KB Home's 2Q Results Show Smaller Might Not Be Better

KB Home (KBH) has staked its future on size-shaved, more-affordable homes designed to compete with a swelling supply of bargain-priced foreclosures. But its results Friday left analysts questioning if smaller remains better.

The Los Angeles-based builder missed expectations when it reported a narrower fiscal second-quarter loss - $78.4 million, or $1.03 a share, compared with a year-earlier loss of $255.9 million, or $3.30 a share - aided by smaller charges as net orders again outpaced closings. While down 31% from a year earlier, orders surged nearly 60% from the first quarter.

"This reflects the success of management's proactive efforts to redesign its product," noted UBS analyst David Goldberg, who had forecast a 50% annual drop. "The company's strategy positions it well to outperform."

Credit Suisse's Dan Oppenheim agreed, pointing out the success in foreclosure-heavy California, one of the states hardest hit by the multi-year housing slump.

But J.P. Morgan analyst Michael Rehaut disagreed, pointing out "the order drop was not only worse than expected, but is also in sharp contrast to last quarter's 26% year-over-year rise."

That could be one reason shares of the nation's fifth-largest builder by annual closings had tumbled 9.5% in recent trading, making it by far the sector's biggest loser.

Debate over the revamped floorplans known as "Open Series" aside, the results came with cautiously optimistic commentary. Chief Executive Jeffrey Mezger said although economic indicators remain mixed, the company is beginning to see signs that "some negative housing-market trends may be moderating at both the local and national levels." He added it is premature to say the market has reached the end of its correction.

Even so, that's a dramatic switch from March, when he saw no meaningful improvement in market conditions for the rest of this year.

The change in tone - which follows similar statements from No. 4 Lennar (LEN) Thursday - is a big deal for homebuilders, battered by the housing bust, which continue to limp through a string of quarterly losses that as forced them to recreate their business model. Numerous private builders have folded -- or are in danger of going out of business.

With the economy still in recovery mode, no one is ready to call a bottom. Indeed, data released Wednesday from the U.S. Commerce Department showed new-home sales unexpectedly fell in May.

Americans remain on the sidelines, afraid of elevated unemployment rates and plunging home values. While smaller homes - now being constructed by several builders that profited from supersize inventory during the boom - are helping the sector compete with foreclosures and short-sales, the inventory continues to catch buyers' eyes. Such transactions can drag down appraisals, builders say, forcing them to cut prices or risk losing a deal.

Builders also face the end of tax credits engineered to stabilize the shaky market. The $100 million California set aside to tempt buyers of new homes with a credit of up to $10,000 is nearly depleted, while the federal government is offering qualified first-time buyers up to $8,000 for deals done before Dec. 1. The federal money could be extended and/or expanded, but it is unlikely the financially troubled Golden State's builders will see any more funds.

For KB Home, "a key question will be the success in CA following the end of the tax credit for new home buyers," Oppenheim said.

The builder's latest results included $49.5 million in inventory and joint venture write-downs and charges, while the prior year's included $176.5 million in similar charges and a $24.6 million goodwill write-down.

Revenue dropped 40% to $384.5 million as deliveries declined 37% and the average price fell 4.6%.

Net new orders for the quarter fell 31% to 2,910. The year-to-year increase was in part due to the cancellation rate dropping to 20% from 28%. That's down from the 58% reported at the end of 2007, according to J.P. Morgan.

The company's backlog, in terms of number of homes, fell 39%.

Gross margin, excluding inventory write-downs, rose to 12.7% from 8.7%.

-Dawn Wotapka, Dow Jones Newswires; 212-416-2193; [e-mail]

-Kerry Grace contributed to this report.