Will KB Home's (KBH) Business Initiatives Drive Margins?

On Jan 16, we issued an updated research report on KB Home KBH, a well-known homebuilder in the U.S. and one of the largest in the state.

KB Home’s shares gained 68.7% in the last one year, outperforming the Zacks categorized Building-Residential/Commercial industry’s 15.1% gain.

Q4 Recall & Initiatives

KB Home’s fourth-quarter earnings and sales surpassed analysts’ expectations by 8% and 2%, respectively. The company finished 2016 with 21% growth in revenues and double-digit rise in deliveries and housing revenues. Strong orders in value (up 27%) and backlog (up 19%) bode well for KB Home as it steps into 2017. Regionally, operations in the West Coast have been encouraging where housing revenues rose 30%. A healthy housing industry and strong demand trends in the markets served by KB Home drove the quarterly results.

Meanwhile, the company is focused on its core KB2020 business strategy which aims to boost scale in the existing geographic footprint, improve profitability per unit, generate higher operating margin and drive earnings while generating positive cash flow to redeploy for growth and debt reduction (read more: KB Home Tops Q4 Earnings Estimates, Backlog Strong).

The company invests aggressively in land acquisition and development, mainly in high-end locations, which is critical for community count as well as top-line growth. The company spent around $1.4 billion in fiscal 2016, significantly higher than $564.9 million spent in fiscal 2015. It has acquired most of the lots required for fiscal 2017, which is expected to generate a steady source of revenues, going ahead.

Positives like an improving economy, modest wage growth, low unemployment levels, positive consumer confidence and a tight supply situation raise optimism about the sector’s performance for 2017.

Concerns

Rising land and labor costs are a drag on the gross margin of KB Home as well as other homebuilders like Lennar Corp. LEN, D.R. Horton, Inc. DHI and PulteGroup, Inc. PHM. Labor shortages are leading to higher wages and delays in construction, which eventually hurts the number of homes delivered.  Also, land prices are on the rise due to limited availability. Further, inflation is likely to rise with time. These adverse factors are denting margins for homebuilders.

Adjusted housing gross profit margin (excluding the amortization of previously capitalized interest and inventory-related charges) contracted 60 basis points (bps) to 21.6% in the fourth quarter. Adjusted homebuilding operating margin (after excluding inventory-related charges) also decreased 250 bps to 4.7% from 7.2% a year ago.

Although KB Home has developed the right strategy to generate cash, accelerate asset turnover, boost returns and reduce debt, the rising interest rates may dent demand, thereby hurting profits for homebuilders.

Estimates Revisions

Estimates moved down for the current quarter, next quarter, current year and upcoming year over the last seven days. Going forward, lower margins, higher construction and labor costs, rising interest rate as well as competitive pricing pressure could hurt the stock.

Zacks Rank

KB Home currently carries a Zacks Rank #4 (Sell).

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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PulteGroup Inc. (PHM): Free Stock Analysis Report
 
Lennar Corp. (LEN): Free Stock Analysis Report
 
KB Home (KBH): Free Stock Analysis Report
 
D.R. Horton Inc. (DHI): Free Stock Analysis Report
 
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