Several years ago, KB Home (NYSE:KBH) laid out a multiyear plan to improve both returns and growth after getting devastated by the housing crisis. The plan was to complete a massive balance sheet deleveraging and improve its return on equity to 10%-15% by 2019. Based on the company's most recent financials, it has already met some of those goals.
For close to a decade, housing starts have been on the rise -- albeit from a very, very low base back in 2008 -- and investors are likely wondering how much longer this run can continue, and how KB Home will be able to maintain these rates of return. Based on management's statements on its most recent conference call, it should be a while. Here's a look at some of the most revealing quotes from KB Home's management that should help investors get a better grasp of the company and the housing market in general.
Getting more out of each sale
Getting higher prices per house sold and higher sales growth is music to a homebuilder's ears. According to CEO Jeff Mezger, the company has been able to hold the line on sales price without sacrificing too much order growth:
During the fourth quarter, we continued our community strategy of maintaining our sales pace and taking price where possible to optimize each asset. We again successfully delivered on this objective with a 9% increase in net order value to $935 million on a 2% increase in net orders.
In a business with historically low margins and the looming threat of higher labor costs, the ability to hold the line on pricing and still get higher order growth is encouraging for the coming year.
A more tailored approach
A large part of the reason that KB Home and others have been able to increase sales prices is that the housing market is tightening, but management is also finding other ways to boost selling prices and margins. According to Mezger, the company is seeing a lot of success with its built-to-order homes:
We believe our differentiated built-to-order approach is a competitive advantage that drives one of the highest absorption rates in the industry, as homebuyers respond favorably to the personalization, choice, and value we offer.
There are two types of homes that KB Home and others build: built to order and spec homes. Spec homes are the ones where the buyer takes the house as built, whereas built to order allows customers to select from a suite of optional packages to be built into the home -- like adding granite countertops or a bathroom upgrade. These built-to-order homes are much more attractive sales for homebuilders because they come with higher selling prices at marginal cost. Also, customers that elect built-to-order homes are much less likely to back out of a purchase. From an investor's standpoint, seeing high rates of built-to-order homes is one of those things to keep track of because it shows the strength of housing and customers' willingness to pay up.
Demand is strong, and homebuilders aren't rushing to add too much supply
According to Mezger, there is still a lot to like about the housing market for this year and even further into the future. Not only does demand for houses look strong, but the demographics of buyers and the supply of houses is really working in the industry's favor right now. Mezger said:
Our sizable backlog provides good visibility in the first half of 2018 and supports our ability to achieve our revenue growth projections for this year. We expect housing market conditions to remain solid in 2018. The economy is growing. The labor market is healthy, and consumer confidence is high. November's existing home sales were the strongest in over a decade, a good sign of consumer demand.
On the supply side, resell inventory continues to drift downward, now averaging 3.4 months across the country and much lower than that in many of the markets that we serve. And specific to KB, with over 50% of our deliveries to first-time buyers, the strength in demand from this buyer segment continues to be an opportunity for us. Collectively, these favorable dynamics are setting up what we believe will be a very good spring selling season.
Here's the surprising thing, though. Despite all of these things that Mezger mentioned, KB Home intends to keep its available housing community level flat in 2018 and possibly 2019. Typically, economic and demographic indicators like these would tell a homebuilder to expand its offerings. It seems, though, that they are all still reeling from the housing collapse and are more comfortable living in a slightly constrained supply market than overreaching for sales growth.
Are rising interest rates really an issue?
If there was one thing that might be a concern for investors in the homebuilding industry, it's the possibility of rising interest rates curbing demand. Mezger believes we are still a long ways off from that being a major concern. Also, if interest rates do start to look worrisome, he views the low amount of housing starts we have seen over the past decade as a reason to think that most customers will simply change their buying preferences than completely exiting the market.
[W]e really aren't hearing much. And rates are still very compelling. They're just under 4%, at 4%. So rates are attractive. And if you visit any of our communities, you'd see that we're heavily tilted to built to order and people want homes. So if rates were to tick up a little, and they can't afford the larger plan, they just rotate to a different plan and still become a homebuyer. I think rates would have to move a lot before you'd see a significant impact on our buyer.
What a Fool believes
KB Home hasn't exactly been the best homebuilder stock to own for a while, but it appears that management finally has its ducks in order to start delivering some better returns to shareholders. Based on the company's most recent performance and signs that the housing market is likely to remain robust for some time, KB Home might be a stock worth watching in 2018.