Company Watch

ANALYSIS OF BREAKING NEWS

  KB Homes:
  Is the Worst Over?

January 8, 2008 - KB Homes (KBH-NYSE) announced a huge quarterly loss, much larger than anticipated. But that wasn't the bad news. That came from management's assessment of the real estate industry and what it sees ahead. So the company lost $9.99 a share or $772.7 million in three months. It was the fact that there wasn't anything positive to say that really hurt.

The CEO, Jeffrey Mezger, stated that "2008 will be another tough year for the homebuilding industry." Fourth quarter results certainly gave no hint of anything positive, even though sales were higher. That most likely came from discounting prices to move inventory. They moved without any profits attached.

Now there's another problem for KB Home. They have to take a charge on reserves they set aside for tax benefits they planned to use against future taxes. Most builders accumulated these tax benefits, taking large losses on their land and home values because of the severe housing slump. Auditors are now advising the home builders that they can't carry the reserves because taxable income is shrinking (or non-existent) and shows no sign of increasing. Hence, their will be nothing to use the reserves against. KB's fourth quarter tax related charge was $514 million. That was on top of $403 million of inventory write-downs.

While the losses were severe, KB bolstered its balance sheet during the year, moving its ratio of debt to total capital down to 31% from 43.2% the previous year. Analysts suggest that KB will generate decent cash from the sale of its homes to reduce debt further. The company also stated that it will most likely reach a deal with its bankers by the end of March for a waiver it needs under its revolving credit line. The advantage KB has with the banks is its size. Smaller lenders are expendable. When one as large as KB needs adjustments to its covenants, they're usually given.

A similar problem was resolved for D.R. Horton Inc., another large home builder. Its banks reduced the builder's credit line for $2.5 billion to $2.25 billion and dropped a previous interest coverage ratio requirement. Another builder, WCI Communities has until January 16 to negotiate a new agreement with its banks. It has received new waivers on its revolving credit line every month since November.

New home orders at KB were down 33%. Analysts predicted 14%. That most likely means lower prices on KB homes to sell more of them. The company does have some strong elements, however. It sells Martha Stewart homes in 6 states, a well received product. It's also launching a Disney-themed effort with wall-coverings, lighting and flooring that are only for KB buyers.

There aren't any home builders exempt from the current mess. While KB caters to more of the entry level buyer, high end builders won't see demand rise substantially until homeowners that want to move up can sell their existing homes to do so. And if a recession is really in the works, which seems likely given the latest reports, the home builders will have a rough 2008 or at least the first half of it as more homes are sold at losses, and investments are written down further. Maybe in the second half, with lower interest rates and better credit conditions, there will at least be stability.

- Company Web site: www.kbhomes.com

- Ted Allrich