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KB Home: Not for Value Investors, Not for Speculators at This Time Either

September 25, 2011 | About:
KB Home (KBH) is one of the largest home builders in the U.S. and it has been in the field for more than a half of a century. It constructs and sells homes through the operating divisions in the U.S. under the name of KB Home. Its home building segment is the largest business of the company, contributing around 99.5% of total sales in 2010 and 2009. The home building operations offers home designed for first-time, move-up and active adult home buyers. Besides, it also offers homes in development communities, at urban in-fill locations and as part of mixed-use projects. In KBH’s home building segments in fiscal year 2010, it delivered 7,346 homes at average selling price of $214,500.

Just few days ago, KBH hosted a conference call to discuss third quarter 2011 earning for the company. For the cyclical housing business like that, we would expected the results would fluctuate in the downsize way of the economy in general. Housing is still very difficult at the moment. However, Jeffrey Mezger, the president and CEO has commented that in the third quarter, he saw a growing number of home buyers who are recognizing the value and affordability in the housing market currently. So he would expect the stabilization process to continue, but not yet to improveme. In this difficult business environment, the company is reinvesting in the very desirable submarkets, primarily in its targeted growth states of California and Texas, lowering the cost level and maintaining the strength of its balance sheet to survive and have enough flexibility for future opportunities.

The California region is a different picture than inland regions. From the Bay Area to Orange County and San Diego, the demand for new homes was never met in the boom years. These submarkets can be considered as very balanced in terms of supply and demand, with stable prices. In another market, Texas, Jeffrey is seeing more demand around Austin and San Antonio. Those two cities are having an inventory imbalance, less foreclosure pressure and more favorable pricing environment.

The company is not aggressive in land investment. Over the past two years, KBH has invested $1.1 billion in land and development. The lot count is down slightly year-over-year, while inventory dollars have increased. That has reinforced that the company has moved into higher priced sub markets in desirable cities with favorable prices.

In terms of sales pace, the net orders increased 40% over the prior-year period with strong comps in July and August. Sales were higher year-on-year in all regions. In California, the comps were 70% higher than the prior year. The Las Vegas division achieved and 80% increase in sales over the last year. In the first half of 2011, the company opened over 60 communities, with 33 in the third quarter, so the total community open for sale is now 233, a 10% increase on last year. What is interesting about KBH is the energy savings house, which is Energy Star qualified and that be considered a great selling point in this environment. The CEO noted the savings in energy bills can be as much as 45%.

For the financial, KBH has happily announced improvement from a net loss of $0.89 per share to the loss of $0.13 per diluted share. It delivered around 1,600 homes in the quarter, a 31% decrease from 2,320 homes the same period last year. But the selling price has gone from $214,200 to $227,400.

Over the longer -term, looking at its 10-year history, 5-7 years ago at the end of the accumulation cycle and booming of the real estate market, its stock price skyrocketed. However, as the economy slashes into the depression, the collapse of the real estate market, the cyclical business like itself can’t get away from being burnt. The most important thing now is to survive, to keep the company going. We can only expect that it would need a strong balance sheet to survive in the downturn.

As we expect from the home builders businesses, its balance sheet is highly leveraged, with the long-term debt taking nearly 60% of the total assets. The long-term debt of nearly $1.7 billion is more than three times the total market capitalization of the company. Even over the years, it has reduced the level of inventories on hand more than $4 billion and used the proceeds to bring down the debt level, it is still got very, very high leverage. The erosion of capital due to the loss in the business for several years has even increased the level of debt/equity ratio, putting the business in riskier position.

I personally think with the weak financial position, the company would have to raise capital or re-finance to survive through the downturn. And if it occurs, the current condition and the capital situations would put KBH to have to obtain financing in a very costly way.

Personally, I think it’s not a stock to hold for the long term, nor a stock for any speculative play, especially in the weak housing market, when the market itself is narrowing down its housing inventory for balancing of supply and demand of the overall market. The future of the macro environment is very unclear, which leads to cyclical businesses, especially housing in very messy conditions. The only thing I would look for is the financial strength it has to survive, but I haven’t seen it here in KBH's balance sheet.

This is the subjective viewpoint of the author, and it is not a recommendation to buy, hold or sell the stocks mentioned in this analysis. Anyone who wishes to buy, hold or sell the stocks has to do his/her own analysis at his/her own risk.

About the author:

Anh Hoang
Money manager into global equities, especially with US and Vietnam markets. CFA level 3 candidate. Lecturer for Stalla - CFA course in Vietnam

Visit Anh Hoang's Website


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