Investors Slam the Door in KB Home's Face

To quote the late, great Rodney Dangerfield: "Two-story house... Yeah, before you buy it they give you one story, after you move in you get another story."

No truer words could be spoken of the housing sector right now. To say that the data in that sector has been anything but conflicted would be the understatement of the year. Housing permits are hitting multiyear highs (717,000 annually) but still aren't even one-third of the way back to where they were in January 2006, when annual home production peaked at 2.27 million units. Yet data from the U.S. Commerce Department shows that housing sales fell for a second straight month in February. Go ahead, scratch your head... I'll give you a moment.

Feel better? Good, because it's about to get even more confusing.

KB's conundrum
Despite lower unemployment rates and rising consumer confidence, KB Home (NYS: KBH) slapped the unicorn right out of optimists' dreams and instilled a sense of reality with its first-quarter results on Friday.

For the quarter, KB Home reported a loss that was far greater than Wall Street had expected on an 8% drop in orders. Revenue of $254.6 million was $80 million below the Street's forecast while its loss of $0.59 was $0.34 worse than expectations. The primary culprit for the worsening results was a higher rate of cancellations, which increased to 36% from 29% in the year-ago period. The company did allude to a 30% rise in backlog, but that may prove to be a moot point if customers continue to cancel.

KB did at least try to justify the high cancellation rate, and to some extent its excuse holds some water. Prior to January, MetLife (NYS: MET) was KB Home's preferred mortgage provider, but when it shut down its mortgage lending division in January, it sent many of KB's prospective buyers scrambling, unsuccessfully, to find alternative funding. KB did strike a deal during the quarter to have Nationstar Mortgage (NYS: NSM) become its new preferred mortgage provider, but it was too little, too late to affect its horrific first-quarter results.

The real problem
What I find even more concerning than the spike in cancellation rates that everyone seems to be focusing on was customers' revolt against its attempted housing price increases. True, KB did net a 6% jump in home selling prices in the first quarter, but I'm willing to bet that its cancellation rate had just as much to do with its audacious attempt to boost home prices all while millions of foreclosures are just waiting in the wings to drive down home prices.

KB's report does present two interesting conclusions, at least to me:

  1. Most homebuilders don't have the slightest clue what the real demand is for their homes. Most of you aren't going to agree with me, but just look at the data. Building permits are growing every month, but total home sales are dropping. It doesn't make any sense for homebuilders to be ramping up production now with so many foreclosed properties already on the market and millions more in the offing.

  2. Homebuilders still have little to no pricing power. All-cash buyers are controlling the secondary market and, in some cases, may even be eating into the margins of new-home buyers as they command bigger discounts for the luxury of streamlining the sale.

Foolish roundup
I plan to continue my research into what's really going on in housing, but in the meantime I can most assuredly say that this report should sap some of the hype out of the housing sector. Trust me, as a homeowner who's currently underwater on his mortgage, I don't wish for any more pain than we've already seen. But I'm also a realist, and the demand for new homes and the ability to price them advantageously just isn't there for homebuilders.

Disagree with me? Tell me and your fellow Fools about it in the comments section below.

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At the time thisarticle was published Fool contributor Sean Williams has no material interest in any companies mentioned in this article. Being underwater on his mortgage is the closest he'll ever come to diving. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy with an unbreakable foundation.

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