KB Homes (KBH) #2 [7]

14:52 ET, 22 Sep 2005

73.07 +2.35: Bubble, no bubble? Increasing concern about a slowdown in the soaring housing market has weighed on the homebuilding group for the past several months - even as homebuilders continue to report solid growth. Anxiety over rising mortgage rates and surging energy costs have led to somewhat somber expectations for what has been one of Wall Street's best performing sectors during the past few years. Furthermore, waning consumer confidence -exacerbated by the impact and aftermath of Hurricane Katrina - have helped share prices retreat from their July highs.

Despite the market's apparent concern, and subsequent halt in the industry's broad-based rally, positive fundamentals for homebuilders remain mostly intact. With interest rates remaining at historically low levels, combined with strong employment and solid economic growth, the sector's stronger performers are well positioned to weather a slowdown and continue to deliver meaningful results.

To that end, KB Home, which on Thursday posted record third quarter results and raised its outlook for full-year profits, highlights the industry's situation. The Los Angeles-based builder said earnings increased 93% to $227.5 million, or $2.55 per share, during the quarter, compared with $117.9 million, or $1.42 per share, a year earlier. The results exceeded the consensus EPS estimate of $1.39, driven by strong revenue growth and improved operating margin (14.9% versus 11.0% in the year ago quarter).

Revenue rose 44% to $2.53 billion - ahead of the average analyst estimate of $2.50 billion - as housing revenue increased 45%. The company said homes closed in the third quarter increased 22% to 9,812 homes, while orders reached 10,467 homes, up 17% from 8,982 homes in the third quarter last year. KBH stated that "net orders continued to show strength within our operating regions, providing important evidence of the fundamental health of our business." It added, "we continue to see high levels of demand in each of our product offerings - first time, move-up, luxury, and active adult buyers - particularly in markets where housing supply remains constrained."

That, combined with a record third quarter backlog of $7.06 billion, or 27,744 homes - up 47% from $4.82 billion, or 21,928 homes, a year earlier - suggests KB Home is well positioned to deliver strong fiscal year results. Accordingly, the company raised its earnings expectations for FY05 to $9.30 per share, up from its previous guidance of $9.00. The new estimate represents a 63% increase from the same quarter last year and reflects the company's strong year-to-date results and robust backlog levels. On average, analysts had projected earnings of $9.14 per share for the fiscal year.

Given the strength of KB Home's results and relatively favorable near-term outlook for interest rates and operating conditions, continued strong demand is expected to drive growth. In addition, the company's completed formation of Countrywide KB Home Loans, a 50-50 joint venture with the nation's leading home loan lender, should offer homebuyers a broader range of products and help drive higher capture rates in its mortgage business. The new venture should also help increase efficiencies, which should lead to lower operating costs.

Although bubble fears have clouded prospects for the industry, KB Home continues to deliver solid results. Given that business conditions persist in its markets and the pricing environment remains strong, the company is well positioned to perform ahead of its peers. Currently, KBH trades at approximately 8x the FY05 EPS estimate of $9.14.