Earlier this year, Warren Buffett handed over the role of CEO of Berkshire Hathaway (NYSE: BRK.B) to Greg Abel. Abel has taken charge of roughly $700 billion in investable assets, spanning stocks and U.S. Treasuries. It is a formidable task, and so far he has drawn on Buffett's advice while also leaning on Berkshire's veteran investment manager Ted Weschler, who oversees about 6% of the company's portfolio. In the final years of Buffett's stewardship of the portfolio, suitable investment opportunities were almost impossible to find; but Abel has already completed large-scale deployments of capital, both building several new publicly traded equity positions and carrying out full company acquisitions. In his first six months on the job, Abel made a big bet on Alphabet, Google's parent company, and also completed the acquisition of homebuilder Taylor Morrison.
Changes to Berkshire's holdings typically only become known once quarterly reports are disclosed. But the latest filing with the U.S. Securities and Exchange Commission (SEC) has revealed another major move by Berkshire: in just three trading days, it bought more than $212 million worth of shares in total.
A Bet on a Turnaround Story
Over the past several months, Berkshire has continued to add to its position in homebuilder Lennar (NYSE: LEN). Hit by rising interest rates, housing affordability has deteriorated further, and the homebuilding sector as a whole has come under pressure. To keep home sales going, Lennar has had to resort to rate buydowns, subsidizing part of the mortgage rate for buyers, but this still failed to stop sales from declining. The company's total revenue fell 8.7% year over year last quarter; total home deliveries dropped 3.4%, and the average selling price of homes fell 2.9%. Management lowered the midpoint of its full-year home delivery target to 80,500 units, down from a previous target of 82,500. In addition, heavy promotional rate buydowns squeezed gross margins, which fell to just 15.8% from 17.5% a year earlier. After the earnings report was released, the stock was heavily sold off by the market.
It was precisely after that, Abel and Weschler decided to raise their stake to more than 10%, buying nearly 2.5 million shares over the next three trading days following the earnings disclosure. Since the end of the second quarter, Berkshire has added nearly 11 million shares in total, increasing its position by 81%. Abel and Weschler are putting into practice Buffett's long-circulated investment philosophy: be fearful when others are greedy, and be greedy when others are fearful. It is fair to say that the vast majority of investors right now do not want to touch the real estate sector. But from the perspective of a long-term investor, there is a huge turnaround opportunity here.
Is Real Estate a Wise Choice Right Now?
Despite the heavy burden of housing affordability, the U.S. housing supply gap remains very severe, with estimates putting the shortfall at 2 million to 5.5 million units. This situation is unsustainable and ultimately benefits those homebuilders with the scale and financial strength to push forward with new home construction. This may also be the underlying logic behind Berkshire's acquisition of Taylor Morrison. This homebuilder will be operated in combination with Berkshire's Clayton Homes, leveraging scale synergies. Berkshire also holds shares in D.R. Horton, the largest U.S. homebuilder. In other words, Berkshire is making a broad bet on U.S. residential real estate as a whole, not just on Lennar alone.
Lennar's current valuation is quite attractive: the stock trades close to its tangible book value, and its price-to-book ratio based on the latest balance sheet is just 0.91 times. In other words, the market is pricing its assets at a discount. The market's pricing logic seems to be: new home construction and home sales will never rebound, and will keep declining year after year. But given the reality of America's severe housing shortage, that assumption does not hold. Over the medium to long term, as the conflicts between housing supply and affordability ease, Lennar can hope to stabilize and raise revenue while also repairing its gross margins.
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