This Stock Deserves a Better Deal

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KB Home's (NYS: KBH) first quarter wasn't as bad as some made it out to be. Its revenue and backlog (a key indicator of potential future revenue) were up 29% and 30%, respectively, from the comparable period last year. KB also delivered 21% more homes during the quarter.

So why did its shares tank after the numbers were announced? Because its orders were down 8% and there were losses in its books. True, these are concerns, but the factors cited by KB for lower orders look reasonable to me, and its losses have more than halved from last year.

Give KB some time
In 2011, KB Home opted for Metlife (NYS: MET) as its "preferred mortgage lender" after Bank of America exited the joint venture agreement with the homebuilder because of regulatory changes. Things were fine until January, when Metlife wound up its mortgage lending division, leaving a lot of KB customers in a lurch. But its customers had been getting restless with Metlife for some months, evident from the fact that less than 40% opted for Metlife in the fourth quarter, against 80% reported earlier.


KB found a replacement in early March when it signed on Nationstar Mortgage (NYS: NSM) . Understandably, all this chaos hurt KB's order flow and fueled cancellations in the last quarter. I'd like to give KB more time to settle down with its new mortgage provider before drawing conclusions about its order flow.

Shifting to greener pastures
KB is moving away from some locations. It exited Charlotte, N.C., and South Carolina markets, and is downsizing in Arizona, so its orders from these markets dropped.

The homebuilder is investing more in its main markets of California and Texas. Almost half of KB's business comes from California. In the fourth quarter, KB built more solar-powered homes in Southern California, pushing the number of communities offering the facility up to 28. At the same time, it is raising prices in some communities. With housing supply tightening, and home loans and land infills rising in the region, KB's focus makes sense. As for Texas, the nation's largest homebuilder, PulteGroup (NYS: PHM) , is also seeing higher demand and considers it to be one of the important markets.

The 6% jump in KB's average selling prices to $219,000 in the quarter was largely because of the shifting strategy. KB expects prices to move up further to an average of more than $240,000 for the full year.

I like it!
Selling homes isn't the only thing KB is focusing on. It is reducing costs through layoffs and other cuts. In the quarter, its selling, general and administration (SG&A) expenses as a percentage of homebuilding revenue improved to 22.1% from 25.4% in the year-ago period. The other thing I noted was KB's inventory remained almost flat at around $1.7 billion and revenue went up -- any improvement in inventory turnover ratio for a homebuilder deserves a thumbs-up.

I was impressed by the 20% rise in KB's built-to-order contracts. KB banks heavily on this model that provides customized homes. Adding energy-saving features to these homes looks like a great idea to woo buyers. KB's new innovative "net-zero energy home," which can eliminate electricity costs fully is sure to grab attention, too. In fact, KB recently bagged the 2012 Energy Star Sustained Excellence Award by the U.S. Environmental Protection Agency -- a first for any builder.

The Foolish bottom line
I am not saying KB is the best homebuilder around, but why bash it for one challenging quarter? The housing market is showing signs of recovery, and KB could see brighter days as the rebound strengthens.

Keep tracking KB's move up the ladder by adding it to your stock watchlist. But if you think homebuilders aren't the best investment, our analysts have been noticing a trend in how the smartest investors have been buying. Click here for a free report on what stocks these investors can't get enough of.

At the time this article was published Neha Chamaria does not own shares of any of the companies mentioned in this article.The Motley Fool owns shares of Bank of America. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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