Fitch Ratings has affirmed Lennar Corporation's (NYSE: LEN) ratings, including the company's Long-Term Issuer Default Rating (IDR) at 'BBB'.

The Rating Outlook has been revised to Positive from Stable.

The Outlook revision to Positive reflects the company's more conservative posture during this cycle by meaningfully reducing debt, pivoting to a more land-light strategy, and demonstrating the ability to generate meaningful and more consistent cash flow from operations (CFO) through the cycle. Fitch expects the company will maintain low leverage levels, including net debt to capitalization below 10% and EBITDA leverage below 1.0x. Fitch expects Lennar will achieve these solid credit metrics despite the assumption that single-family starts fall 15%-20% in 2023 and grow slightly in 2024.

Fitch may consider upgrading Lennar's IDR to 'BBB+' if the company's operating performance meets or exceeds Fitch's rating case forecast (see Key Assumptions) and the company continues to strengthen its balance sheet.

Key Rating Drivers

Solid Results Despite Industry Slowdown: Fitch expects Lennar will outperform the industry and gain market share, resulting in a mid-single digit increase in home deliveries in fiscal 2023 and slightly higher closings next year. Fitch expects the company will continue to focus on pace, which may lead to lower average home sales price in the next 12-18 months. Fitch expects EBITDA margins will fall 550-650 bps this year and 100-150 bps in 2024 as price adjustments and incentives remain elevated to drive demand.

Conservative Balance Sheet: Fitch expects Lennar's credit metrics will remain strong for the 'BBB' IDR, including net debt to capitalization below 10% (excluding $250 million of cash classified by Fitch as not readily available for working capital) and EBITDA leverage of 0.5x-0.8x during the next few years. These ratios provide Lennar with meaningful rating headroom relative to Fitch's negative rating sensitivities of 35% net debt to capitalization and 2.5x EBITDA leverage.

Lennar has meaningfully delevered its balance sheet since acquiring CalAtlantic in February 2018, reducing debt by $6.5 billion of debt since 2018. Fitch expects further debt reduction in the next 12-24 months, including the recently announced the redemption of its $425 million 5.875% sr. notes due November 2024 on Aug. 30, 2023.

Land-Light Strategy: Lennar has lowered its owned-lot position and increased lots controlled through options. Fitch views this strategy positively, as it reduces carrying costs and should lessen impairments during severe housing contractions. At May 31, 2023, Lennar controlled 424,000 lots (including homes under production), of which 36% are owned and 64% are controlled through options.

The company has a 2.3 year owned-lot supply and 6.2 years of total lots controlled. Its owned-lot position is among the lowest in Fitch's coverage. Fitch expects Lennar will continue controlling the majority of its lots through options in a stable-to-growing housing market and will be willing to walk away from these options in a cyclical downturn if the returns are not justified.

Higher Speculative Activity: Lennar has increased its spec activity due to higher demand for quick move-in homes, stemming from volatile mortgage rates and longer cycle times. While still inherently riskier than a pre-sold strategy, Fitch views the current level of spec activity as appropriate in the current environment given low existing inventory and still-elongated, although improving, cycle times. At May 31, 2023, Lennar had 17,000 spec homes, including 1,300 finished homes. Fitch will continue to monitor spec building activity by homebuilders, which could further pressure margins if the supply of existing homes for sale increases from current low levels or demand pulls back quickly.

Consistent Cash Flow Generation: Lennar's shift to a more land-light strategy has resulted in the company generating one of the strongest and most consistent CFO among its investment-grade peers. The company generated CFO margin of almost 10% annually in fiscal 2021 and 2022. Fitch expects Lennar will generate CFO of $2.0 billion to $2.3 billion in fiscal 2023 and 6.5%-7.5% of homebuilding revenues in fiscal 2024. Fitch expects Lennar will likely generate positive CFO in most periods during a housing cycle as it executes its land-light strategy.

Disciplined Capital Allocation: The company has been disciplined with its capital allocation strategy, prioritizing debt reduction while making modest share repurchases. Lennar repurchased $1.4 billion of stock in fiscal 2021, $1.04 billion in fiscal 2022 and $465 million during 1H23. Fitch expects the company will continue to repurchase its stock, funded primarily with free cash flow. In January 2022, the company increased its annual dividend by 50%, resulting in annual cash outflow of about $440 million.

Large Diversified Builder: Lennar is the second largest homebuilder in the U.S. and has leadership positions in the local markets in which it operates. Fitch views this as a competitive advantage, providing efficiencies in purchasing, as well as enhanced access to local labor pools and land. Lennar's broad product and geographic diversity also provides cushion from regional and buyer segment downturns. Lennar is one of a few builders that has a national focus with about 1,263 communities across 26 states.

The company has heavy exposure to the Western region, with 40% of homebuilding assets and 36% of homebuilding revenues generated from this region. Lennar serves first-time, move-up, active-adult and luxury homebuyers. Lennar has a top 10 position in 42 of the 50 largest new home metro markets in the country, including a top position in 21 markets.

