Should I Buy KB Home? 3 Pros, 3 Cons

by Tom Taulli | September 24, 2012 11:58 am

KB Home (NYSE:KBH[1]) continued its torrid performance last Friday after a knockout earnings report[2].

The homebuilder announced a profit of $3.3 million, or 4 cents a share, for the latest quarter, completely blowing out Wall Street predictions for a 15-cent loss. The move sent KBH shares up more than 16% Friday, and despite a 3% pullback by midday Monday, KB Home still is looking at 120% year-to-date gains.

That’s right — KBH’s price (around $15) is back to levels last seen in early 2010 … though it still pales in comparison to 2005, when KB Home was north of $80.

So should you buy KB Home, or is its stock getting too bubbly? To decide, let’s take a look at the pros and cons of KBH stock:

Pros

Top Homebuilder: Founded in 1957, KB Homes quickly became a top-notch player in its industry. The focus is primarily on the first-time homebuyer, who wants an affordable price tag without sacrificing quality. The company also stands by its properties by providing a 10-year limited warranty to its customers.

Restructuring: Amid the depression in the U.S. real estate market, KB Home had no choice but to rethink its business model. To this end, the company withdrew from low-performing markets and aggressively cut back its costs. As a result, the company can reach profitability at lower levels of home deliveries. KB Home’s focus on quality also is delivering results. The average selling price of its homes has increased on a year-over-year basis for nine consecutive quarters, which has been key to boosting margins.

Growth: KB Home should continue its winning ways. In the most recent quarter, KBH’s backlog increased by 33% to $745 million, the company’s highest level since 2008. A big part of the growth has come from the California market, where KB Home is the dominant operator. A recent piece[3] in The Wall Street Journal shows that 13 of the 15 cities with the biggest declines in inventories were in California.

Cons

Constraints: While demand might be growing, homebuilders still are having a tough time ramping up construction. Some problems include tight supplies for lumber and other raw materials, but they also are experiencing difficulties in finding skilled labor, including carpenters, roofers, electricians and plumbers.

Competition: Even with the weeding out of smaller players, the homebuilder market is still highly competitive. KB Home is merely the fifth-biggest player in an American market that includes PulteGroup (NYSE:PHM[4]) D.R Horton (NYSE:DHI[5]), Toll Brothers (NYSE:TOL[6]) and Lennar (NYSE:LEN[7]), among others.

Mortgages: Even rock-bottom rates might not be enough to keep the market on the upswing. It still is tough for many people to qualify for home loans because of damaged credit and high down payment requirements. KB Home’s mortgage provider, MetLife (NYSE:MET[8]), had to leave the market because of regulatory difficulties. To deal with this, the company recently struck a deal with Nationstar Mortgage (NYSE:NSM[9]).

Verdict

On the earnings conference call, KB Home CEO Jeffrey Mezger said he’s on “offense.” Seems like good timing as the real estate market continues to get traction, and a rebound in California could be a huge boost to the company. Once again, Wall Street analysts severely underestimated KB Home’s latest quarter.

So should you buy KB Home? Yes — in light of all this, I think the pros outweigh the cons. However, KB Home’s stock has proven volatile, so in the short run, investors might do well to hold off and buy on a strong dip.

Tom Taulli runs the InvestorPlace blog IPOPlaybook[10], a site dedicated to the hottest news and rumors about initial public offerings. He also is the author of “All About Short Selling”[11] and “All About Commodities.”[12] Follow him on Twitter at @ttaulli[13]. As of this writing, he did not hold a position in any of the aforementioned securities.

Endnotes:
  1. KBH: http://studio-5.financialcontent.com/investplace/quote?Symbol=KBH
  2. knockout earnings report: http://investorplace.com/2012/09/kb-home-back-in-the-black/
  3. recent piece: http://blogs.wsj.com/developments/2012/09/18/for-sale-listings-drop-again-led-by-california-cities/
  4. PHM: http://studio-5.financialcontent.com/investplace/quote?Symbol=PHM
  5. DHI: http://studio-5.financialcontent.com/investplace/quote?Symbol=DHI
  6. TOL: http://studio-5.financialcontent.com/investplace/quote?Symbol=TOL
  7. LEN: http://studio-5.financialcontent.com/investplace/quote?Symbol=LEN
  8. MET: http://studio-5.financialcontent.com/investplace/quote?Symbol=MET
  9. NSM: http://studio-5.financialcontent.com/investplace/quote?Symbol=NSM
  10. IPOPlaybook: http://investorplace.com/ipo-playbook/
  11. “All About Short Selling”: http://www.amazon.com/All-About-Short-Selling/dp/0071759344/ref=sr_1_1?s=books&ie=UTF8&qid=1302184310&sr=1-1
  12. “All About Commodities.”: http://www.amazon.com/All-About-Commodities/dp/0071769986/ref=ntt_at_ep_dpi_10
  13. @ttaulli: https://twitter.com/ttaulli

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