The house rules are simple in this weekly column.
- I bash a stock that I think is heading lower.
- I offset the sting by recommending three stocks as portfolio replacements.
Who gets tossed out this week? Come on down, KB Home
If you build it, they will run
Homebuilders have been storming back since the darkest recessionary stretches. KB Home's stock has more than doubled since bottoming out 19 months ago.
Are the gains earned? I don't think so.
Let's take a look at the developer's most recent quarter. Revenue fell 14%, as a result of the one-two punch of an 8% dip in homes delivered and a 6% slide in average prices. If you back out writedowns from both periods, KB Home's loss actually widened during the period.
I'm no fan of the real estate developers. By and large, they continue to post operating losses, and there's no denying that there's a glut of existing homes on the market. Building more cookie cutter homes further out into suburbia isn't doing anyone any favors.
The industry is backed by temporary stimulants at the moment. There's the $8,000 federal home-buyer tax credit that mercifully ends this month. Mortgage-modification programs are in full swing, providing relief to problematic home loans. There are also long-standing tax incentives to support home ownership, propping up home prices yet again.
Last summer, the "cash for clunkers" was all it took to kick start the auto market. A costly TARP helped get most banks back on their feet. There's no quick fix for the housing industry.
Homebuilders lobby for any legislation that supports higher prices than the market would organically bear because they have costs to cover in the construction process. If home prices dropped to the levels where tax breaks and other stimulus rounds weren't necessary, many of these homebuilders would be out of business.
KB Home isn't horrendous. It doesn't have the ugliest balance sheet in its niche. For the first time in four years, KB Home actually has a healthier backlog of orders than it did a year ago.
However, while analysts see many homebuilders roughly breaking even or posting small profits this year, KB Home is pegged to close out fiscal 2010 deep in the red. Analysts see the company earning $0.66 a share next year, but that target was $0.80 a share just three months ago. KB Home has landed well short of Wall Street's profit projections in 10 of the past 12 quarters.
In other words, don't get too enamored with visions of promised profitability around the corner. KB Home remains a broken home.
As I do every week, I don't talk down a stock unless I have three alternatives that I believe will outperform the company getting the heave ho. Let's go over the three fill-ins.
(NYSE: NVR): I'm no fan home of homebuilders, but I have no problem singling out the relative victor. NVR made it through the economic downturn, posting a quarterly deficit only once (in the final period of 2008). Unlike KB Home's practically serial disappointment, NVR has posted better than expected quarterly profits in four of the past five quarters.
(Nasdaq: MOVE): There are several new media plays when it comes to real estate. LoopNet (Nasdaq: LOOP)runs the largest collection of commercial real estate listings. Internet Brands (Nasdaq: INET)owns several smallish sites in this space. However, Move is the parent company of Realtor.com, the popular residential real estate listings website. Move is in a funk right now, and understandably so. Revenue is soft, as it will continue to be until next year. Thankfully, the new media company is consistently profitable. I'd bet on the existing real estate market bouncing back before new home construction, so I'd feel safer parked in Move than in KB Home. It's also an App Store sensation. Since launching earlier this year, Move's Realtor.com app has been downloaded a million times.
(NYSE: EJ): The best real estate plays require a passport. Gafisa (NYSE: GFA)is a profitable homebuilder in Brazil, trading for a mere 10 times this year's earnings and less than 9 times next year's target. However, it's hard to deny the upside potential of China, where E-House resides as a leading real estate agency. How hot is the market in the world's most populous nation? Well, E-House posted amazing quarterly results last month. Revenue and adjusted earnings soared 118% and 169% respectively. E-House has blasted past Wall Street expectations through the past year. China's government is trying to cool down the sizzling real estate market, tightening lending standards and dissuading speculation. The regulatory lull simply gives investors an opportunity to pick up E-House for just 11 times next year's earnings estimate.
I'm sorry KB, but I don't think those initials stand for kicking butt.