Housing Stocks Continue Trying to Bottom -

Now KB Home Admits Bad News

By Dr. Duru written for One-Twenty

February 15, 2006

Strange things continue to happen on the way to some kind of bottom for housing stocks. On Friday, February 10, 2006, homebuilder KB Home filed its latest annual report (also known as a 10-K) with the SEC. Buried on page 34 of an 80+ page report, KB Home provides its outlook. The bad news reported here was bad enough to cause additional selling in the stock. For whatever reason, call it media lag, none of the major media outlets interpreted this sour outlook until Monday evening. Once the news hit the main street, the market followed obediently with more selling Tuesday morning. Yet, buyers stepped right in and turned a one point loss into a one point gain in the stock for the day. As shown below, the buying occurred on high volume.

KB Home intra-day

The stock of KB Home is still under both its 50 and 200 day moving averages (DMAs) - a very bearish technical pattern. At the same time, KB Home appears "cheap" on a P/E basis. The stock sells at a trailing P/E of 7.0 and a forward P/E of 5.5. As they say, stocks sell for cheap for a reason, but let us not forget that steel stocks were in the same situation last year. It is hard for a housing bubble bear like myself to recommend that you watch out for an imminent bottom in housing stocks, but I cannot help but note the building evidence. On Tuesday, we saw the market sell on negative news and then buy right back into it. Sure, the market in general rallied well, but do not let that distract you (see here for disclaimer on discussion of individual stocks). And sure the Fed is threatening to keep increasing interest rates, but do not let that distract you either - traders can find all sorts of reasons for buying a bottom. For example, the Wall Street Journal quoted UBS analyst Margaret Whelan speculating on the potential for a soft landing in the housing market. She also repeated an often expressed hope that the larger homebuilders can continue to do well by beating the brains out of the smaller, less capitalized homebuilders (if they decide to play nice, the big guys will just buy out the smaller guys).

In case you still have not read KB Home's outlook for yourself, here is my own summary of the bad news that KB Home put in its annual report (trust me, the report also had a lot of good news too, even if it was mostly in the past):
  1. "There are signs that consumer demand in the U.S. residential housing at current prices is softening. For example, the U.S. Census Bureau reported that single-family housing starts in December 2005 were approximately 12% lower than in November 2005 and approximately 8% lower than in December 2004."
  2. "The Bureau also reported that the median sales price for new homes fell approximately 3% in December 2005 relative to the median sales price in December 2004."
  3. "Our results to date in fiscal year 2006 reflect these broader market trends. In the first two months of the year, we have experienced an increase in home order cancellations and a decline in net orders for new homes when compared to the same period last year." [emphasis mine]

After reporting this bad news, KBH asks investors to keep their collective chins held up high. KBH reminds us that the poor performance in the first two months may not necessarily be an indicator of things to come. If these conditions do continue, they will have to lower revenue guidance, but they will not lower earnings guidance. (I take this to mean that they will find a way to cut costs enough or buy back enough shares to maintain the earnings per share guidance. If so, watch out. Neither action is sustainable through an extended economic downturn.)

Again, the news is truly bad and getting worse for the homebuilders. More and more of them are admitting that their previous optimism may have been misplaced. The macro conditions are conspiring to put more pain into their stocks. However, everyone knows this bad news. In fact, folks have speculated, announced, and broadcast the bad news for quite some time. It is the copmanies themselves who are late to the pity party. How many more people are still willing to sell their shares on this news? How many more sellers are still out there? Stay tuned and be careful out there!

DrDuru, 2006