KB Home Sees Tricky Times Ahead

While its quarterly profit decline was not as bad as the Street had feared, the homebuilder is bracing for a rough 2007

KB Home (KBH) warned investors on Mar. 22 to expect more trouble in 2007. While the pace of order declines at the Los Angeles-based homebuilder has slowed during recent months, KB Home is bracing itself for headwinds such as fallout from the recent meltdown in the mortgage lending industry.

The slower housing market has already taken a toll. KB Home's net income during the first fiscal quarter ended Feb. 28 amounted to $27.5 million, down from $173.3 million during the same period last year. Feb. quarter revenue totaled $1.77 billion, down 19% year over year.

"Our 2007 first quarter results reflect the sharp downturn in the housing market that began in 2006 and that continues to pressure the sales and profit margins of domestic homebuilders today," CEO Jeffrey Mezger said in a press release Mar. 22. "We believe these conditions will likely continue for at least the remainder of 2007."

To be sure, there were bright spots. KB Home's customers cancelled orders during the February quarter at a rate of 31% compared to 48% in the preceding quarter of 2006. While the company's net orders decreased 12% year over year to 7,677 during the Feb. quarter, most of those hits took place in the southwest and central regions. Orders even increased in the west coast and France, while they remained essentially flat in the Southeast.

Meanwhile the number of KB Home's unfulfilled orders dropped during the February quarter to 18,406 units, representing potential housing revenue of around $4.78 billion, from 26,536 backlog units and $7.24 billion in backlog value during the same period of 2006.

Analysts had braced themselves for worse. KB Home's earnings per share during the Feb. quarter amounted to 34 cents per share, handily beating the consensus estimate of 25 cents, according to Thomson Financial.

But changes are roiling the housing market. Investors have been panicking about the mortgage industry during recent weeks, as subprime specialists such as Accredited Home Lenders (LEND) and Fremont General (FMT) struggle with their finances. And on Mar. 13 the Mortgage Bankers Assn. reported a record percentage of mortgages entering foreclosure in the fourth quarter (see BusinessWeek.com, MM/DD/YY, "Making Sense of the Mortgage Mess"). As those houses go for sale on the market, it will bring on more supply.

Recent improvement in trends "should be viewed with caution," Mezger said in the press release. "Having now entered the spring selling season, we continue to observe instability in the marketplace. Moreover, recent problems in the subprime mortgage market combined with tightening credit requirements could exacerbate the already difficult conditions in the homebuilding industry."

The stock was little changed in afternoon NYSE trading Mar. 22, down one cent to $47.78.

Mezger has been coping by taking steps like building more homes based on orders already received, rather than trying to guess the amount of interest customers will have in the future. He's also "exercising extreme caution" with his land purchases and management of assets, among other things. Apparently, Mezger isn't the only one.