One of the classic benchmarks of the economy’s health and strength is the housing market. Stocks of retail companies like Home Depot (HD) and Lowe’s (LOW) often serve as proxies of to guide the market’s perception of the housing market, but it also isn’t uncommon to see experts and analysts referring to homebuilders like D.R. Horton (DHI) and Toll Brothers (TOL) in the same way. That’s why this is another pocket of the economy that is usually worth keeping an eye on no matter what the current direction of the market looks like.
One of the surprising things about the past year is the way homebuilders have prospered. Even as the pandemic raged in 2020, home sales – new and existing – around the country continued to see strong demand. Certainly, a big part of that is tied to accommodative monetary policy, as the Fed has maintained rates near zero throughout the pandemic, with the stated intention to keep doing so for the foreseeable future. That is a reason that I think homebuilders could still be a good bet in 2021.
One of the stocks in this industry that I’ve followed for quite some time is KB Home (KBH), a small-cap homebuilder with a footprint throughout much, but not all of the United States. They specialize in homes for first-time home buyers as well as those looking to move up from their current home. Like pretty much everybody else, KBH’s stock price plunged at the beginning of the pandemic last year to a bear market low at around $10; but from that low point, the stock rallied to a little above $42 by October, a little above their pre-pandemic high point. After sliding back to around $32 at the beginning of January, the stock has picked up quite a bit of momentum. This week seems to be picking up strength on their latest earnings report, which indicates that the company still has a healthy backlog of pending orders to fulfill this year. In addition, this is a company with no long-term debt, healthy Free Cash Flow, and a value proposition that belies the stock’s impressive year in the last ten months. Let’s dive in.
Fundamental and Value Profile
KB HOME is a homebuilding company. The Company is engaged in selling and building a range of new homes designed primarily for first-time, move-up and active adult homebuyers, including attached and detached single-family residential homes. It operates through five segments, which consist of four homebuilding segments and one financial services segment. Its homebuilding segments include West Coast, Southwest, Central and Southeast. The homebuilding segments are engaged in the acquisition and development of land primarily for residential purposes. The financial services segment offers property and casualty insurance and, in certain instances, earthquake, flood and personal property insurance to its homebuyers in the same markets as its homebuilding segments, and provides title services in the majority of markets located within its Central and Southeast homebuilding segments. It offers homes in development communities, at urban in-fill locations and as part of mixed-use projects. KBH has a current market cap of about $3.9 billion.
Earnings and Sales Growth: Over the last twelve months, earnings declined by 14.5%, while revenues declined more than -23%. On a quarterly basis, earnings grew nearly 35%, while sales improved by about 19.5%. KBH’s margin profile is healthy, with solid signs of improvement; over the last twelve months, with Net Income as a percentage of Revenues at 7.08% in the last quarter, and strengthening in the last quarter to about 8.88%.
Free Cash Flow: KBH’s free cash flow is healthy, at a little more than $702 million. It has also grown steadily throughout the year, from about $402 million at the beginning of 2020. The current number translates to an attractive Free Cash Flow Yield of 20.5%.
Debt to Equity: The stock’s current debt/equity ratio is .0, owing to the fact that KBH has no long-term debt. The company’s balance indicates cash and liquid assets are around $722 million as of the most recent quarter, which marks an improvement from about $430 million at the beginning of 2020. The company’s margin profile, along with their solid balance sheet indicates they have excellent liquidity to manage expenses, pay dividends, and invest back in the business.
Dividend: KBH’s annual divided is $.60 per share, which translates to a yield of about 1.5% at the stock’s current price.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target at $48 per share. That means the stock remains undervalued despite its latest surge, with about 20% upside from its current price.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The red diagonal line measures the length of the stock’s long-term upward trend from its March 2020 bear market low at around $10 to its October peak a little above $42. It also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. The stock dropped back in November to a support low point around $30, and then settled into a consolidation range that held until about a week ago, when the stock rallied off of $32 to push strongly higher following its last earnings announcement. Immediate resistance is at the October peak, at $42, with current support now expected to lie around $37. The distance from the resistance break that resulted in the October peak at $42 is about $5, suggesting that if the stock can break $42, it could have additional upside to about $47. A drop below $37 could find next support anywhere between $35 and $32.
Near-term Keys: It is very interesting to see that, even though KBH has made a big move to the upside, there is still a good value proposition in place, with strong supporting fundamentals. Considering that the Federal Reserve is unlikely to start raising rates 2021, I think demand in the housing market will continue to be strong, which should be a positive for KBH. If you prefer focus on short-term strategies, the stock’s current rally could be an interesting signal to consider buying the stock or working with call options. The stock has about $2 to immediate resistance, which means that you should be on the look out for a pivot high at this level and be ready to take profits quickly if it does start to drop back again. If bullish momentum remains strong, however, you could be looking for an exit at around $47. If the stock does reverse its current momentum and drops below $37, you could use that as a signal to short the stock or buy put options, with a target price between $35 and $32 for a bearish trade.