Friday, April 08, 2011

Is KB Home A Screaming Buy? Not Bloody Likely

KB Home (KBH) trades at 86% below its July 2005 high at the peak of the U.S. housing boom. With operations in all the overbuilt housing markets larded down with foreclosures – including California, Arizona, Nevada and Florida – it’s hard to imagine a company with worse prospects in the near- and medium-term.

In order to stomach the idea of swapping your cash for shares in KB Home, you’d have to believe that this company’s future is going to be much brighter than recent statistics suggest. But the odds of it running out of cash are higher than the chances for a quick turnaround.

In the quarter ending February 2011, KB Home suffered a 32% plunge in new home orders and a 28% decline in the number of homes it delivered after the April 2010 expiration of a government home-buying tax credit. Two pieces of good news at KB Home are that the average prices of its delivered homes rose by 4% to $206,000 and despite a $69 million loss in 2010, it had $736 million in cash available at the end of February 2011, which should be enough to cover the $324 million in debt it must repay in 2011.

But that cash cushion is wearing thin at an alarmingly rapid rate. For example, in November 2010, KB Home had $904 million in cash. So if it continues to burn through $168 million in cash a quarter -- it will run out of money in a little over a year. In theory KB Home could borrow more money to keep operating, but a recent analyst report suggests things are getting worse.

How so? Analysts at Credit Suisse are becoming less optimistic about KB Home. On Wednesday, it added a whopping $1.42 to its loss per share estimate for 2011 and reduced its expectations for 2012 EPS by 46% to $0.68.

There's not much reason for hope for a turnaround after that because of the level of foreclosures in the markets where KB Home builds new ones.  Overall, foreclosures in the U.S. were up 2% in 2010 to 2.9 million and the most rapid growth was in markets where KB Home has a presence -- including California +15%, Nevada +18%, and Arizona +31%.

It does not make sense to me that demand for new houses is going to rise as long as the number of foreclosures keeps growing. Moreover, with the possibility of a government shutdown looking likely beginning first thing Saturday morning, borrowers looking to get government-backed loans will be out of luck.

And compared to its peers, KB Home looks like a market laggard. Its stock has lost 29% of its value in the last year. By contrast Lennar Corp (LEN) is up 6%, Toll Brothers (TOL) is about the same as it was a year ago, and NVR (NVR) rose 9%. The entire group lags the S&P 500 -- which rose 12% in the last year. But KB Home is the homebuilders' weakest link.

It’s too soon to dip your toes in this equity’s choppy waters.


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