Strong business model boosts KB Home (KBH), inflation suffers

Against a backdrop of significant inflation, supply chain issues and growing affordability concerns, homebuilders in the United States are experiencing subdued housing demand. Additionally, they incur high costs to sustain current operations and anticipated growth. Recently, a notable home builder, Knowledge base home KBH, released its results for the second quarter of fiscal 2022.

Although it generated strong profits and revenue year-over-year, its net orders fell 9% from the year-ago quarter. The cancellation rate, as a percentage of gross orders, was 17% compared to 9% a year ago. Due to growing uncertainty in the market, it has tightened its previously announced guidance for fiscal year 2022.

Nonetheless, KBH remains confident in its Built-to-Order business model, which allows it to navigate these changing market conditions. (Read more: KB Home’s second-quarter earnings and revenue beat, margins up year-over-year)

Its continued focus on the return-driven growth plan, consumer-centric approach and favorable pricing environment help it mitigate these challenges. KBH shares have slightly outperformed the Zacks Building Products – Home Builders industry this year.

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Let’s discuss the factors that influence the growth prospects of this Zacks #3 (Hold) ranking company. You can see the full list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Strategic growth initiatives Solid, supply chain and cost issues persist

Over the past six years, KB Home has pursued a returns-driven growth plan that is designed to drive revenue and margins, return on invested capital and equity, and maintain the debt-to-equity ratio. The plan is primarily focused on executing its core business strategy, improving asset efficiency and monetizing significant deferred tax assets.

KB Home is in a better position to expect significant growth in fiscal 2022, driven by an increase in backlog and its ability to match housing starts to net orders. The company is executing its plan to expand the scale of operations while generating both margins and returns.

However, it faced challenges related to raw material shortages and municipal delays. Commodity inflation is eating away at homebuilders’ margins. In addition, labor shortages lead to higher wages and construction delays, which ultimately hurt the number of homes delivered. Land prices are also increasing due to their limited availability. Due to these headwinds, KBH reduced its number of year-end communities to 250 in fiscal 2022, from 255 expected earlier.

Built-to-order approach attracts affordability worries

KB Home’s highly consumer-centric approach helps buyers design a home with the features and amenities they want. It offers buyers a wide range of choice in key aspects of their future home and a personalized customer experience through in-house community teams.

This approach gave KB Home a competitive advantage over its peers and led to low cost production. The company follows a strategy of starting construction only after signing a purchase contract. This reduces inventory risk, improves construction efficiency, and provides greater visibility and predictability on future deliveries.

However, sky-high house prices and Fed expectations of future interest rate hikes have left homebuyers worried. According to the government’s recent census report, the median selling price of new homes sold in May rose 15% year-over-year. The average selling price also increased by 14.8% compared to the same period of the previous year. Consumer confidence fell 4.5 points in June, the lowest level since February 2021, due to decades of high inflation.

Although house prices have started to moderate, the trend should remain constant for housing this year.

Supply constraint limits land acquisition movement

KB Home invests aggressively in land acquisition and development, primarily in premium locations, which is essential for community count as well as revenue growth. During the second quarter of fiscal 2022, the company expanded its lot position to 89,778 owned or controlled lots. The lot pipeline has increased by 16% since May 31, 2021, reflecting KBH’s substantial investments in land and land development over the past 12 months. In the first half of fiscal 2022, it invested $1.40 billion in land acquisition and development, up 24% year-over-year.

However, a shortage of building land, skilled labor and capital available to small builders is limiting house production, reducing the stock of new and existing homes. Limited capital for land and land development has left licensed land in short supply while growing demand has driven up land prices. The labor market is tight with the limited availability of labour, halting the rapid growth of housing production. If the supply situation does not improve, prices could increase, which would affect affordability.

2 higher ranked stocks from the same sector

Two higher-ranked stocks that deserve a look in the same space are Meritage Homes Corporation MTH and Toll Brothers, Inc. TOL.

Meritage Homes is a leading designer and builder of single-family homes. The company currently sports a Zacks Rank #2 (Buy).

Meritage Homes is down 36.8% year-to-date. That said, earnings are expected to rise 42.7% in 2022. Earnings estimates have risen 1.4% north for 2022 over the past 60 days.

Toll Brothers is one of the leading builders of luxury homes. The company benefited from its strategy of expanding product lines, price ranges and geographies. In addition, it is benefiting from a favorable real estate context, a lack of competition on the new luxury market and buyout synergies.

Revenue for Toll Brothers — carrying a No. 2 Zacks rank — is expected to rise 53.7% in fiscal 2022. It’s down 35% this year. Toll Brothers has seen a 3.2% upward revision to the 2022 fiscal year earnings estimate over the past 60 days.

A recent version of residential construction

Lennar Society LEN has released its results for the second quarter of fiscal 2022 (ended May 31, 2022). Quarterly earnings and revenue beat Zacks’ consensus estimate, despite unprecedented supply chain challenges.

Lennar is down 46.8% year-to-date. That said, earnings are expected to rise 42.7% in 2022. Earnings estimates for 2022 have moved north 1.4% in the past 30 days.

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