by Joseph Hargett | March 18, 2014 11:02 am
Homebuilders Lennar (LEN) and KB Home (KBH) face significant headwinds when they step up to release their quarterly earnings reports later this week. Despite heading into what is typically a strong cyclical season, revenues are being pressured by a harsh U.S. winter, rising interest rates, and the potential for a drawdown in Fed stimulus.
What’s more, the National Association of Home Builders/Wells Fargo housing market index fell to 46 in February from 56 in January, indicating declining confidence in homebuilders.
In spite of these tough market conditions, analysts are forecasting solid year-over-year growth for KB Home and Lennar. KB Home is seen posting a profit of 8 cents per share on revenue of $437.1 million, up from a loss of 16 cents per share on revenue of $405.2 million a year ago.
Meanwhile, Lennar is expected to report earnings of 28 cents per share on revenue of $1.28 billion, up from 26 cents per share on revenue of $989.9 million in the same quarter last year.
The pair of homebuilders missed Wall Street’s expectations in the prior quarter, with results once again pressured by a poor weather and rising interest rates. But even the prospects of a repeat performance have not dimmed high expectations in the brokerage community.
Specifically, EarningsWhisper.com reports that the whisper number for Lennar arrives at 31 cents per share, 3 cents better than the consensus, while KB Home’s whisper number of 9 cents per share is a penny better than the consensus.
Digging a bit deeper into sentiment on KBH and LEN stock, we find a plethora of “buy” ratings from the brokerage community. According to Thomson/First Call, KBH has attracted eight “buys,” 10 “holds,” and only six “sells.” LEN stock, meanwhile, has racked up 11 “buys” and 10 “holds,” with nary a “sell” rating to be found.
This wealth of optimism also is spilling over into the options pits for LEN and KBH stock. Looking at just front-month March options activity, KBH sports a put/call open interest ratio of 0.27 while LEN’s ratio arrives at 0.33. In other words, call options are roughly three times as popular as put options among short-term traders. Furthermore, since March options expire at the end of this week, it indicates that many investors could be betting on a post-earnings rally from KBH and LEN stock.
For LEN, peak call open interest resides at the out-of-the-money March 41 strike, with nearly 13,000 contracts. Another nearly 9,000 contracts are open at LEN’s at-the-money March 40 strike. Turning to KBH stock, call traders have zeroed in on the out-of-the-money March 19 and 20 strikes, where roughly 9,700 and 8,000 contracts reside, respectively.
Click to Enlarge Technically speaking, LEN stock is currently trading within striking distance of those open March 41 calls. Despite recent broad-market pressure, the shares are holding firm near their 50-day moving average in the $40 region. Unless Lennar’s earnings completely whiff expectations, this technical support should continue to hold. On the upside, LEN stock faces resistance near $42, when its 10-day and 20-day moving averages are crossing, and above that at the $45 level.
Click to Enlarge KBH stock, meanwhile, took a considerably worse beating during the recent market weakness. The shares have plunged from a peak near $21 in late February to a low near $17 this week. KBH appears to have stabilized, but the stock’s 50- and 200-day moving averages have recently completed a bearish cross, which is likely to spook many technical traders. The shares are sitting on support at $17, however, and a short-term oversold situation could provide a modicum of near-term buying power if earnings come in as expected.
Those looking for a trade on LEN or KBH stock will be interested in knowing that March implieds are pricing in post-earnings moves of about 6.4% for KBH and 5.7% for LEN. This places the upper and lower bounds at $15.91 and $18.09 for KBH stock, and at $37.71 and $42.29 for LEN stock.
With the recent selloff behind us, and both homebuilders near short-term oversold situations, I’m inclined to side with the bullish crowd on both heading into this week’s earnings reports.
For KBH, an April 17/19 bull call spread looks promising, while an LEN April 40/42 bull call spread has plenty of potential.
The KBH April 17/19 bull call spread was offered at 55 cents, or $55 per pair of contracts, as of the close on Monday. Breakeven for this trade lies at $17.55, while a maximum profit of $1.45, or $145 per pair of contracts, is possible if KBH closes at or above $19 when April options expire.
For LEN, the April 40/42 bull call spread was offered at 87 cents, or $87 per pair of contracts. Breakeven for LEN lies at $40.87, while a maximum profit for this trade comes in at $1.13, or $113 per pair of contracts, if the stock closes at or above $42 when options expire.
As of this writing, Joseph Hargett did not hold a position in any of the aforementioned securities.
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