I Wouldn't Bet the House on this One
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinions of our bloggers and are not formally edited.
I've repeatedly warned on the dangers of investing in certain homebuilders. Back in March, I even looked at KB Home (NYSE: KBH)
Positives:
KB Home reported earnings recently, and while some of the numbers were better than before, the company is still in a massive amount of trouble. The positive numbers I saw were revenues up 11%, delivered homes up 2%, and the average selling price up 9%. That last number gives credence to the fact that housing is recovering, whether the general news media wants to believe it or not. Given that KB Home's average selling price was $233,000, we are talking about the sweet spot of house prices that many customers could afford. All of this sounds pretty good, what's the problem?
Challenges:
To start with, KB Home hasn't found a way to turn positive revenue growth, more homes, and better prices into positive net income. The company's homebuilding operating loss was still $15.5 million. While that's better than last year, what else does KB Home need to turn a profit? When you compare this result to Toll Brothers (NYSE: TOL), a high-end homebuilder that made $16.8 million in net income, it seems KB Home is doing something wrong. The scariest number in the whole earnings report was KB Home's cancellation rate. The company reported that as a percentage of gross orders, 26% were canceled! Think about that number for a minute, one in every four orders is being canceled. By comparison, Toll Brothers saw a cancellation rate of just 2.4%. The difference between the two companies is startling.
Competition:
Of course Toll Brothers isn't the only homebuilder that KB Home is going up against; companies like Lennar (NYSE: LEN) compete in the same industry as well. Look at the difference in relative cash versus debt at the three companies:
You can see that while Toll and Lennar carry more total long-term debt, they also cover this debt with nearly twice as much cash in both cases. For example, in order for KB Home to have the same relative amount of cash versus long-term debt as Toll Brothers, the company would need at least $790 million. For KB Home to have a ratio of cash to long-term debt that is equal to Lennar, they would need $695 million in cash. Even more disconcerting is KB Home's cash balance was closer to $480 million just three months ago, showing the company is burning through cash at an alarming rate. Since housing is a cyclical industry, the more cash a homebuilder has on hand, the longer the company can survive until the next upturn in business. By this measure, both Toll Brothers and Lennar have the upper hand. Looking at where future cash flows might come from, it makes sense to compare the company's order backlogs as well. By this measure, investors should be worried about the relative weakness in KB Home's order backlog compared to their competition.
You can clearly see that both Toll Brothers and Lennar have seen a significant increase in their backlog by number of units. Lennar looks particularly strong with almost three times the growth in numbers of units versus KB Home. Lennar also has the largest increase in dollar value in their backlog over the last year. At first, you might say that the change in absolute dollar value is nearly the same between KB Home and Toll Brothers, but I'll remind you again that 26% of KB Home's orders are being canceled versus just 2.4% for Toll Brothers. At KB Home, this cancellation rate would mean as many as 770 homes worth about $180 million could disappear. Adjusting for these possible cancellations, KB Home's backlog changes dramatically.
Conclusion:
When it comes right down to it, KB Home's numbers just don't compare well. If you want a final crushing blow to the argument that KB Home could be a good investment, consider this. For the full year 2012, both Lennar and Toll Brothers are expected to be solidly profitable. KB Home on the other hand, is forecast to report a full year loss. Both Lennar and Toll Brothers are expected to grow earnings at over 20% in the next five years, compared to just 4% growth at KB Home. With a weaker balance sheet, huge cancellations, and losses even when the numbers have improved, I wouldn't bet the house on this homebuilder.
Source: http://beta.fool.com/mhenage/2012/07/13/i-wouldnt-bet-house-one/7041/
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