Summary:
Reasons to Buy:
KB Home delivered impressive results during the first two quarters of 2016,
surpassing the Zacks Consensus Estimate on both counts in both the quarters.
Healthy housing industry and strong demand trends in the markets served by KB
Home in the first half drove the strong results. It was benefitted from strong backlogs in
the previous quarters and broke the previous trend of soft revenues resulting from
delays in construction and lower number of homes delivered in 2015. While demand in
Houston is stabilizing, it will take a while before it rebounds. Moreover, community
count, which declined during second quarter 2016, due to fewer home openings, is
expected to decline further in the third quarter of 2016. The company does not expect
community count to recover till 2017 beginning.
Built-to-Order Approach Gives Competitive Advantage: In order to drive profit per unit,
KB Home operates through its operational business model – KBnxt – by which
construction is initiated only after a purchase agreement has been executed.
KBnxt appeals particularly to high-income consumers. This high-income group likes to
enjoy the flexibility to design their homes and is ready to pay more for the same, thus
driving the average selling price and revenues. KB Home is opening more design
studios, expanding the size of existing stores and introducing new displays in a bid to attract these customers.
Aggressive Land Acquisition Strategy: The company invests aggressively in land acquisition and development, mainly in high-end
locations, which is critical for community count as well as top-line growth. The company spent around $967.2 million in fiscal 2015,
$1.47 billion in fiscal 2014 and $1.14 billion in fiscal 2013 for acquisition and development of land, significantly higher than $564.9
million spent in 2012. The company expects to invest $1.5 billion in land and development in fiscal 2016. It has already acquired
land for fiscal 2016 and most of the lots required for fiscal 2017, which is expected to generate a steady source of revenues, going
ahead.
Growth Initiatives to Drive Profitability: Over the last three years, KB Home has focused on four strategic initiatives to drive its profit
and revenues, and ensure its success in fiscal 2016 and beyond. These initiatives include boosting community count, achieving
higher revenue per community and higher profitability per unit, and increasing asset efficiency and return on capital invested.
The company opens communities in highly favorable submarkets, primarily in the Central and West Coast regions, particularly
California, where housing demand is strong and supply is limited.
Moreover, the company focuses on profit per unit by improving cost efficiencies without compromising on the quality of the product.
A Positive Housing Market Outlook: 2015 was more or less a good year for the housing market, possibly the best since 2007 when
the housing recession set in. Despite a weak start this year amid equity market volatility and global concerns, the construction sector
seems to have recovered on the back of strong housing fundamentals. The spring selling season in 2016 was better than the last
year. The springtime weather boosts construction activity and traffic trends. Positives like an improving economy, modest wage
growth, low unemployment levels, low interest rates, positive consumer confidence and a tight supply situation raise optimism about
the sector’s performance for the second half.
Improving labor markets, falling unemployment rates, low mortgage rates and a limited home supply are supporting a continued rise
in home prices, thereby booting homebuilders’ top line.
Moreover, housing remained an affordable option in 2015 as mortgage rates remained close to historic lows. Even if
mortgage/interest rates rise with the Fed probably announcing further federal fund rate hikes this year or next, the rates should still
remain reasonable, in our view, keeping housing affordable. Modest hikes in interest rates in the context of an improving economic
environment can be a net positive for the housing sector
Apartment rental rates have been moving up, making home buying more financially attractive. Additionally, as the millennial
generation leaves their parents’ home, a sharp spike in household formation is translating into higher demand for new homes.
With oil prices still subdued and the job market looking good, the demand for new homes is on a steady rise.
Further, a shortage of buildable lots, skilled labor and available capital for smaller builders are limiting home production, thereby
lowering the inventory of homes, both new and existing. The convergence of healthy demand and low inventory levels is boosting
new home sales and is expected to continue for some time.
More than 50% of the company’s deliveries are generated from first time buyers. KB Home is witnessing strong demand from this
buyer segment. With an improvement in the employment market, the millennial generation is increasing moving out of their parents’
homes. This is translating into higher demand for new homes.
Last Earning Report:
Risks:
Rising Labor, and Land Costs: Rising labor costs are threatening margins as they limit homebuilders’ pricing power. Labor
shortages are leading to higher wages and delays in construction, which eventually hurts the number of homes delivered. Also
land prices are increasing due to limited availability. More inflation is anticipated, going ahead. This is denting homebuilders’
margins considering that home price increases are moderating.
Concentration in a Few Markets: KB Home depends heavily on the housing market in Central U.S. (Colorado and Texas) and the
West Coast (California). Lack of geographic diversity exposes the company to fluctuations in a few markets and does not allow it
to capitalize on the strong housing demand in other regions of the U.S.
Houston is dependent on the oil complex, which is hurting the region’s overall economy and thereby home sales. While demand
in Houston is stabilizing, it will take a while before it rebounds.
Supply Constraints: Several years of production deficits during the housing downturn limited the supply of both rental and new
homes in the country. At present, a shortage of buildable lots, skilled labor and available capital for smaller builders are limiting
home production, thereby lowering the inventory of homes, both new and existing. The labor market has also tightened with
limited availability of labor arresting the rapid growth in housing production.
Moreover, community count, which declined during the second quarter of 2016 due to fewer home openings, is expected to
decline further in the third quarter 2016. The company does not expect community count to recover till 2017 beginning.
Federal Government Actions: The federal government’s actions related to economic stimulus, taxation, borrowing limits could
affect consumer confidence and spending levels which, in turn, could hurt both the economy and the housing market.
With the Fed announcing a hike in the benchmark Federal Funds target rate in December last year, for the first time since 2006,
mortgage rates will probably rise later in 2016 or in 2017. High mortgage rates dilute the demand for new homes as mortgage
loans become expensive. This lowers purchasing power of the buyer’s and hurts volumes, revenues and profits of homebuilders.
