Can KB Home (KBH) ride the wave of housing market recovery?

The housing sector made a surprise recovery in May after shrinking in the previous months, giving hope to homebuilders like KB Home (NYSE: KBH) in a market battered by the virus attack. In a sign that the withdrawal of pandemic-related movement curbs is bringing fresh vigor to the economy, new residential building permits rose in double digits last month, aided by the affordable interest rates.

Lingering Volatility

The housing sector had a positive start to 2020, on the back of the healthy job market and a booming economy. Reflecting the improvement in people’s spending power, KB Home witnessed solid order growth in the early months of the year. Since the upbeat momentum has given way to widespread slowdown, the management might not have fulfilled all the orders in the quarter ended May, the results for which will be published on Wednesday evening.

While the latest housing data is encouraging, the Detroit-based company might need to keep innovating in order to take on rivals like Lennar Corp. (LEN) at a time when uncertainty continues to shroud the market. It can cash in on the built-to-order model and customization facility that allows buyers to make choices at every stage of construction.

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The spring season is considered to be the most preferred time of the year for homebuyers, but sales will depend on factors like availability of mortgage. Moreover, it is a highly competitive industry that is influenced by seasonal factors, which often leads to inconsistency in the quarterly performance of companies.

Headwinds

Initial estimates indicate that the present challenges, ranging from logistics issues to labor shortage, have affected KB Home’s performance in the current quarter to a certain extent. While land prices and raw material costs tend to remain high, favorable average selling prices should ease the strain on margins. On the liquidity front, the company has maintained a healthy cash position, historically. In 2019, it invested a total of $1.62 billion in land and land development.

“We are diligently managing our operations with a focus on being both prudent and strategic with our cash resources. While we continue to close homes and generate revenues, we are also taking steps to curtail land acquisition and development until circumstances become more stabilized. We have a long-tenured, hands-on team that is experienced in navigating changing market conditions, which will help guide our actions in this challenging environment,” said chief executive officer Jeffrey Mezger in a recent statement.

Growth Strategy

As far as the business strategy is concerned, the adoption of the KB2020 and KB Edge models was the right step towards driving geographical expansion. However, last year, homebuilding revenue was slightly below the $5-billion target set by the management. With a market capitalization of around $3 billion, KB Home claims to have delivered 600,000 homes of various types in the past six decades.

Taking a cue from the general risks, experts on average predict a moderation in market value this year. So, it might not be the right time to invest in KB Home and it makes sense to follow a wait-and-watch strategy, even though the valuation is favorable. Considering the strong fundamentals, long-term investors might still find the stock attractive. It is worth noting that the shares regained strength pretty quickly after the recent selloff.

Earnings Surge

In the February-quarter, earnings more than doubled to $0.63 per share as the core homebuilding segment thrived on the encouraging demand conditions, driving up revenues to about $1 billion. Analysts had forecast lower top-line and profit figures. Despite the encouraging outcome, the management withdrew its full-year guidance due to the deepening uncertainty.

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When the company unveils its second-quarter numbers next week, analysts will be looking for earnings of $0.49 per share, representing a 3% decrease from the prior-year period. On the other hand, the top-line is seen growing 5% year-over-year to $1.07 billion, with most of the inputs coming from the homebuilding segment that accounts for around 97% of revenues.

Stock Performance

Investor sentiment has remained in the positive territory in recent quarters as earnings surpassed the Street view consistently. Though the pandemic-linked selloff dragged KB Home’s shares down to a three-year low in early March, they bounced back in the following weeks and closed the last trading session close to the pre-crisis levels. The stock has gained 34% since last year.