Shares Outstanding: 77 Million
Market Cap: $977 Million
Book Value: $648 Million
Adjusted Book Value: $1,232 Million
Enterprise Value: $1,352 Million
Normalized Earnings Power: $100 MM
Earnings Per Share 2009: ($12.59) TTM 2010: ($1.33)
FCF per share 2009: $349 MM
Normalized Return on Equity: 8-10%
Founded in 1957, KB Home builds and sells single-family homes mostly to first-time, and first-time move-up buyers. in 30 markets in 10 states. In 2009, it delivered 8,488 homes at an average price of $207,100. Its most significant operations are in California, Arizona, Florida, Texas, and Nevada. The company divested its French operations in 2007 and now focuses entirely on the U.S.
KBH primarily focuses on the first-time home buyers which we view as the most attractive demographic being that most new home purchases are likely to be the result of new household creation, as opposed to speculation or vacation purchases. They have been catering products specifically for this niche through their Open Series line of homes which is specifically suited to qualify for Fannie Mae and Freddie Mac mortgage financing. Management has proven to be some of the most competent in the industry in that they quickly move to downsize operations, cut costs, and refocus operations to a more specific demographic. Many of their competitors engaged in value destructive mergers and equity issuances while KBH has lowered its share count over the last few years.
The company has been paying off debt and generating cash. Now they boast a relatively clean balance sheet and they expect to maintain over $1 Billion in cash by the end of the year. This has allowed them to make strategic purchases of finished lots at attractive deals in some of the more attractive geographies. We expect them to continue to selectively buy more properties and we are comfortable with their current inventory make up of $1.7 Billion, in which $1.2 Billion is related to homes sold, in backlog, or finished lots. This means that they don’t have some of the spec properties that a lot of the other builders are still holding on to.
For the first time since 2005 KBH has seen increased year-over-year home orders. A lot of this increase was due to the tax credit for new home buyers but we do feel that positive momentum combined with aggressive cost cutting is putting KBH back on the track to profitability. Because of their losses over the last several years KBH has about $6 a share in net operating loss carryforwards that they can use against profits, which accounts for the higher adjusted book value.
Due to significantly lower collateral values, extremely low interest rates, and an uncertain outlook on inflation we are confident that housing is close to a bottom. Prices have actually been rising in California and several of the other trouble markets over the last few months which is encouraging. The banks still aren’t extending the credit that is needed for new home buyers to step in at much higher volumes but we feel that the situation is fluid and as banking profits stabilize we will see increased lending levels. Many of the foreclosures and short sales are working their way through the system and eventually these homes are going to have to buy homes again, and KBH is perfectly situated in that many homebuyers will be faced with the proposition of downsizing to more affordable homes.
Typically home builder stocks rally in anticipation of an increase in new home purchases so we think the stock will perform well prior to the actual economy showing significant strength. The key is that we are getting in at a price substantially below the adjusted book value, with expectations extremely low on a well financed company with excellent prospects over the next 3-5 years.
Buy 100 KBH at $11.10
Sell 1 August KBH 10 put for .50
Sell 1 August KBH 12 call for .50
Target Profit: $590 if options expire worthless and stock goes to $16
Maximum Risk: $2,010 if both put options are exercised
Days Remaining: 52
Target Net on Cash: 29.3%
Target net on cash if options expire and stock doesn’t move: 9.9%
Annualized target net on cash if options expire and stock doesn’t move: 71%
Break Even Price: $10.10
Target Price: $16 a share or equal to adjusted book value
Primary Risk Factors:
Disclosure: Long KBH, Short KBH puts,