Lennar (NYSE:LEN) is one of the biggest homebuilders in the US. It’s been publicly traded since the early 70’s and currently has a market cap of $27.5 billion. Their three operating segments are: homebuilding at 93% of revenue, financial services, and multifamily for the rest. Below is the long-term share price performance:

Below are the return metrics compared with peers:

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Capital Allocation

Below we see LEN’s free cash flow and how capital was allocated over the past decade:

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Source

As you can see, there has been a significant effort on deleveraging after acquiring CalAtlanta for $9.3 billion. With debt at lower levels, more cash flow will likely go towards reducing the share count.

Risk

The biggest risk here is industry risk and the correlating price one would be (over)paying right now.

Home builders are something that I would categorize as long-term growth plays that are also very cyclical along the way. This doesn’t mean you can jump in at any price and enjoy the compounding though. If you buy at the wrong time, you would have to basically wait for another full cycle to play out before you get back to break even. The cyclicality can be your best friend if you time it right, and your worst enemy if you overpay.

Any of the big home builder stocks such as LEN are a bet on the US housing market fundamentally. I don’t follow this sector very closely, but in general the effects of rising rates on house prices have not fully kicked in yet. It’s going to take time to see more adjustable rates kicking in, and to see where rates end up normalizing over the next few years. I’m not saying you should wait years to even consider buying a home builder, but right now is not the time.

The only other notable risk is that LEN has been adopting the strategy of its competitor NVR in using options to purchase land. So far the returns on equity and invested capital have improved, but it will still take some time to see if they can mimic the success of NVR with this strategy.

Valuation

First let’s look at the multiples comp to peers, followed by historical multiples:

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Source

I think this is a case where the company and industry are a bit too cyclical to use a DCF model. It’s also problematic for the intrinsic value compounding rate (ROIC x Reinvestment rate), which gives a rough approximation of the true value of the enterprise. This leaves us relying on the multiple comp.

From the comparisons, LEN does not appear to have any discount as far as pricing. Shares are up 50% since June of last year, so now it doesn’t look like an attractive price at all.

Conclusion

To invest in any of the top home builders is placing a bet on the direction of the US housing market. LEN is certainly not a bad choice, but there is too much uncertainty regarding the future impact of rising rates on home prices. I see it as a low probability that home prices will not increase from here.

This type of stock is one I would consider as a longer term investment, but only at the right price. I think this stock fits the bill of both growth and cyclical. The size of the business is materially larger decade over decade, but the share price does not mean very linearly. This means you can essentially lose money for an entire cycle if you buy at or near the top of the cycle. Now is not the time to buy any home builder, the effects of the rising rates need to be played out a bit more before acting.