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KB Home's Inorganic Plans Drive Growth, Macro Woes Stay

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On Sep 29, we issued an updated research report on Los Angeles, CA-based homebuilder KB Home (KBH - Free Report) .

KB Home operates through its operational business model – KBnxt – which initiates construction work only after the signing of a purchase agreement. Hence, the company’s built-to-order approach gives competitive advantage.

The company mainly caters to the high income group who can afford to design their homes and are ready to pay more for the same, thus driving the average selling price of homes and in turn revenues for the company.

Apart from that, KB Home 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 $967.2 million in fiscal 2015, $1.47 billion in fiscal 2014 and $1.14 billion in fiscal 2013 for the acquisition and development of land, significantly higher than $564.9 million spent in 2012. The company plans to put in $1.5 billion in land and development in fiscal 2016. It has also acquired land in fiscal 2016 and most of the lots for fiscal 2017, which are expected to generate a steady source of revenues, going ahead.

Overall, the housing market has done reasonably well this year with demand for new and existing homes rising on the back of historically low interest rates, an improving job market and income growth.

An improving economy, low interest rates, positive consumer confidence and a tight supply situation should also favor the sector going ahead.

That said, rising land and labor costs are threatening drag on the gross margin of KB Home as well as other homebuilders like Lennar Corp. (LEN - Free Report) , D.R. Horton, Inc. (DHI - Free Report) and PulteGroup, Inc. (PHM - Free Report) . 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, going ahead. These adverse factors are denting margins for homebuilders.

Additionally, sales slowdown in Houston might put a check on the housing growth momentum. While demand in Houston is stabilizing, it will take a while before it rebounds.

It is important to note here that existing-home sales for August fell 0.9% to an annual rate of 5.33 million units, as per the recent report of National Association of Realtors. This is because the supply of existing homes for sales fell 10% from a year earlier. Sales also fell significantly in July to a revised 5.38 million units from the previously reported 5.39 million units.

Despite sales being at their second-lowest level in the year, home resale was up 0.8% year over year. Nonetheless, homebuilders are optimistic about the improving demand trend as the housing market has been strengthening on healthy job data. Notably, the National Housing Association of Home Builders/Wells Fargo Housing Market Index scaled to 65 in September – the highest since Oct 2005. This reading mainly reflects builder perceptions of current single-family home sales and sales expectations for the next six months.

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