An improving economic and job scenario, growing consumer confidence, moderating home prices and a low level of housing inventory resulted in an improvement in the housing market in the second half of 2014, albeit at a slow pace.
The market generally believes that homebuilding activity will pick up in 2015 backed by improving job numbers and a rebounding economy.
However, with the earnings season warming up, the optimism is waning as gross margins of two leading homebuilders — KB Home (KBH) and Lennar Corp. (LEN) — in the fourth quarter of 2014 took a hit due to increasing construction costs.
KB Home’s adjusted homebuilding gross margin declined 110 basis points year over year and also missed out on the company’s expectation of sequential improvement over the third quarter of 2014. Higher construction, labor and material costs and higher incentives mainly hurt gross margins. Moreover, moderation in pricing power also pulled down gross margins.
In fact, KB Home expects gross margin to be lower than 20% in 2015. Gross margin is expected to hit a bottom in the first quarter of 2015, with sequential improvement through the rest of the three quarters of 2015. Shares of KB Home have declined 25.2% since the company reported dismal fourth quarter 2014 results on Jan 13.
Meanwhile, Lennar lost 7.17% in share price, despite beating the Zacks Consensus Estimate for both revenues and earnings in the fourth quarter of fiscal 2014 reported on Jan 15.
Lennar’s gross margin on home sales declined 120 basis points owing to rising labor, land and material costs and increased incentives. Lennar too faced moderation in pricing power owing to an increase in labor, material and land costs. The company expects gross margin in 2015 to be around 24%, which is lower than 25.4% reported in 2014.
Following the lower margins reported by KB Home and Lennar in the same week, share prices of other homebuilders also dipped. Share prices of PulteGroup, Inc. (PHM), Meritage Homes Corp. (MTH) and DR Horton Inc. (DHI) declined over 5% on Jan 15, the day Lennar released its earnings result. All three homebuilders are expected to report earnings later this month.
The margin pressure from rising costs and incentives come amid other concerns, which include a possible rise in interest/mortgage rates in 2015 with the Federal Reserve closing the ‘quantitative easing’ program in October. Higher interest/mortgage interest rates may have a moderating impact on housing demand and pricing.
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