Can KB Home Pull a 'Lennar Surprise'? - TheStreet

Can KB Home Pull a 'Lennar Surprise'?

Last week, Lennar pulled a market surprise by booking a profit in the fourth quarter. Will KB Home bring the market any surprises in its earnings on Tuesday morning?
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Updated from Monday, Jan. 11

LOS ANGELES (

TheStreet

) --

KB Home

(KBH) - Get Report

is reporting earnings on Tuesday. After last week's surprise profit from

Lennar

(LEN) - Get Report

should investors expect KB Home to give the market a repeat homebuilder surprise earnings?

To be fair,

Lennar engineered a profit with a one-time tax gain and, to be exact, without the tax gain would have lost money yet again in the fourth quarter. However, Lennar's new orders were also up 3% as measured by new units -- and 12% in dollar terms -- and that was an encouraging sign of recovery for the homebuilder regardless of accounting tricks.

Still, some analysts were perplexed by the

15% share price surge that Lennar received last week with the tax-gain triggered profit. ANd even if KB were to take a big tax gain and arrive at profitability that way, analysts say the operating data -- new orders, backlog levels, and cancellation rates -- should continue to dominate investor outlook on the homebuilders. At this point in the homebuilder cycle, it is all about getting orders, and lowering cancellations to drive growth of sales and bring down the current backlog.

Everything else is pretty much data noise.

KB Home is also a trickier case than Lennar when it comes to the one-time tax gain. While Credit Suisse estimates the potential gain to KB Home at $200 million -- and upgraded the homebuilder as a result -- KB Home is also currently under investigation by the Securities and Exchange Commission for undisclosed accounting issues. Even more unsettling, a CFO who joined KB in the fall recently left after only three months with the homebuilder.

Jay McCanless, analyst at FTN Equity Capital Markets, says that while KB Home could engineer a profit like Lennar managed to engineer through tax gains, the homebuilder also might shy away from pursuing it while it is still resolving accounting issues with the SEC. KB Home hasn't revealed the exact nature of the accounting issues at the heart of the investigation, but it is possible that they relate directly to tax valuations. McCanless noted that KB had a $12 per share tax valuation on its balance sheet in the third quarter, when the average in the homebuilding industry was $6 per share.

Since the decision of whether or not to take the tax gain is impossible to peg, analysts like McCanless are looking to order growth first and foremost. To that end, the best thing KB Home has going for it is a 28% neighborhood concentration in California, where home sales and prices have rebounded. "An improving sales environment in California translates more quickly for KB Home than other homebuilders," McCanless said.

What's more, KB Home's low-end single family homes in the Open Series were designed to compete specifically against foreclosures, and should help KB Home to show some encouraging operating data for the fourth quarter. "California home prices increased for the first time in more than two years in November," McCanless noted.

Orders were up for KB Home 62% in the third quarter, and FTN Capital is predicting order growth of 59% versus a year ago for the fourth quarter. "I thought prior to the Lennar earnings I was being too aggressive with KB Home order estimates," McCanless noted, adding "orders could even come in a little better than I've anticipated."

Lennar managed a gross margin improvement of 230 basis points, and on its earnings conference call spoke about the need to provide incentives to sell homes as lessening year over year. "We will see more of that gross margin improvement now, with less competing inventory of foreclosures and new homes having been depleted in certain areas. Builders can hold price better, and being able to hold price is great way to hold gross margins up," the FTN analyst said.

McCanless, however, noted that KB Home's gross margin improvement may trail its improvement in the third quarter, due to a rush to sell homes at competitive prices ahead of the original expiration date for the first-time home buyer tax credit. The fourth quarter is usually the best gross margin quarter for homebuilders, but may not be for KB Home this year in particular.

Still, McCanless believes that KB Home would have to do a lot better than his forecast of a 12.6% decline in sales price versus a year ago, and a much higher closings number, to provide an earnings surprise. "I know they have regained pricing power in certain markets, but not enough to move up the average sales price much, especially since the successful Open Series homes are lower priced," McCanless said, adding, "We need a much smaller decline, or a marginally positive number, to change our view on KB Home." FTN has KB Home at neutral.

The Street is at a 42-cent estimates loss for KB Home for the fourth quarter, and continuing losses in the first quarter next year, albeit at a lower 38 cent loss. FTN Equity Capital is slightly bullish from this perspective, estimating a fourth quarter loss of 31 cents for KB Home. FTN has a more bullish outlook on KB's ability to bring down its backlog and show higher order and closing numbers.

Even with the fourth-quarter gross margin trailing the previous gross margin for KB Home, was the market tipping its hat on Monday with its trading of KB Home shares? KB Home closed on Monday up 2.6% or 41 cents, to $16.38, on almost twice its daily average trading volume -- 7.9 million versus 4.7 million shares.

-- Reported by Eric Rosenbaum in New York.

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>>Lennar Bull Puzzled by Extent of Share Rise

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