Stock spotlight: KB Home building its way back to profitability

KB Home has endured some rough patches during its 56 years in business. There have been real estate downturns, painful recessions, even the criminal prosecution of its former chief executive.

But things hardly looked darker for the home builder than they did in the tough years that followed the downturn in the real estate and financial markets. The company posted losses in six consecutive fiscal years — 2007 to 2012 — and watched its stock price fall to its lowest point in 20 years.

As was the case with many builders, the early 2000s were quite profitable, fueled in part by easy-to-obtain subprime mortgages. Business declined quickly after the banking system nearly collapsed under the weight of bad loans and foreclosures.

“We rode uphill much steeper than we ever had, and came down much harder,” said Jeffrey T. Mezger, the company’s chief executive.

Today, things are looking a little brighter for KB Home. The Los Angeles company, the fifth-largest U.S. home builder, has predicted it will turn a profit this year. Its stock has more than tripled in the last year.

“The downturn was very dramatic and traumatic,” Mezger said. “What I’m seeing past that is a desirable recovery.”

The company was founded in 1957 by Donald Kaufman and Eli Broad, who named it Kaufman and Broad. In 2001, the company became KB Home.

It sells most of its homes on a custom-built basis, allowing buyers to choose design, finishes, materials and upgrades. The company gets a higher profit margin on those than it does on homes built for the mass market, Mezger said.

KB Home is now building in 33 cities in 10 states: Arizona, California, Colorado, Florida, Maryland, Nevada, New Mexico, North Carolina, Texas and Virginia.

Mezger was named CEO in 2006 after KB Home’s longtime leader, Bruce Karatz, resigned amid an investigation into the company’s backdating of employee stock options.

A federal jury later convicted Karatz of making false statements about the stock options. He was sentenced to five years of probation.

The latest

KB Home expects to spend about $1 billion on land this year, focusing on more expensive communities than it has in the past.

In California, it’s building near the coast in Irvine, Playa Vista, San Marcos and San Jose. Housing sells for a premium in those cities compared with inland areas.

“There’s no better market in the country than coastal California,” Mezger said. “California cities are the strongest in the country right now.”

Progress

Housing prices in each of KB Home’s 33 markets are increasing, Mezger said. The average price of its homes sold in the first quarter of the fiscal year, ended Feb. 28, was $271,000, the company reported.

Last year, the company completed 6,282 homes at an average price of $246,500. That was an increase over the 5,812 homes it finished in 2011 at an average of $224,600.

“We decided to invest in these more desirable areas and were able to reach out to a higher-income, first-time buyer,” Mezger said. “They’re buying a bigger home in a higher-priced area and are picking higher-priced options.

“We’re a totally different company than we were a year ago.”

Challenges

Several factors out of KB Home’s control could hurt sales: unemployment, interest rates and millions of foreclosed properties that banks own and need to resell into the market.

If people can’t get jobs, especially better-paying ones, they probably can’t qualify for loans for KB homes. And if interest rates rise, that could raise monthly loan payments and reduce the pool of buyers.

Banks own about 2 million foreclosed properties, and home builders could be hurt if the banks sell too many too quickly because that would drive down home prices. Mezger said he is less concerned about that possibility, though it can’t be ignored.

“I think there’s more to come, but I think the worst is way behind us in the rear-view mirror,” he said.

Analyst opinions

Six analysts recommend the stock as one to buy, 13 as a hold and seven as a sell. The average one-year target price is $21.

“Although we expect sales to improve, we see KBH continuing to lag peers in terms of net orders,” Standard & Poor’s analyst Michael Souers said in a research report.

“In addition, we believe stronger labor markets are needed to see a sustained recovery in housing demand,” Souers said. “We think a rebound in demand for the entry-level and move-up products KBH focuses on will largely depend on the broader economy.”

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Stock Spotlight is a weekly profile of a notable company in Southern California.