KB Home: Still Capable of Creating Value (NYSE:KBH)

One industry that I have been very bullish on for over a year now is the home building industry. Estimates vary, but usually the consensus is that this country suffers from a shortage of between 4 million and 7 million houses. Until this deficit is significantly reduced, I would argue that the real estate market would be quite attractive to investors. And a company I’ve been optimistic about during this time, and actually more, is Home KB (NYSE:KBH).

Overwhelmingly, KB Home focuses on newer home buyers. 49% of the homes it delivered in the second quarter of this year were sold to first-time buyers. Another 24% were sold to homeowners who were relocating from their first home. This composition, combined with how stocks have been rated and the catalysts they face homebuilding industry, led me to reaffirm the company as a “buy” candidate when I have last wrote about it in January of this year. Since then, things have turned out pretty well, with the stock up 34.9% versus the 17.8% gain seen by the S&P 500 over the same time window.

As great as this growth is, it pales in comparison to how things have been in the long run. Since my first bullish article about the company, published in March 2015, the stock has risen 480.1%. By comparison, the S&P 500 rose just 167.7%. After such a massive move above, you’d think I’d be ready to tone it down to something more modest. But given the current catalysts and the way the stock is currently priced, I’d argue that keeping the company rated an easy “buy” makes sense at this point.

KB Home continues to create value

Fundamentally, things have been somewhat mixed for KB Home of late. Consider the most recent quarter for which data is available, the second quarter of fiscal 2024. During that time, the company reported revenue of $1.71 billion. Unfortunately, that’s down from the $1.77 billion the company reported a year ago. Even though the company benefited from an increase in the average price of a delivered home from $479,500 to $483,000, this was more than offset by a drop in the number of homes delivered from 3,666 to 3,523.

The good news is that higher prices helped the company increase its net profit from $164.4 million last year to $168.4 million this year. Unfortunately, all other profitability metrics for the company have worsened during this time. Operating cash flow, for example, fell from $514.8 million to $61.5 million. Adjusting for changes in working capital, the picture was better, with value falling from $200.1 million to $173.9 million. Meanwhile, EBITDA fell slightly from $226.9 million to $212.4 million.

When it comes to the first half of this year compared to the same period last year, KB Home saw a very similar picture. There was one exception to this. That includes revenue, which rose from $3.15 billion last year to $3.18 billion this year. Despite the pain experienced from the delivery perspective in the second quarter of this year, deliveries for the first half of 2024 were strong at 6,560 homes. This is slightly above the 6,454 homes delivered in the first half of 2023. Unlike the second quarter, however, the company suffered from a decline in the average price of a home delivered. That figure dropped from $486,000 last year to $481,700 this year.

As was the case for the second quarter, KB Home posted an increase in net profit in the first half of this year compared to the first half of 2023. Net income increased from $289.9 million to $307 .1 million USD. Other profitability metrics we are not as lucky. Operating cash flow fell from $608.7 million to $90 million. Adjusting for changes in working capital, the decline was much smaller from $350.5 million to $334.2 million. And finally, EBITDA for the company fell from $403.4 million to $392.1 million.

This mixed picture could deter some investors. That said, there are some positives to consider. First, new orders have been solid. For the first half of this year, the company secured contracts for 7,320 new homes. This is a significant increase on the 6,078 homes for which the business secured contracts for the same period last year. Of course, most of this year-over-year improvement occurred in the first quarter. But even the second quarter saw a year-over-year increase from 3,936 homes last year to 3,997 this year. Some of the improvements seen can certainly be attributed to a decrease in the company’s cancellation rate. For the first half of last year, this number was 28%. For the first half of this year, it was just 13%. And for the second quarter, it totaled 13% this year, compared to 22% last year.

That doesn’t mean everything is great. It still needs some work. The company ended the most recent quarter with 6,270 homes in inventory. That’s down from the 7,286 homes the company counted for the second quarter of fiscal 2023. That said, it’s all about perspective. At the end of 2023, management reported a backlog totaling just 5,510 homes. This means that in the space of just two orders, the company has increased its backlog by 13.8%. Considering how high interest rates are right now, I think this is a remarkable performance.

Another thing that I find bullish about the company is that we are facing a housing shortage at a time when new starts on privately owned housing are in decline. In the graphic above, you can see exactly what I mean. Just take July as an example. In that month this year, there were about 1.24 million new homes in private ownership. That’s a pretty substantial 16% drop compared to 1.47 million at the same time last year. The general trend around 2022 was for declines to occur. But at some point, between falling interest rates and rising pent-up housing demand, that trend should reverse. When it happens, this would be very bullish for the company. And in fact, the improvement in prices seen in the second quarter of this year compared to the same period last year, the decrease in the cancellation rate and the increase in net new orders could be evidence that we are not too far from that happening.

When it comes to company valuation, I think the best thing to do is to annualize the results experienced so far this year. By doing this, we get an estimated 2024 net income of $625.2 million. Adjusted operating cash flow would be $692.9 million, while EBITDA would be $783.5 million. In the chart above, you can see what this means for business valuation. The chart also values ​​the company based on historical results to 2023. To be honest with you, the company is pretty close to being fairly valued. And relative to similar firms, I’d say that’s also the case. In the table below, we have compared KB Home with five comparable companies. On a price-to-earnings basis, our candidate was the most expensive of the bunch. It was the cheapest on a price-to-operating cash flow basis. But when it comes to the EV to EBITDA multiple, we found that three of the five companies ended up being cheaper than it is.

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Take away

Based on the data provided, I’d say KB Home is definitely having mixed results right now. But overall, I think the picture is bullish for the business. The stock could be fairly valued compared to other companies. But they are still absolutely underrated for me, if only marginally so. This puts the company on the line between a “buy” and a “hold.” But when you factor in the catalyst, which I think should propel higher revenues and profits, I think there’s enough upside on the table to justify a soft “buy” rating.