KB Home’s (KBH - Free Report) robust earnings trend is a result of its Returns-Focused Growth Plan and customer-centric approaches. Also, healthy housing industry and strong demand bode well for the company’s earnings. Its adjusted earnings have surpassed the Zacks Consensus Estimate in each of the trailing four quarters, with average surprise of 17.6%.
However, rising land and labor costs along with interest rate hikes mar the company’s growth potential. Consequently, shares of KB Home have declined 39.3% so far this year, underperforming its industry’s fall of 38.8%.
Let’s delve deeper into the factors that substantiate its Zacks Rank #3 (Hold).
Catalysts Driving Growth
KB Home’s fiscal third-quarter earnings increased a considerable 71% year over year on the back of top-line growth. Moreover, its top-line growth was backed by healthy and growing economy, as well as higher level of new construction demand. Notably, net order of 2,685 homes was up 3% from a year ago during the quarter.
Its Returns-Focused Growth Plan is designed in such a way that it will drive homebuilding revenues and operating margin in the upcoming quarters. In fact, in the fiscal third quarter, adjusted gross margin in the Homebuilding segment expanded 140 basis points (bps) year over year to 23.1%. The positive result was mainly driven by margin improvement from community-specific action plans like targeted home selling price increase, increased demand and new higher-margin communities.
Moreover, the company expects 2019 homebuilding revenues to grow 12% year over year. Additionally, it anticipates to achieve gross margin of 17.5-18.2%, operating margin of 8-9%, selling, general and administrative expense ratio in the range of 9-9.5%. Also, it projects return on invested capital of more than 10%, and net debt-to-capital ratio of 40-50%. This optimistic view was mainly backed by the above-mentioned growth plan and its core KB2020 business strategy, which aims at boosting scale in existing geographic footprint, improving profitability and operating margin, driving earnings, as well as generating positive cash flow to attain growth and debt reduction.
Its consumer-centric Built-to-Order approach helps homebuyers to personalize their home with features and amenities of their choice. The company follows a strategy of initiating construction only after a purchase agreement has been executed. This allows KB Home to gain a competitive advantage over peers and enjoy low-cost production.
Moreover, the robust housing industry will continue to drive its performance in the near future. Although the recent interest rate hike has raised doubts over the future of home prices, steady job and wage growth, a recovering economy, rising rentals, rapidly increasing household formation and a limited supply of inventory point toward strong near-term demand.
Hurdles to Cross
Although the company remains strong on the aforementioned factors, rising land and labor costs along with interest rate hikes remain major concerns. It has been witnessing rising land, trade labor and material cost inflation. Land prices are increasing due to limited availability. In fact, during the fiscal third quarter, land generated $2.3 million in revenues, down 33.3% year over year.
Moreover, the recently imposed lumber tariff on imported steel and aluminum is a raising concern, as it will escalate raw material cost for home builders, who are already grappling with increased costs. Consequently, the consensus estimate for the current year is pegged at $1.68 per share, reflecting a decline of 9.2% from the prior-year figure of $1.85.
Stocks to Consider
Some better-ranked stocks in the Zacks Construction sector are KBR, Inc. (KBR - Free Report) , Altair Engineering Inc. (ALTR - Free Report) and EMCOR Group, Inc. (EME - Free Report) , each carrying a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
KBR surpassed earnings estimates in three of the past four quarters, with the average positive surprise being 12.6%.
Altair’s earnings are expected to grow 23.1% in 2018.
EMCOR’s earnings for the current year are expected to increase 20%.
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