U.S. Markets open in 2 hrs 56 mins

Recommendation: What Lennar and KB earnings mean for the sector

Brent Nyitray, CFA, MBA

Realist real estate roundup, September 23–27 (Part 7 of 7)

(Continued from Part 6)

KB Home and Lennar gave us a preview of homebuilder earnings

Last week, Lennar (LEN) and KB Home (KBH) reported third quarter earnings. They’re on a November fiscal year, so their third quarter ended in August. Both companies beat Street estimates. These two companies give the analyst a preview into earnings for the rest of the sector.

Summary of Lennar’s quarter

Lennar reported third quarter earnings per share of $0.54, which includes an exceptional tax provision of $67 million or $0.30 a share. Last year’s third quarter earnings were $0.40, with a $12.8 million tax benefit or $0.06 a share. So apples-to-apples, earnings more than doubled from last year. Revenues were $1.6 billion—an increase of 55%—while deliveries increased 37%. New orders increased 32%.

Lennar CEO Stuart Miller said there has been “sticker shock” for buyers and demand has “cooled a bit.” July appears to have been the weakest month. Gross margin came in at 24.9% and is expected to continue at that level. The cancellation rate increased to 18%.

Summary of KB Home’s quarter

KB Home reported a third-quarter profit of 30 cents a share versus an expected profit of 21 cents a share. In Q112, it reported a gain of 4 cents a share. It expects to be profitable for 2013. Unlike some of the other builders, KB is a turnaround story. Revenues increased 29% to $549 million, and average selling prices (or ASPs) were up 22%. Net orders were up 7% on a dollar basis, while deliveries increased 6%.

KB noted that some buyers are taking longer to make decisions and some are backing out of purchases. They also believe that tight underwriting standards matter more than increases in rates. The tight underwriting standards are affecting the first-time homebuyer more than the move-up buyer.

Read-across to other builders

KB noted a big increase in average selling prices—22%. Part of that rise is driven by its strategy to focus more on the high-priced markets in coastal California. Both Lennar and KB noted issues with the lower price points, and KB’s increase in ASPs tells you that the higher end is performing better.

The government shutdown is also important here. If the government shuts down for any length of time, it will affect FHA and VA loans, which will disproportionately affect builders at the lower price points. The jumbo market, which affects the bigger builders, will be unaffected. So that will be another headwind for the entry-level builders.

What this means overall is that the luxury segment is performing better. This means buy builders with good geographic exposure that concentrate on the higher price points. In other words, builders like Toll Brothers (TOL) and Meritage (MTH) are likely to outperform names like PulteGroup (PHM) and Beazer (BZH).

Browse this series on Market Realist: