It’s been a bumpy year for home-building company KB Home (NYSE:KBH), but the firm’s second quarter results showed that things are looking up for the developer’s future. The firm reported EPS of 57 cents per share on revenue of $1.1 billion compared to estimates of 48 cents per share on revenue of $1.043 billion on Thursday after the bell.

The news sent the stock more than 8% higher in pre-market trade on Friday morning. KBH is still up more than 7% as of this writing.

While the results have been a boon for KBH stock, the firm’s share price hasn’t returned to its near $40 per share highs back in January as investors remain cautious about swings in the housing market. 

Improving Operations

KB Home has been struggling under the weight of long-term debt and concerns about the reliability of the US housing market, however on the company’s earnings call management addressed some of those concerns  which should have somewhat assuaged investors’ fears.

Over the past 18 months, KBH has been working to improve operations and cut costs through its “Returns-Focused Growth Plan objectives” and so far the initiative appears to be paying off. CEO Jeffrey Metzler said the company was able to internally generate an additional $2.4 billion which was used to up investment in land and development by 26%. The company was also able to repay nearly $600 million worth of debt, significantly lowering its obligations and setting the stage for improved margins going forward.

In addition to KB Home’s improving operations, the company also benefited from a booming housing market in the U.S. KBH saw its average selling price rise 4% to $401,800 and deliveries were up 5% to 2,717 homes. Those factors both contributed to the company’s overall improved revenue figures. 

Future Concerns

While KB Home’s improved operational efficiency and business growth were impressive in the second quarter, there are still some potential headwinds facing KBH in the coming year.

Perhaps the most pressing is rising interest rates, which in turn has made mortgages more expensive. That trend is expected to continue and could eventually weigh on the demand for new homes which would hurt KB Home’s progress.

So far, management has said that rising mortgage rates haven’t changed buyer behavior, which is a good sign — but that doesn’t mean it won’t have an impact in the future. Metzler said that although the company is keeping a close eye on buyer behavior, any significant impact on the housing market looks to be a long way off. He also said that when mortgage rates start to impact buyers’ behavior he doesn’t expect to see people completely exit the market but instead shift their buying preferences. 

Outside of keeping an eye on the impact of interest rates, KBH is also hoping to continue posting strong growth by offering buyers the ability to buy homes that are built-to-order, meaning they can choose between different options to customize their home as it’s being built. This has a few benefits for KB Home — the first being that it provides higher margins than a built-to-spec house that buyers purchase as-is. Making the necessary changes to customize the house means KBH can charge more, but it doesn’t significantly impact the cost of the build. Built-to-order homes also tend to have a higher follow-through rate, meaning that  buyers tend to commit to the sale so there are fewer sales that fall through at the last minute. 

The Bottom Line for KB Homes

Right now KB Homes looks to be firing on all cylinders. The company’s improving efficiency should help it stay afloat in the event of an unexpected turn in the housing market, and as long as demand remains strong the company should be able to continue paying down its debt and improving margins. 

However, it’s worth taking into account the possibility that interest rate hikes will impact buyer behavior sooner than KBH is expecting. So far, rhetoric from management implies that the company is thinking about the possibility that falling demand could be on the horizon, but no concrete plans appear to be in place to offset that. 

All in all, KBH looks like a solid bet for now, but investors who are looking further into the future should be cautious as interest rates rise.

As of this writing, Laura Hoy did not hold a position in any of the aforementioned securities. 

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