After homebuilder KB Home (KBH -3.29%) released earnings late last month, Wall Street heaped loads of praise on the stock with upgrades and increased price targets galore. The praise was so great that one would assume the company is the best homebuilder stock out there.
While there were some marked improvements in the company's results, the upside in this stock doesn't seem as great as Wall Street makes it out to be. Let's take a look at the company's most recent earnings numbers and see why KB Home may not be able to live up to the high expectations analysts are giving it right now.
Image source: Getty Images.
By the numbers
| Metric | Q2 2018 | Q1 2018 | Q2 2017 |
|---|---|---|---|
| Revenue | $1.1 billion | $871 million | $1.0 billion |
| Homebuilding operating income | $75.1 million | $44.1 million | $49.1 million |
| Net income | $57.3 million | ($71.2 million) | $31.7 million |
| EPS (diluted) | $0.57 | ($0.82) | $0.33 |
DATA SOURCE: KB HOME EARNINGS RELEASE. EPS = earnings per share.
You have to give credit where credit is due. KB Home delivered better-than-expected results this past quarter. Sales improved over the prior year, home prices are up, and net new orders outpaced home deliveries for the quarter. All of which led to the company beating earnings expectations and leading to many of those upgrades and higher price targets.
Digging into some of the operational numbers, though, there are a couple of things that should cause concern. One is that sales growth was concentrated in only one of its operating regions, while the rest remained mostly flat.
Data source: KB Home earnings release. Chart by author.
Another cause for concern is the company's rather tepid gross margins. KB Home reported a gross margin of only 17.1%, which is well below the margins its peers have posted recently. Management says that its adjusted margin, which accounts for inventory charges, is 22.2%, but its peers would also have higher margins if they adjusted for these effects as well.
KBH Gross Profit Margin (TTM) data by YCharts.
Another statistic that doesn't look that great is KB Home's debt load. Management has been investing heavily over the past several quarters to meet growing demand, and as a result, it has maintained a rather high amount of debt compared to its peers. Management did note that it paid down some of this debt load, but it's still on the high end.
What management had to say
According to CEO Jeff Mezger, some of the issues mentioned should start to improve as the company starts to cash in on that high rate of investment recently:
As part of implementing our Plan over the last 18 months, we have used internally generated cash to invest $2.4 billion in land and development, a 26% increase over the preceding 18 months, to drive growth. At the same time, including our repayment of senior notes earlier this month, we have reduced our outstanding debt by nearly $600 million, which will enhance our future gross margins and returns. We expect to continue to generate considerable cash flow from our operations that can be deployed in a balanced manner to enhance stockholder returns.
You can read a full-length transcript of the company's most recent conference call here.
A lot of hype for an also-ran homebuilder
For a company receiving that much praise, you would think it would be in a better position than KB Home is today. Sure, the macro trends still appear to be in the homebuilder's favor, and could likely remain that way for some time, but there are some things that stick out as cautionary flags with KB Home specifically.
One thing that immediately sticks out is the company's gross margins, which are well below those of some of the better operators in the business. That might make some say there is room for improvement, but much of KB Home's appeal to customers is the high levels of customization for homes that aren't at luxury home prices. That's great for customers, but not great for margins. Also, with the average selling price pushing above $400,000, it's going to get harder to appeal to the largest demographic group in the housing market today: millennials looking to buy their first homes.
Low margins coupled with a high debt load isn't exactly the most appealing value proposition in the housing market today. That's especially true when there are other companies that look to be in much better positions to succeed in this tough business. KB Home may be a Wall Street darling right now, but it's hard to get too excited about this stock.