Non-Homebuilding Activities: Lennar has diversified its real estate activities to include nonresidential activities, multi-family construction, large-scale master-planned communities, and construction of single-family rental units. The company also has strategic investments in technology companies. Lennar intends to spin-off its multifamily and single-family home for rent asset management businesses, together with some investment assets, by transferring them to a newly formed subsidiary, Quarterra Group, Inc.

Lennar expects its asset base to be reduced by about $2.5 billion as a result of the spin-off. The spin-off will only have a modest effect on Lennar's debt to capitalization ratio, and will allow management to focus on its core homebuilding operations.

Derivation Summary

Lennar's closest peers are D.R. Horton, Inc. (BBB+/Stable) and PulteGroup, Inc. (BBB/Positive). NVR, Inc. (BBB+/Stable) is a less appropriate peer given its unique land strategy. Lennar is the second largest U.S. homebuilder, delivering 67,805 homes (excluding unconsolidated joint ventures) for the LTM period ending May 31, 2023. By comparison, DHI (the largest U.S. homebuilder), delivered 83,201 homes for the LTM ending June 30, 2023 while PulteGroup had 29,807 home closings.

Lennar and DHI are more aggressive with their speculative building compared with PulteGroup. Lennar's credit metrics are comparable to PulteGroup and DHI. Lennar controls a slightly lower proportion of its lots through options compared to DHI, but higher vs. PulteGroup. Lennar's owned lot position is comparable to DHI and lower than PulteGroup.

Key Assumptions

Fitch's Key Assumptions Within The Rating Case for the Issuer:

Homebuilding revenues fall low-single digits in fiscal 2023 and remains relatively flat in fiscal 2024;

EBITDA margins of 15%-16% in fiscal 2023 and 14%-15% in fiscal 2024;

CFO of $2.1-$2.3 billion in fiscal 2023 and 6.5%-7.5% of homebuilding revenues in fiscal 2024;

Net debt to capitalization below 10% and EBITDA leverage below 1x during the forecast period.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Lennar continues to control a majority of its land through options, including maintaining an owned-lot position (including homes in production) of less than three years;

Fitch's expectation that net debt to capitalization will sustain below 30%;

Fitch's expectation that EBITDA leverage will consistently be below 2.0x.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Fitch's expectation that net debt to capitalization will consistently be above 35% because of sustained erosion of profits due to meaningful and continued loss of market share, ongoing land, materials and labor cost pressures, and/or significant inventory or goodwill impairment charges;

Fitch's expectation that EBITDA leverage will sustain above 2.5x;

Lennar maintains an overly aggressive land and development spending program that leads to consistently negative CFO. In particular, Fitch will focus on the company's ability to repay debt maturities with available liquidity and internally generated cash flow;

The company meaningfully changes its financial and growth strategy, including large, debt-funded acquisitions and/or aggressive land and development spending and shareholder friendly activities that could result in significantly weaker credit metrics.

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Solid Liquidity Position: As of May 31, 2023, Lennar had $4 billion of unrestricted homebuilding cash and no borrowings under its $2.575 billion revolver that matures in May 2027 ($350 million of the commitments mature in April 2024).

Lennar has meaningful debt maturities in the next 18 months, including $398 million of senior notes maturing in December 2023, $494 million of senior notes in April 2024 and $425 million in November 2024 (which will be redeemed on Aug. 30, 2023). During the first six months of fiscal 2023, the company repurchased $158 million of its December 2023 and April 2024 notes through open market repurchases. The company has sufficient cash and revolver availability to repay these note maturities.

Issuer Profile

Lennar Corporation (NYSE: LEN) is the second largest U.S. homebuilder based on revenues and home deliveries, with operations in 1,263 communities across 72 markets in 26 states. The company serves first-time, move-up, active-adult and luxury homebuyers.

Summary of Financial Adjustments

Historical and projected EBITDA is adjusted to add back non-cash stock-based compensation, interest expense included in cost of sales and impairment charges and land option abandonment costs.

Fitch also excludes the EBITDA and debt of Lennar's financial services (FS) operations as this subsidiary's only debt, a mortgage repurchase facility, is non-recourse to Lennar and the FS subsidiary generally sells the mortgage it originates and the related servicing rights to third party purchasers within 30-45 days. However, as part of its captive finance adjustment, Fitch assumes a capital structure for the FS operations that is sufficiently robust for that entity to support its debt without reliance on the corporate entity.

Fitch applies a hypothetical capital injection from the corporate entity to achieve a target capital structure (2.0x debt/equity) that is indicative of a self-sustaining credit profile for Lennar's FS operations. The debt to equity ratio of Lennar's FS operation was below this target level, so Fitch did not make any adjustments related to the FS operations. Shareholders' equity is assumed to be unaffected. Fitch reviews historical CFO on a consolidated basis and also estimates CFO excluding these operations.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.

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