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From KB Home, Affordable Shelter

By Gene Marcial If you missed the robust advance of the homebuilders last year -- when the rest of the market was in sharp retreat -- you might get a fresh chance to catch their next wave up.

The group has given back much of 2000's hefty gains, which were fueled by the Federal Reserve's rate cuts, as worry about the economy's more-than-expected sogginess spread. Now some market strategists suggest that this may be the time for investors to go back to the group -- while many of the housing stocks are on the ropes.

One stock way off its high that some opportunistic investors are starting to snap up is KB Home (KBH), a New York Stock Exchange-listed manufacturer of single-family homes, primarily designed for entry-level and first-time home buyers. Formerly known as Kaufman & Broad, KB Home caters to a niche market that most of the larger homebuilders have tended to ignore or neglect.

RELATIVE BARGAIN. "We believe KB's focus on the affordable market is a great strategic move, especially as this buyer base is larger, less discretionary in its home purchasing, and likely to grow faster than the population as a whole over the next 10 years," says Carl Reichardt Jr., an analyst at Banc of America Securities. Currently trading at 26 a share, KB Home is the cheapest among the major homebuilders, he says, selling at a modest 5.3 times his fiscal 2001 earnings estimate of $4.89 a share. For next year, he expects earnings of $5.31.

Reichardt's target price for KB stock is 41, based on an 8.4 times multiple of his 2001 estimate. The average price-earnings ratio in the universe of homebuilder stocks that Reichardt follows is 7.4 times, he notes. Centex (CTX), for example, trades at a p-e of 7.8, and Lennar (LEN) has a p-e of 9.1. Over the past 10 years, KB Home's stock itself fetched a much higher p-e: It sported an average p-e of 9.9, says Reichardt, peaking in 1998 with a lofty 16 multiple.

Indeed, shares of KB may deserve a higher valuation. One reason that the stock isn't given its due: The perception that the company is overexposed to California. In fact, KB has been diversifying its geographic market by expanding into other states, including Arizona, Nevada, New Mexico, Colorado, and Texas. Another drawback that some investors worry about: KB has a relatively high debt burden, with a debt-to-capitalization ratio of 57% as of the first quarter of 2001, compared to an average of 51% for other builders.

"COMPELLING." Offsetting those concerns, says Reichardt, is the company's "powerful operating strategy that, with proper execution, could make KB the low-cost producer in the industry. In an uncertain economic environment, he adds, KB's focus on entry-level housing is more likely to see sustained demand.

At its current depressed valuation, says Reichardt, "the risk-reward ratio for KB shares is compelling," with limited downside risk. The company will post its second-quarter earnings next week, and Reichardt expects it to meet expectations.

Even last year, when shares of most homebuilders sizzled, with the group scoring a stunning 100% gain, KB Home's stock lagged behind its rivals, with a gain of 70%. And despite KB's much more focused stratregy, its stock is trading close to its historical lows, notes Reichardt. Yet he believes that KB's business plan is the one that's most likely to result in earnings growth during economic slowdowns.

GOOD TIMES ROLL. John Stanley, analyst at UBS Warburg, believes that homebuilder stocks will bounce back and move to much higher valuations as it becomes increasingly evident that the economy isn't all that bad. KB's stock has fallen some 25% from its high in December, he notes, and trades at a 20% discount to the average of the seven homebuilder stocks with market caps of roughtly $1 billion and higher. KB's current market cap is $1.1 billion.

"The good times should continue for KB this year," says Value Line analyst William Ferguson. With a record backlog of homes worth $2.2 billion, combined with a 19% jump in first-quarter orders, the company should post strong earnings gains, says Ferguson. If the KB bulls are on target, investors seeking shelter from the market's turbulence might find it in KB Home. Marcial is BusinessWeek's Inside Wall Street columnist

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