, sporting a score considerably below what it would take to consider them a bankruptcy candidate, and trending considerably lower the next 8 quarter where it will slightly improve in a lateral trend. It is unlikely that Lennar will be able to survive like this for such an extended period. I need to check to see if my team has discovered any tripped covenenats, but chances are they either are tripped or will be tripped within a year.
zscorezscore
From a purely fundamental perspective, it is easy to see how Lennar got to this point. Let's browse through the numbers and compare to the macro backdrop.
earningsearnings
As you can see, there earning have deteriorated horribly. Lennar' earnings are a function of their margins, which are highly correlated with housing values. That shouldn't be the case since they can pass lower and higher costs off to thier customers. The problem is that Lennar funds acquisistions with debt, and the processed is lagged. So, when the market is rising, Lennar benefits wth cheap inventory and productive leverage. When the market is falling, they have overpriced inventory that won't move, negative margins and the leverage strangles them. This relationship leaves Lennar (as well as other builders, this is not a Lennar specfic phenomenon) with a extremely sensitive and leveraged connection with landvalues as you can see in the chart below.
share price trendshare price trend
The chart below is a dated example of my housing value forecasts. I was more pessimistic than most pundits in terms of the severity of the housing downturn, and it appears that even I undershot the mark. Although I feel that these projections may not be accurate in terms of being slightly optimistic, they still can easily illustrate a trend for the purposes of showing the predicament of Lennar. Using the sensitivty of Lennar's share price comparison above with the value forecasts below, you can guess where the market will push Lennar's share prices. This is not taking into consideration thier insolvency.
land run upland run up
These are the comparative Census regions to assist in making the following chart on gross margins more coherent.
Lennar's operating regionsLennar's operating regions
Now, knowing that thier margins are highly sensitive to housing value fluctuations, where do you think those are going, and what effect do you think that will have on Lennar's solvency?
margins margins
Even if we exclude the impairments (which drive everything deeply into the negative), Lennar's operating margins are heavily negative in almost all operating areas.
gross margins exluding impairmentsgross margins exluding impairments
Revenues look no better.
revenuesrevenues
Which brings us round robin back to the issue of Lennar's solvency.
solvencysolvency
Now, Lennar and the homebuilders in general have become a trading commodity, and thus their share prices don't necessarily directly reflect the fundamentals on a day to day basis. In the case of Lennar, I have felt that this has offered me an oppurtunity, since I believe this company is truly done for. Even if they raise significant cash by selling off assets, if they sell them off for anywhere near what the most recent market transactions have priced them at, they will still be balance sheet insolvent. I am betting that their creditors don't perform the level of analysis that I do, and as long as they are not reading this blog now, they will not be pulling credit right now. Since these have become trading commodities and traders look at price and not value, I ignore daily price fluctuations except as oppurtunities to increase a bearish standpoint. But those who fancy themselves fundamental investors and trying to go long are most likely doing so by attempting to measure book value and trying to find a bottom. Bottom fishing is gambling and not worth the risk in my opinion. In the case of Lennar, the bottom is either bankruptcy and/or liquidation. Like I said, a dangerous gambit - there are easier ways to make money.
The bottom fishing value guys look at Lennar, and probably see this:
Lennar BVLennar BV
They then say, "Hey, anything below $14 is a B-U-Y!" Unfortunatey, they don't see what's below if they are not careful. I am all for value investing and buying on the cheap. It is just that sometimes, you get what you pay for!
Lennar InsovlentLennar Insovlent
