KB Home's Recovery Spells Turnaround In Homebuilders

Jun.29.12 | About: KB Home (KBH)

KB Homes' (NYSE:KBH) recent quarter operating results have shown a huge improvement. Better operating results posted by a company, which was previously one of the worst-performers in the entire industry, shows a possible rebound of the gloomy Housing Sector. Those companies that were already performing better than KB Homes are expected to benefit from this positive earnings' release. Hence, we continue to recommend long positions in Lennar Corp. (NYSE:LEN) and Toll Brothers (NYSE:TOL), as their deliveries, orders and backlogs are increasing, while cancellation rates are dropping. DR Horton (NYSE:DHI) can be a buy in the long-term, but we recommend a neutral position for now because of its expensive valuation, as we wait to see its third-quarter performance.

KBH 2Q2012 results

Today, KBH released its earnings for 2Q2012. Although its revenue exceeded expectations by 1%, its EPS fell short by 9%.

Actual

Expected

% Change

Outlook

Revenue ($ million)

302.9

301.3

1%

+

EPS

(0.31)

(0.34)

(9%)

-

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The following table compares KBH's results with those of 1Q2012, as well as 2Q2011.

2Q2012

1Q2012

% Change
(QoQ)

Outlook

2Q2011

% Change
(YoY)

Outlook

Net orders

2049

1197

71%

+

1998

3%

+

Order cancellation rate

26%

36%

-10%

+

25%

1%

-

Quarterly backlog homes

2962

2203

34%

+

2422

22%

+

Average selling price

$ 233,000

$ 219,000

6%

+

$ 213,400

9%

+

Number of home deliveries

1290

1150

12%

+

1265

2%

+

Revenues ($ million)

302.9

254.6

19%

+

271.7

11%

+

Gross margin

16.90%

9.70%

7.2%

+

7.30%

9.6%

+

EPS

-0.31

-0.59

47%

+

-0.89

65%

+

Click to enlarge

We were previously bearish on KB Homes, primarily due to a reduction in its number of new orders, and an increase in its order cancellation rates. However, KBH has shown significant improvement from its previous quarter's disappointing results. Its number of net orders has shown an increase of 3% on a year-over-year basis, while the order cancellation rate dropped to 26% from 36% last quarter. Still, this cancellation rate is 1% higher than the 25% for the previous year.

The number of quarterly backlogs has also increased as against the last quarter (by 34%), as well as last year (by 22%). In addition, both the average selling price and number of home deliveries have increased by 9% and 2% respectively (relative to the previous year), resulting in an increase in KBH's revenue of 11% (even beyond analysts' expectations).

As a result of this significant revenue, its gross margins showed an increase of 9.6% on a YoY basis. More significantly, its operating losses reduced by 65% as against last year.

Industry Overview

We feel that KBH's positive results are going to have a positive impact on its industry, as well as other homebuilders' stocks. In addition, the fact that mortgage rates have dropped to record-low levels and new-home sales have risen to two-year highs, are strong indicators of a possible recovery for the Housing Sector.

Click to enlarge

Click to enlarge

Other Homebuilders:

Lennar Corp.

Recently, Lennar also announced its latest earnings, which showed that the Housing Sector has started to recover. LEN's new orders increased by 40%, while its number of deliveries rose by 20% this quarter on a YoY basis. Its backlog of 3,970 homes is 61% higher than that in 2Q2011. In addition, its long-term growth rate of 30% makes it our favorite pick amongst homebuilders.

Toll Brothers

We reiterate our long position for TOL because of its high exposure to luxury buyers (who have better credit records), an increase in the number of new orders by 47%, a jump of 37% in quarterly backlogs, and a rise of 14% in the number of deliveries.

DR Horton Inc.

DHI's net orders and backlogs increased by 19% and 17% respectively. Plus, order cancellation rates dropped to 22%. However, its expensive valuations, as evident from its high PEG (4.3x) and price-to book (1.8x) ratios (which are the highest among its peers), prevent us from recommending a long position for short-term investors. We still want investors to wait for its recent earnings release and then take a decision to buy the stock or not. However, for long-term investors, DHI is a potential buy given its strong fundamentals.

Recommendation

We are optimistic about KB Homes' ability to sustain its loss-reduction efforts. According to Jeffery Mezger, KBH's President and CEO, "We expect the benefits of our repositioning efforts and the shifting of our geographic footprint to become more fully realized in future quarters."

If the company's management is able to live up to its claims, then its stock will jump to huge highs in future.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.