Investors assessing the narrative for homebuilding company KB Home (KBH) face a tough dilemma. On one hand, its management team delivered solid results for its second quarter. Still, the other side of the equation is the tough economic environment. Between two conflicting forces, investors may want to consider opting for the conservative approach. I am bearish on KBH stock.
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If earnings reports always correspond with market success, one would be hard-pressed to ignore KBH stock. For Q2, KB Home delivered adjusted earnings per share of $2.32. This figure beat Wall Street’s consensus estimate of $2.04, translating to a positive earnings surprise of 13.7%. This was a 55% increase from $1.50 per share on a year-over-year basis, which can be attributed to growth in revenue and margins.
On the top line, KB Home rang up sales of $1.72 billion. Again, this tally beat covering analysts’ consensus target, which was set at $1.61 billion, a positive surprise of 7.1%. Further, the latest revenue haul represented an increase of 19% compared to the prior year.
“We delivered strong results in the second quarter, generating significant year-over-year growth in revenues, operating income, and diluted earnings per share,” said Jeffrey Mezger, chairman, president, and CEO of KB Home. “With our ending backlog of over $6 billion, we are reaffirming our fiscal 2022 guidance, which we believe we are well positioned to achieve.”
Ordinarily, such results would yield strong market returns. To be fair, KBH stock did swing higher on the disclosure. However, since the announcement, shares are up only around 13%. Further, on a trailing-month basis, KBH shed almost 10%.
Clearly, momentum isn’t moving the right way, which brings the discussion to the other side of the fence.
The Fed Brings the Pain for KBH Stock
Tellingly, KBH stock ended up losing nearly 5% of its market value during the trading session on August 26. The culprit? A less-than-encouraging disclosure by Federal Reserve chair Jerome Powell sent the broader equities sphere tumbling.
As the TipRanks Team reported, “Any hopes of the Fed’s pivot from its hawkishness were dashed on Friday when Powell reinforced the Fed’s stance. Now that July’s inflation data came below expectations, many were hoping that the Fed would ease its policy. However, Powell did not mince his words while reinstating that more aggressive interest rate hikes are on the way this year and that the central bank will not depend on a month or two of positive inflation data.
Now, investors are left to second-guess the effects of more rate hikes on the economy’s health. Once again, investors are reassessing their risk positioning and pulling out of risky bets. Being most sensitive to interest rates, the technology sector was hit the hardest.”
While the tech segment did suffer severe losses, Powell’s comments also bring poor tidings to KBH stock and its ilk. With borrowing costs set to rise in an effort to mitigate multidecade highs in inflation, homebuying sentiment will almost surely strain under the pressure.
In early August, I stated the following. “In 2021, the purchasing power of the U.S. dollar declined by 6%. However, just in the first half of this year, purchasing power dipped by 5.3%. Put another way, the rate of acceleration in currency erosion almost doubled this year.”
It just comes down to simple logical deduction. At a certain point, economic forces can only fleece the flock so much until consumers give up.
KB Home Stock and the Inventory Dilemma
As financial pressures build for millions of American families, investors can reasonably expect that homebuilders such as KB Home will incur rising inventory. Should the metric get out of hand, it would be a clear sign to run for the exits or hit the sidelines.
To be fair, management insists that it’s well-positioned to handle current market risks. “We believe the flexibility of our Built-to-Order business model will enable us to navigate these changing market conditions,” stated Mezger.
“Our model allows our customers to choose from a wide array of floorplans and price points, offering them the ability to personalize their home in a way that reflects what they value and can afford. Our approach resonates with buyers and is a key reason we have sustained among the highest absorption rates in the industry for many years.”
Still, investors should consider the hard data. In Q2 2022, KB Home’s days inventory line item was nearly 383, representing almost a 13% lift from the year-ago quarter. On a trailing-12-month basis, this metric stands at 372.15.
In its fiscal year ended November 2021, KB Home’s days inventory was 410.41. In the following year, it dipped down to 355.27, a historically healthy level under bullish circumstances. However, the key here is that the days inventory line item tends to fluctuate based on underlying economic dynamics.
For instance, in 2009, this metric was 376.29, moving up to 445 a year later. However, during the last housing boom in 2007, days inventory was at a subterranean 242.15.
Is KBH a Good Stock to Buy?
Turning to Wall Street, KBH stock has a Moderate Buy consensus rating based on eight Buys, four Holds, and one Sell assigned in the past three months. The average KBH stock price target is $38.67, implying 29.5% upside potential.
Takeaway: KBH Investors Need to Read between the Lines
While investors shouldn’t dismiss what management teams say about their companies, ultimately, they must conduct their own independent research. Here, when assessing the days inventory metric, it’s moving northbound as rising borrowing costs are on the horizon. Frankly, that’s a bearish signal all day long for a home builder.
