As has become all too common, KB Home (NYSE:KBH) reported another tough quarter last week. The company lost $68.5 million, and the stock fell roughly 15% on the news.
Consider that over the past five years the stock’s average annual return was a horrible -22.2%. Ouch!
No doubt, markets eventually come back and there should be rewards for gutsy shareholders. But can we expect this with KB Home — perhaps soon?
Let’s take a look at the pros and cons:
Restructuring. KB Home has worked aggressively to lower its operating costs. In fact, the company continues to pare down its employee headcount. It believes that it can achieve profitability in the fourth quarter of 2011.
There is also more focus on markets that are showing strength, such as the coastal areas of Texas and California.
Affordability. Interestingly enough, it is often cheaper to buy a home than rent. As a result, there has been more demand from higher-income families as well as those looking to move up.
To this end, KB Home has been focused on catering to these types of customers. For example, its new communities have attractive energy-efficiency systems and the homes are based on a built-to-order approach.
Deals. With the residential marketplace still depressed, KB Home is finding opportunities to buy choice properties at low valuations. A recent case is the acquisition of land from a private builder in San Antonio. It is an attractive location, and KB Home shelled out a small amount of capital.
Cons
The market. The conditions continue to be rough. According to the S&P/Case Schiller report, home prices fell by 4% in 20 cities in April. The market continues to suffer from an overhang of foreclosures and weak job growth.
Lending. Even though mortgage rates are at rock-bottom levels, the fact is that banks are extremely tight with their underwriting standards. Actually, there will be a lowering of conforming loan limits, which will put further pressure on lending.
Capital structure. While KB Home has $730 million in the bank, its outstanding debt is still a hefty $1.69 billion. If the market deteriorates further and the company remains unprofitable, there may be a need to go back into the market to raise equity. This would dilute those already holding the stock.
Verdict
KB Home is a good company. It has a strong focus on quality and customer needs.
But as seen with the latest drop in the stock price, investors remain unconvinced about the future. Unfortunately, there are powerful negative forces. Perhaps the most important is the sluggish real estate market. It looks like it may still take several years for things to get better.
In light of the situation, the cons outweigh the pros on the stock.
Tom Taulli’s latest book is “All About Short Selling” and he has an upcoming book called “All About Commodities.” You can find him at Twitter account @ttaulli. He does not own a position in any of the stocks named here.
