Kaufman & Broad Home Corp. has beaten analysts’ expectations for the last five quarters in a row. Its reward from Wall Street? A tanking stock price.
No matter how strong the performance, the market is looking at one thing only: interest rates. And the rise in mortgage rates is not painting a pretty picture for homebuilders, even though demand remains strong.
For the second quarter ended May 31, the company reported net income of $28.6 million (58 cents per diluted share), compared with $17.2 million (42 cents) for the like period a year ago. The increase in earnings per share came in spite of a 19.2 percent jump in the number of common shares outstanding in the second quarter due to the acquisition of Lewis Homes.
Earnings per share for 1999 is expected to increase 36.9 percent over the previous year.
Meanwhile, Kaufman & Broad’s stock closed at $20.81 on Aug. 11, down nearly 18 percent since July 1 and 33 percent from a 52-week high of $31.13 in November 1998.
“It’s interest rates,” said Michael Jaffe, an analyst with S & P; Equity Group. “In the homebuilding industry, it doesn’t matter how well you do and how many homes you build and sell, you’re guilty by association as far as the long-term outlook is concerned.”
With 30-year, fixed-rate mortgage rates at a two-year high, and with the Federal Reserve likely to increase benchmark rates to counteract inflationary pressures, investors believe that fewer people will be able to afford new houses in the foreseeable future. So the general expectation is that lean times are ahead.
“The psychology on Wall Street is that homebuilding is a cyclical business,” said Mary McAboy, a spokeswoman for Kaufman & Broad. “Our challenge is to show the markets, by continuing to deliver earnings gains quarter after quarter, that the industry has become more mature and the consumer more sophisticated. For example, all our backlog is sold but not delivered, which means that we know exactly what our revenues will be for the next two quarters. Unlike five years ago, we don’t build on spec anymore.”
It’s not a foregone conclusion that higher interest rates will seriously impact the industry.
“Higher mortgage rates are not going to the take the spokes off the wheel,” said Bob Bray, national marketing consultant with the Meyers Group, a real estate consulting firm. “The overall outlook for the industry is quite strong. People are still very confident in the economy, income levels are rising, and the supply level of new homes is the lowest it has been since the late ’80s. At most, what will happen is that buyers will start looking at less expensive homes.”
Last month’s increase in new orders could have been due in part to the anticipated increase in higher mortgage rates. The jump in orders is expected to translate to an increase in revenues two to three quarters down the road.
The company’s acquisition of Upland-based Lewis Homes, for $449 million in debt and shares, made Kaufman & Broad the largest homebuilder in the United States. It was part of an ongoing wave of consolidation in the homebuilding industry.
Kaufman & Broad’s acquisition strategy is aimed at becoming the dominant builder in selected markets, rather than being spread out nationwide. Thus, the company can negotiate better prices for labor and materials by building a large number of houses in one geographic area. In addition, by acquiring Lewis Homes, Kaufman & Broad greatly improved its portfolio of developable land in the Western U.S., its strategic heartland.
“The timing on the purchase of Lewis Homes was very good,” said Bray. “They instantly increased their market share in Las Vegas and the Inland Empire, two markets in which Lewis was very well established and which are expected to see a tremendous amount of growth in the coming years. They played it right by buying only when it made sense strategically, and not just for the sake of market share.”
Earlier this month, the company announced the planned repurchase of 5.2 percent, or 2.5 million, of its outstanding common shares. Officials said at the time that the shares will be used to fund employee compensation and benefits plans.
“It is a clear statement on the part of the board of directors and of management that we think our stock is currently undervalued,” said McAboy.
Not all of Wall Street takes a dim view of Kaufman & Broad’s future potential. Last week, Warburg Dillon Read upgraded the company from a “buy” to a “strong buy,” and set a 12-month price target of $40.
