KB Home (KBH) Margin Issues Likely Company Specific, Says Deutsche Bank

Deutsche Bank maintained a Hold rating on KB Home (NYSE: KBH) and lowered its price target to $18.00 (from $21.00). Yesterday the stock declined after the company made cautious comments on margin. Analyst Nishu Sood sees this as a company specific issue.

"One of the leading fears of housing/builder skeptics over the past 18 months has been a collapse in gross margins following the 2H13 housing slowdown. With KB Home's gross margins likely to fall ~500 bps in 1Q15 has this fear finally materialized? Will other builders' margins follow suit?" said Sood.

"We don't think so," continued the analyst. "A far more likely explanation is that KB's surge in land spend in 2013 is mixing in a significant number of lower margin communities at the same time that some high-price/high-margin communities are closing out. We don't expect other builders' margins to follow KB's but we do see continued turmoil ahead for KB; accordingly, we maintain our Hold rating,."

"A 500+ bps sequential decline in 1Q15 gross margins for KB is a shocking headline; however, recent history shows it isn’t out of the ordinary. KB’s gross margins declined by more than 600 bps in both 1Q11 and 1Q12 as well, making 2015 the third time in five years that KB will have a greater than 500 bps decline. This is in keeping with KB’s overall pattern of showing greater quarterly volatility in gross margins. Since the housing downturn began in 2006, KB’s median quarterly gross margin moves have been the highest in the group at roughly 160 bps vs. an overall group median of about 110 bps," added the analyst.

Sood went on to say, "Perhaps 150-200 bps of the forecast 1Q15 gross margin shortfall is due to seasonality; however, that leaves 300-350 bps from other factors. We think the primary other reason is a mixing in of low margin communities from KB’s 2013 land spend surge. KB’s land holdings increased by 37% in 2013 vs. 13% overall for the builders. At the same time, we think KB is losing some significantly above average margin communities in coastal California. This is evidenced by the $50K run-up in ASP’s during 2014 and the reversal that will begin in 1Q15."

For an analyst ratings summary and ratings history on KB Home click here. For more ratings news on KB Home click here.

Shares of KB Home closed at $13.87 yesterday.

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