KB Home: Why This Homebuilder Will Never Be Great Again

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Lennar housingShares of Lennar (LEN) are hitting highs last seen in 2007 after the homebuilder posted better-than-expected quarterly results this week.

Since bottoming out in October, shares of Lennar, D.R. Horton (DHI), and PulteGroup (PHM) have more than doubled, making real estate development one of the market's hottest sectors over the past six months.

Most homebuilders saw their shares pop higher Tuesday on Lennar's report, but not KB Home (KBH). The company that is apparently becoming the Charlie Brown of developers actually declined slightly on a day when rival developers were having a ball.

Instead of hitting multiyear highs, KB Home has had a March to forget.

Building on a Bad Foundation

Lennar impressed the market this week. Revenue climbed 30%, fueled by a 29% increase in new home delivers. The Miami-based developer posted a better-than-expected profit. Perhaps more importantly, Lennar revealed that new orders -- the pipeline for future revenue growth -- climbed a hearty 33%.

The news contrasts the sorry mess that KB Home reported for the same three months just last week.

KB Home posted a larger quarterly deficit than analysts were expecting. New orders fell by 8%, and the percentage of contracts that were canceled spiked to 36%.

Lennar dazzled. KB frazzled.

KB's report was bad enough to send the stock plunging nearly 20% last week. Don't wait up for KB Home to be invited to the open-house parties being thrown by its profitable and growing peers.

Doesn't Feel Like Home

Things aren't exactly rosy in this problematic industry.

Census data last week showed that new-home sales dropped in February. The National Association of Realtors reported that pending sales were also off last month.

Despite the soft demand, there may be some good news for builders on the pricing front. The S&P/Case-Shiller composite of 20 major metropolitan cities did show that home prices slipped 0.8% in the month of January, slipping 3.8% over the past 12 months -- but some of the more troublesome housing markets during the real estate bubble are actually starting to bounce back.

February was apparently a decent month. One preliminary government report shows that prices for new homes popped 6.1% higher last month, and the National Association of Realtors claims that a 0.3% gain in existing-home prices is the first gain for pre-owned houses since late 2010.

It's against this backdrop that the future promises to throw a few curves. The Federal Reserve is adamant about keeping interest rates low through 2014, but inflation is starting to creep into the picture.

Have you had to pump some gas lately? If so, you've noticed that fuel prices are soaring. This may not be much of a factor to folks trying to sell older houses, but what about KB Home and its building buddies? They need a lot of heavy gear transported, and suddenly the spike in energy costs makes building a home just that much more expensive.

Higher gas prices pose another challenge to residential developers. Since most of the real estate in heavily populated areas has already been developed, homebuilders have to push off deeper into the suburbs to find vacant land to build on. If the pain at the pump intensifies, do you really think potential homebuyers want to face even longer commutes?

Here Comes the Shakeout

Let's say that the perfect balance is struck for home manufacturers. Mortgage rates stay low in an improving economy. The renting craze subsides. After seeing their previous homesteads crumble in value, families actually begin to trust the old American dream of homeownership and buy back in.

It's hard to imagine all of this happening, but let's just say that it does. Are you a buyer of KB Home's stock?

Probably not. There will be a shakeout. There will be fewer developers cashing in on the recovery. You'll see Lennar there, but it's hard to picture KB Home in that snapshot.

Keep in mind that while many homebuilders are returning to or enhancing their profitability, Wall Street sees KB Home posting another hefty loss this year. The profit that analysts were targeting for KB Home for 2013 just three months ago has been more than slashed in half.

The likely outcome here is that we won't get a perfect balance. The economy will improve, but then interest rates will creep higher (driving down home prices since borrowers will get less bang for their leveraged buck). Renters will want to own, but they'll do so in metropolitan areas with plenty of existing properties available.

KB Home's future is torn between merely bad and horrendous. If you have to take a risk and invest in a homebuilder, buy into the ones that are starting to get it right now.

Longtime Motley Fool contributor Rick Munarriz does not own shares in any of the stocks in this article.



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