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On May 13, we maintained a Neutral rating on the U.S. homebuilder, KB Home (KBH - Analyst Report) on the back of solid first-quarter 2013 results and the improving housing fundamentals. However, the overall weak economy and the tight mortgage lending standards keep us on the sidelines.

Why the Neutral Rating?

KB Home’s first-quarter 2013 loss of 16 cents per share was narrower than the Zacks Consensus Estimate of 23 cents as well as the year-ago loss of 51 cents riding on higher homebuilding revenues, improved housing gross margins and reduced SG&A ratio. Revenues increased 59% and operating margins grew 12.5% year over year.

In addition to the strengthening housing market, KB Home’s strategic growth initiatives helped drive revenues and profitability higher in the quarter. The company gained from repositioning of land investments toward highly sought-after land constrained, high-end housing markets where the demand for larger homes is increasing which in turn significantly pushed up the average selling prices (ASP).

The company is also improving and refining its products to meet consumer preferences. KB Home expects further profitability in 2013 on the back of its strong land position, significant financial flexibility, increased community count, rising ASPs and improving housing momentum.

Following the solid first-quarter results, the estimate revisions were mostly biased upwards. The Zacks Consensus Estimate for 2013 rose a sharp 210% to 31 cents per share while that for 2014 increased by 11.4% to $1.17 over the last 60 days.

Notwithstanding the improving trend, new home demand in the U.S. remains at historically low levels due to the currently weak economic conditions and tight mortgage lending standards. Consumers will remain cautious until the employment scenario improves, home prices appreciate further and access to the credit markets eases. Sustainable increases in housing and housing demand for the long term will require the overall economy to strengthen, including further job growth, which we believe will take time.

Rising input costs is also a concern due to increasing costs of raw material and labor.  As housing starts accelerate, both labor and construction material costs continue to experience an upward pricing pressure, which could prove to be a major deterrent for margins in the future quarters.

Other Stocks to Consider

KB Home carries a Zacks Rank #2 (Buy). Other stocks in the homebuilding sector that are performing well and deserve a mention include D. R. Horton Inc. (DHI - Analyst Report), Ryland Group Inc. (RYL - Snapshot Report) and Meritage Homes Corp (MTH - Snapshot Report), all carrying a Zacks Rank #1 (Strong Buy).

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