JP Morgan (JPM) and Goldman Sachs (GS) have published interesting reports on U.S homebuilders. Since these reports are not publicly available, we thought we should summarize their analysis. Goldman Sachs analyst Kristen McDuffy and her team published the report “Beazer and KB Home: Relative value, recovery analysis & outlook” on Dec 20, 2011. JP Morgan’s analyst Michael Rehaut published the report “Post-Call Notes: Gross Margins Should Improve Only Modestly in FY12; Equity Raise Unlikely; Neutral Positive industry data points towards the start of a recovery” on Dec 21, 2011. Below is the summary analysis by these investment bank analysts.
Despite a higher share of distressed house activity in the housing industry, recent data indicates stability in the prices of non-distressed houses over the past year. According to the provisional data released by the US Census Bureau, we also see stable to increasing number of monthly home sales in 2011, adjusted for seasonality – November saw a 9.8% increase in single family new home sales compared to the same month last year. Another interesting fact is the growing divergence in prices of distressed and non-distressed houses, showing the strengthening demand for non-distressed houses and the possibility of a significant recovery of the housing sector next year.
Also pointing towards the recovery is the increasing foreclosure inventory by number of days where approximately 40% of the non performing home loans are over 24 months old while additions of new loans are sustained at the lowest levels since January 2009. Addition in the number of mortgages categorized as seriously delinquent (90+ days) has also been falling and the monthly number is now consistently below 4%. This seriouly deliquent mortgage rate has now fallen to three year lows.
Housing recovery is usually associated with an increase in new home sales – people who are first-time home buyers. The increase in new residential construction, estimated at 685,000 units in November, which is a 9.3% increase MoM, is far below the historical levels of approximately 1 million units but has started rising, indicating the start of a recovery.
Other economic data also supports this opinion. Ratio of housing starts to jobs created is approximately 0.99, and with higher numbers of jobs created this year, housing starts is expected to benefit from these 1.8 million new jobs. Lastly we have seen a steady increase in the NAHB Homebuilder Sentiment Index as well as in the index for traffic of prospective buyers, and both these indices are at their highest levels since May 2010 with the former now above mid-2001 levels.
But not soon enough for KB Homes
KB Homes (KBH) recently announced its FY11 results (Nov-end). The results were below market expectations as the company reported a loss of $2.32/share. The company’s bottom-line is expected to remain in the red next year before making a profit in FY13.
In FY12, with the sector’s concentration on reducing the SG&A expenses, the same is expected from KB Homes, which also showed significant improvement in the SG&A expenses for 4QFY11 results. The company booked a $4.5 million legal reserves accrual; adjusting for this non-cash expense shows a SG&A ratio of 14.9%. Based on these figures, margins are expected to improve next year, assuming the same SG&A ratio and 6-7% growth in the top line.
The decline in selling and administration expenses is a result of active measures taken by the company. The company is focusing on redesigning its existing products by focusing on reducing costs through built to order sales, building smaller homes and lowering costs of production.
A favorable factor which emerged in the last quarter’s result was the increase in the company’s top line which was supported by a 3% overall increase in average prices as well as a 6% QoQ increase in home sales.. The company also managed to deliver higher numbers of homes at 1,995 units in the last quarter, taking the full year’s number to over 7,300 homes.
There have been some positive developments which the company might benefit from in the next couple of years. Recently the company also shifted some of its business to MetLife (MET). Before this, 80% of the company’s home mortgages were handled by a single entity which the company has successfully managed to decrease to less than 40%. However, MetLife’s announcement of selling its Home Loan business slowed the shift in the last quarter for KB Homes.
Another noteworthy development for the company was its victory in the South Edge litigation which results in the company being able to develop land in the city of Henderson by the end of 2012, according to the company’s estimates.
KB Homes has also successfully managed to increase its backlog of houses at the end of the financial year, which in the event of increasing home prices, should benefit the company in the coming year if housing demand remains on the same trend.
While estimates for companies across the sector have been revised upwards by Goldman, at current prices most of the stocks are not likely to outperform the market.
KB Homes trades at a 50% discount to its peers’ at 0.57x P/BV. According to JP Morgan, KBHome’s valuation is appropriate as they foresee negative profitability over the next half year and liquidity concerns to remain in the company (though they think it is unlikely that the company will issue any new equity). JP Morgan has a Dec-2012 target price of $8.00 based on historical 10-year average P/BV multiple of 0.63x.
However, higher gross margins next year and lower impairment charges will result in an upward revision in earnings estimates. Order growth is also a key factor especially in the company’s key markets like California and Texas and also makes the company more dependent to improving conditions in these regions.