We maintain a Neutral rating on KB Home (KBH) following appraisal of the second quarter 2012 results.
KB Home’s adjusted net loss per share of 31 cents in the second quarter was significantly narrower than the prior-year quarter’s loss of 89 cents and the Zacks Consensus Estimate of a loss of 36 cents. Double-digit rise in revenues and higher net order growth led to the narrower loss in the quarter. Total revenue increased 11% driven by increase in homes delivered, net orders and average selling price.
KB Home is a well-known homebuilder in the United States. Its operational business model KBnxt offers consumers the flexibility to design their new homes. Apart from the obvious benefit of offering choice to consumers, the model also helps the company turn over its inventory more quickly than its peers, thereby supplying capital for reinvestment. Further, KB Home focuses on providing homes with energy-efficient features without materially increasing the price for the customer due to its single business model, thereby lowering the total cost of home ownership. This gives the company a competitive advantage.
Management is strategically reallocating resources to invest in highly favorable submarkets, which allow it to sell larger, higher priced homes, thereby boosting the average selling price and net orders. KB Home is also targeting the higher income, first-time and move-up buyers; all of whom are more inclined toward buying a new home rather than buying foreclosures. Further, it is activating communities in stabilizing markets, increasing revenues per community, and strengthening management teams with additional resources to improve its operating performance in the next half.
Management believes that the housing market is slowly stabilizing with a gradual recovery in the overall economy, including the increase in employment rates and higher consumer confidence. Houses are more affordable now, as home prices stabilize, mortgage loans come with relatively low interest rates and home rents become more expensive. Thus, KB Home is witnessing increasing traffic levels due to heightened consumer demand. Inventory of foreclosed homes and short sale homes is declining, thus stabilizing prices of new homes. All these bode well for the company’s profitability.
Management believes that the housing recovery combined with the company’s strategic initiatives (like overhead reduction, margin expansion, and land investments towards higher priced, better located communities) and the preferred mortgage deal with Nationstar (announced in March 2012) will help it to achieve profitability by the fourth quarter of 2012 and also in fiscal 2013. It expects to see year-over-year improvements in deliveries, gross margin, average selling price, and SG&A ratio, to drive better operating results in the second half.
However, though the housing market is recovering, we believe that the process is erratic, uneven and not yet broad based. Moreover, the company’s net order growth rates are lower than that of its peers like Lennar Corporation (LEN), Pulte Group, Inc. (PHM) and D R Horton, Inc. (DHI). We also believe that the company may take time to achieve sustainable profitability. Further, integrating a new mortgage partner, Nationstar has proved challenging for KB Home and the complete transition from MetLife Home Loans to Nationstar will take some time.
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