Assessing KB Home's earnings for the first quarter this year (Part 5 of 6)
KB Home is a turnaround story
Like virtually every builder, KB (KBH) struggled with cash burn in the post-bubble years. KB made some strategic decisions to focus on its most profitable metropolitan statistical areas and spend heavily, buying land at rock-bottom prices. Plus, it’s dealing with a lawsuit. As KB executes its turnaround, it will almost inevitably hit some bumps on the road. The fourth quarter of 2013 was one of them, where KBH attributed the drop in orders to a shift in focus to the more profitable and fast-growing coastal markets, and also some delays in new communities. It appears that some of those issues were temporary, as orders increased in every region in the first quarter of 2014.
Earnings per share
Net income increased to $10.6 million on a GAAP basis, compared to a loss of $12.5 million the year before. These numbers include some special items. The company reported an extraordinary gain on the sale of an unconsolidated joint venture in Maryland. This was the first profitable Q1 for the company since 2007. Last year was the first year of positive net income since 2006.
Costs will rise in the future
The homebuilders have been in an enviable position over the past year, with the ability to raise prices pretty much at will, and costs that have been increasing at a slower pace. That dynamic is definitely going to change. Labor costs are increasing—especially in the skilled construction trades. Because the housing bust was so long and so deep, many construction workers left the industry to pursue new careers, primarily in the energy sector and trucking.
Second, as home price appreciation begins to cool, the builders will have to focus on increasing the volume to drive revenue growth. This means increased competition for building materials, which means lower gross margins, as cost of goods sold increases. This will act as a drag on profitability going forward, although demand should remain strong. This will be an issue for other builders like D.R Horton (DHI), Lennar (LEN), PulteGroup (PHM) and Toll Brothers (TOL).
Browse this series on Market Realist:
- Part 1 - Why KB Home’s turnaround increased: A good geographic exposure
- Part 2 - KB Home’s sustainability initiative gives it an important niche
- Part 3 - Must-know update: Why KB Home’s revenue growth topped estimates
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- KB Home