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KB Home’s gross margins continue to expand in Q2 2014

Brent Nyitray, CFA, MBA

Rising revenue: Assessing KB Home's Q2 2014 earnings (Part 4 of 6)

(Continued from Part 3)

Gross margins are the basic profits from building individual homes

Analysts keep close tabs on a company’s gross margins, which are revenues less the cost of goods sold. This estimates the gross profit on building homes. But it ignores other expenses like selling, general, and administrative costs, taxes, interest, and other corporate expenses. Major costs include land development, construction costs, materials, and labor. In the second quarter, KB Home’s gross margins increased 380 basis points year-over-year, to 18.9%. This is a sequential increase from the first quarter, where gross margins were 17.8%.

Average selling prices continue to climb

Average selling prices for KB (KBH) rose to $319,700 in the first quarter. This was an increase of 10% from the corresponding quarter a year ago. Most of the other builders have noted larger increases in average selling prices. Average selling prices are a function of geographical exposure and average sizes. Luxury builders like Toll Brothers (TOL) can increase average selling prices by simply building bigger homes.

High average selling prices reflect the dearth of the inventory we’ve seen. This was caused by a lack of building since the housing bust and also restricted existing homes for sale. Many people who would like to sell are underwater on their mortgages. In other words, they owe more money than the home is worth. Plus, many of these people can’t sell their home without permission from their lender for a short sale. Second, foreclosed inventory is being held off the market. This is happening especially in the judicial states, as judges invariably side with the borrower over the lender and generally make foreclosure as painful as possible for the lender.

For builders, this means they have less competition with existing homes than they otherwise would. This allows them to raise prices without having to offer promotions and incentives. The days of high margins may be numbered. We’re seeing bidding wars for skilled labor, and once builders can’t drive revenue growth simply by raising prices, they will increase deliveries. We’ve seen big increases in average selling prices from other builders, like D.R. Horton (DHI), PulteGroup (PHM), Lennar (LEN), and Toll Brothers (TOL).

Continue to Part 5

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