Buy KB Home (NYSE: KBH) to Cash in on Housing Shortage

A lot of people are looking to buy a home. You can look at the anecdotal evidence: countless people in desirable neighborhoods are reporting that real estate agents are cold calling – now more than ever – in hopes that they are open to selling their home. The remote working boom has led to a mass exodus to the suburbs.
Or you can look at the numbers: the median price of an existing home sold in August increased to $310,600, a record high and up 11.4% yoy.

The National Association of Home Builders/Wells Fargo Housing Market Index measures builder confidence. It plummeted all the way to 30 during the dog days of April. But September’s number was 83, the highest reading ever in the index’s 35-year history.

Mortgage rates are now in their third month of sub-3% levels.

Supply is Constrained

At the same time, there aren’t enough homes being listed to satisfy the elevated demand.

According to realtor.com, around 400,000 fewer homes have been listed since the onset of the pandemic. People are concerned about safety; the selling process could put many at risk.

Housing starts are increasing, but remain well below the levels seen in the mid-2000s.

KB Home’s Q3 Solidifies Confidence

I covered KB Home NYSE: KBH a month-and-a-half ago. Back then, I said to expect a combination of upward revisions and earnings/revenue beats over the remainder of 2020.

Well, the company released its Q3 numbers in September and did just that:

Revenue of $999 million blew away expectations for $895.8 million. EPS of 83 cents per share was well above the expected 48 cents.

Shares traded up a bit on the news, but not as much as you may have expected for such a big beat. The whisper numbers were likely a lot higher than the published estimates.

Nevertheless, KB Home is taking advantage of the emerging housing boom. CEO Jeff Mezger said:

“Reflecting this strength, our net orders expanded 27% year over year, with growth in each of our four regions. We achieved a monthly absorption pace that accelerated to 5.9 orders per community, an increase of 36%, while we also increased prices in most of our communities. We believe that our Built-to-Order model is a key factor driving our sales pace, with this quarter’s results underscoring the robust demand for the choice and personalization we offer to our homebuyers."

Back in August, I pointed out the potential of KBH’s “Built-to-Order” model. To recap, it’s an excellent way to capitalize on the work-at-home boom.

KBH Faces Headwinds, But Don’t Worry

There’s a lot to like about KBH, but it’s also important to acknowledge its flaws.

The company should be able to fulfill its increasing backlog – which grew 12% to $2.57 billion, its highest Q3 backlog since 2007 – but KBH may have to do so at an increasing cost.

High lumber prices have been a story since the onset of the pandemic and they continue to hang over KB Home (and the other homebuilders). Lumber is a key input and the price increases either cut margins or require KB Home to pass on the cost increase to its customers. Labor and land costs are also facing upward pressures, and it’s not clear when those effects will abate.

A couple of comments:

1. Demand is so high, and people are showing such a willingness to pay more for homes, that the cost increases should be easy to pass on to the customer. I wouldn’t worry about KBH bearing the brunt of the costs.
2. KB Home is trading at 13x forward earnings and just under 9x projected earnings one year out. At that price, things are never going to be perfect, but they’re really good for KBH.

The Final Word

KB Home looks like it was held back by a choppy market in September:

On the plus side, shares are trading just shy of post-pandemic highs even after a tough September. It’s good to see that relative strength; it bodes well moving forward. KBH has the potential to be a leader in the next market rally.

But the real money is in buying-and-holding KBH for the next six months – and perhaps longer. This company is trading at way too low of a valuation relative to its prospects, and has a good chance of seeing a substantial multiple expansion.