KB Home And Tri-Pointe: Short-Interest Or Short-Squeeze?

Includes: KBH, TPH
by: John Gilluly

When I first began coverage of the homebuilder sector in June, 2012, I was astonished at the high level of short interest in these stocks. KB Home's (NYSE:KBH) short-interest (44 ML) had swelled to 62% of its float and it was one of the most-shorted stocks in the S&P 1500, trading around $6.75/share.

Shortly afterwards it began an epic surge of 300%, filled with dramatic hops, flops and fake outs. In the process, the short interest dropped 70% to 12.6 ML on May, 15, 2013, or "just" 18% of the float. 32 ML shares had covered, and I am assuming, at a brutal loss.

Most recently, the short-interest in KB Home has again risen 50%, this time to 19 ML on September 13, 2013, just prior to the Federal Reserve's No-Taper announcement. The shares also were down 35% at $15.90 on September 5, 2013.

The culprit? An explosive 35% rise in mortgage rates that precipitated the equally dramatic drop in the home-builders.

In the meantime, the strong growth in its coastal CA market continued apace; and now the tapering-tizzy is behind us (for the moment).

In just the last week, mortgage rates have already dropped 10%. And it's highly-likely that yields will continue some degree of mean-reversion during the 4th quarter. There have been only 6 times in the last 30 years where bonds have put on such a dramatic short-term show, and each time they mean-reverted during the coming months (see chart at the bottom of Andrew Kassen's article, Is September's FOMC Setting Up A US Treasuries Rally?, September 7, 2013).

The next 4 months look like better-sailing for the builders. In the most recent New Homes Sales figures, the median number of months to sell dropped to 3 months, and the 175,000 homes in inventory is one of the lowest levels seen in 47 years.

There is also another short-term tailwind brewing: more restrictive lending practices to begin on January 10, 2013. The government in its wisdom has now figured out a way to protect some new buyers from the crisis-past by denying them a future in the real estate market. Current buyers will have Q4 to lock-in a home purchase under the old rules.

The slight lessening of mortgage rates - combined with buyer urgency due to financing concerns and tight inventory - could create a pick-me-up in Q4 new home sales.

This is what KB Home had to say about its most recent quarter (9/24/2013) vis a vis coastal CA.

"..In the third quarter, 66% of our California revenue came from our coastal divisions, which is a significant flip from where our mix has been historically. The difference in sales price and margin is considerable between the coastal and inland regions, in many cases more than double. And as a result, we have been able to generate significantly more revenue and profits on fewer units. In our third quarter, we delivered 14 additional units in California compared to the prior year, yet our revenue was up by approximately $60 million.

This ability to successfully identify, acquire and open high-priced communities in the coastal region is a direct reflection of the distinct competitive advantage of our KB Home brand...New communities located in these land constrained areas are highly sought after and take time to replace. Accordingly, the last thing we would want to do is push absorption rates, compromise margin and in turn, sell through these communities before our new acquisitions are brought online. Our coastal business continues to grow as we have made significant investments in communities that have not yet opened for sale. We will continue to maintain this discipline of balancing price and pace with the goal of growing revenue, expanding gross margins and elevating profitability.

We had 7 communities opened in August that had been delayed. And as a result, they contributed less than 1 month of sales to our quarterly totals. In these land constrained areas, finished lots are all but gone, and we are now acquiring more land that typically requires some level of entitlement and development, and both municipal processing and development times have extended. When these 7 communities opened, they all opened to a very favorable buyer response with pricing and gross margin well above projections, and all are expected to be strong contributors to our fourth quarter results. In addition to these 7 openings, we have 12 more community openings planned in the state for the fourth quarter.

In essence, this intentional shift to quality locations has resulted in significantly more profit for the company, along with revenue growth, albeit at lower unit volumes in the short term. As the coastal markets have strengthened, demand and strong pricing power is spreading to the Inland areas, and we have recently been investing more aggressively in the most desirable sub-markets of the Inland regions as well.

With the investments we have already made, we anticipate our year-over-year community count in the state to increase in the first quarter of next year, and expect a positive unit sales comp for 2014.

Which leads me to Tri-Pointe Homes (NYSE:TPH), and the reason I am lumping them in with these recent comments from KB Home. Tri-Pointe serves the coastal markets of Los Angeles, San Diego, Orange County, and the SF Bay Area, the same regions where KB Home has just had such a stellar quarter.

Here is a chart of the San Francisco, Los Angeles, and San Diego real estate markets. The month over month Case-Shiller price changes (June-July, 2013) in San Francisco were +2.23%; Los Angeles: +2.1%; San Diego: +2.04%. Q3'2013 was a very good quarter for the CA builders. The year over year changes in San Francisco were +25%; Los Angeles: +21%; San Diego: +20%.

As explored in two recent articles (A Concentrated Way To Play Rapid Price Appreciation In The California Housing Market, by Ahanotu Duru, April 9, 2013; and TRI Pointe Homes: The Gold Rush In California Real Estate Continues, by John Gilluly, June 12, 2013) Tri-Pointe is one of the fastest-growing builders in California, exceeding analyst expectations in each of their last two quarters.

So why is the stock languishing at $14.45, just a few pennies above its all-time low? Concentrated short-sellers have piled into this young IPO at every uptick in the real estate sector, driving down the price. It would now take 23 trading days (4.6 weeks) of Tri-Pointe's recent average daily volume to cover the 2.4 ML shares short in this stock. This is reminiscent of KB Home's position in the summer of 2012, just before its rally.

After a 30%+ haircut this summer - along with the recent downtick in mortgage rates and a renewed investor interest in the sector - a sudden resurrection could precipitate for these beaten-down builders; like one of those turn-on-a-dime short-covering rallies that KB home is so well-known for..

Disclosure: I am long TPH, BRP, DHI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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