KB Home: Despite Positive Earnings Proceed With Caution

| About: KB Home (KBH)
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Average sale price could reveal underlining problems.

Orders and deliveries are not as stable as they seem.

Thin operating margins exposes KB to greater external risk.

Proceed with caution due to general precariousness.

KB Home:

Despite the share price rising after 2016Q2 earnings, investors should proceed with caution. That is, there are several underlining factors that illustrate a precarious position for KB Home (NYSE:KBH) and could prove to be trouble later this year or early 2017. This precariousness is from the following: average sale price, regional sales, target segmentation, external uncertainty, and thin operating margins.

Average Sale Price: broke out as the following: (YOY) West Coast drop in price from $565,500 to $564,800, Central $237,900 to $262,300, Southwest $275,400 to $285,700, Southeast $271,800 to $275,200. Average sale price only rose 2% overall. The two regions in which KB sells in California are San Bernardino and Riverside Counties. Estimates state that the average home value in San Bernardino County is $226,200 and Riverside County is $323,200. Over the last year home prices have risen 11.5% in San Bernardino and 6.8% in Riverside Counties respectively. This begs the question, if home prices rose considerably in those counties and California as a whole what caused the drop in average sale price? Perhaps, the fact that KB's average selling price was $560,000 plus. These regions have a large working class and a lot of first time buyers. Hence, KB was able to move inventory, but had to bargain to attract these buyers from California's dynamic rental market and lower average price.

Although all regions rose considerably in price besides the West Coast the problem is that the West Coast accounted for the over whelming majority of sales growth and is their second biggest market of 28% of net orders and 25.4% of homes delivered. Sales growth broke out as the following: West Coast +2%, Central +3%, Southwest +2%, and Southeast -6%.

Lagging Regional Sales: Although there was net order growth of 8% YOY for the quarter, sales in the three regions besides the West Coast were either stagnant or declined as described above. Hence, this puts KB in a dangerous position. If California sales slow later in 2016, and if the other regions remain flat or even decrease, earnings would greatly suffer. More narrowly, the Southeast accounted for 18.2% of homes delivered and 17.3% of net orders for six months 2016, which makes it their third largest region. If sales continue to decline in this region it would considerably weigh down the profits of the entire company.

Target Segmentation/External Pressures: It is well known that KB targets first time home buyers and the average American. Consequently, talks of a possible recession (albeit a relatively slim chance), economic uncertainty, and slowed employment could be affecting sales. That is, these groups are almost always disproportionately impacted by uncertainty or economic down turns. Hence, there could be a run to safety in which these individuals are sticking with renting or are just simply holding off on buying a home until the dust settles. This caution might subside following the 2016 election or when the overall state of the economy becomes less ambiguous, etc. As a result, KB does not benefit from the same inelasticity that a homebuilder like Toll Brothers (NYSE:TOL) enjoys. Moreover, the regions where sales stalled or declined are marked by lower average selling prices. This could be the indicator that the working class and first time buyer are indeed slowing their acquisitions.

It could be extrapolated that these individuals are starting to feel the ripples of slow economic and employment growth. Perhaps, they are being dissuaded by the constant negativity from the media. With that being said, a stock market decline following the presidential election or poor economic conditions entering 2017 would dramatically reduce home sales and prices, especially for KB Home.

Thin Operating Margin: KB Home has relatively poor construction, land, and SG&A costs. This has led to historical operating margins of about 5%. For example, for the first six months of 2015 the operating margin was a mere 2.6%. However, it did improve to 3.2% because of the increase in average selling price of 2% and an increase in homes delivered of 26.6% (first six months YOY). Simply, these margins are lagging their competition. For example, D. R. Horton Inc. (NYSE:DHI) has operating margins of 11%, Lennar Corporation (NYSE:LEN) 12%, and PulteGroup (NYSE:PHM) 13%. Consequently, KB Home has a thin margin of error, so if prices miss or if orders/homes delivered lag (due to the above mentioned reasons) KB would be in deep trouble in terms of cash flow, debt, etc.

Summary: Yes, there was growth of 8% for homes ordered for the quarter, a 26.6% increase in deliveries for the first six months, and an average increase in sale price of 2%. Yet, these figures are underpinned with precariousness. That is, KB's third largest region, the Southeast, experienced a sharp decrease in sales. Moreover, their largest region, the West Coast, experienced a decrease in sale price in spite of average prices increasing significantly in California. This could point to a fundamental problem of the KB offering mix or its target market segmentation. Additionally, the relatively lagging and thin operating margin creates little room for error and puts KB even more at the whim of external factors. Finally, the potential for economic decline and the uncertainty of the presidential election create opportunities for turbulence in the housing market.

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

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.