KB Home (KBH) reported a larger-than-expected quarterly loss early Friday, as it held firm on pricing, fueling a stunning order decline and rise in cancellations as potential buyers walked away.
The third-quarter results are the latest in a recent string of grim statistics that show the sector's worst downward spiral in decades - one that has forced dozens of builders out of business - drags on.
Chief Executive Jeffrey Mezger was bleak: "Market fundamentals appear unlikely to improve significantly in the near-term" amid competition from increased foreclosures, bloated inventory and tighter requirements for mortgage rates, even for potential buyers with good credit.
"It's pretty clear that the home building market has undergone another leg down," said Morningstar analyst Eric Landry.
Shares of Los Angeles-based KB Home slipped about 3%, slightly below the Dow Jones US Home Construction Index's 3.13% fall.
For the quarter ended Aug. 31, the company, one of the nation's largest builders, reported a net loss of $144.7 million, or $1.87 a share, compared with a prior-year net loss of $35.6 million, or 46 cents. Analysts polled by Thomson Reuters expected a loss of $1.22 a share on $734.7 million in revenue.
Revenue actually dropped 55% to $681.6 million, while orders plummeted 66% - well above the 40% JP Morgan expected. New home deliveries slid 51%. "The contraction in KBH's operating metrics are staggering in our view," noted Wachovia's Carl Reichardt. "Q3 unit backlog is 79% lower than in Q305 while orders this quarter were 85% lower than those generated in Q305."
The cancellation rate - typically unit cancellations divided by gross orders - jumped to 51%, up from 27% in the second quarter. Until recently, some builders have seen cancellation rates improve slightly.
Mezger said the dramatic order decline "reflects the broader dynamics of the housing market" and its strategic response: cutting the amount of developments underway - its active community count was sliced by 38% - and changing offerings. It is at work on "new, value-engineered product with smaller, more affordable standard features" and a lower base price.
In California's Inland Empire, one of the nation's worst housing markets, KB Home has cut the size and prices of houses - by more than half - to make them competitive with resales and foreclosures, often bargain-priced to sell quickly. The change is working, Mezger said during the earnings conference call.
The company also reduced its use of sales incentives and price discounts as it reviews pricing strategies. Since the downturn began, builders have tried everything - free gourmet kitchens, paid closing costs and even six-figure discounts - to move inventory. KB Home has even offered price protection guarantees to reassure buyers afraid of buying a house only to see it fall in value.
Analysts were divided over the decision to hold prices.
"KB Home is in an enviable position where they can afford to do that," Landry said. "The liquidity is such, where they can say 'We don't need to fire sale homes anymore.'"
KB Home executives echoed that sentiment during the earnings conference call.
But there isn't a lot of differentiation in what public builders construct - with the exception of Toll Brothers Inc.' (TOL) luxury product - so buyers could easily score price discounts from nearby competitors.
Holding firm on prices kept charges down this quarter, but JP Morgan's Michael Rehaut thinks there's more pain to come.
"While we believe this was enough to prevent material impairment charges this quarter, given the highly negative commentary, we believe that KBH will be forced to reduce its prices over the next 2-3 quarters, which should trigger further material impairments," he noted.
Builders also face the loss of seller-funded down payment assistance, or DPA, which has been a key driver of recent sales. As part of this summer's housing bill, DPA ends at the end of the month. After that, as much as 15% of the buying base could be erased.
Some investors and analysts have pinned their hopes that the effects of a proposed $700 billion government bailout of the financial industry can stem home builders' pain. But industry watchers, including the National Association of Home Builders, point out it doesn't immediately address some of the builders' biggest problems: The difficulty for first-time buyers to come up with a down payment and the downward pressure foreclosure sales are putting on house and land values.
Friday, KB Home's Mezger said "difficult conditions have now been exacerbated by the recent, unprecedented turmoil in financial and credit markets," while noting "it is too early to assess" whether conditions will improve following government intervention.
KB Home is the second builder to report a loss this week. Lennar Corp. (LEN), the nation's second-largest builder, reported a narrower loss of 56 cents a share, compared with a prior-year net loss of $3.25 a share. Orders dropped 42%, while deliveries fell 49%.
Chief Executive Stuart Miller's comments mirrored the same issues KB Home reported: "While we expected the housing market to remain constrained throughout the third quarter, the weakness in the market actually accelerated as a result of increased foreclosures, weakened consumer confidence and tightened mortgage lending standards."
Meanwhile, August's new-home sales fell 11.5%, sliding to their lowest level in 17 years, the government said Thursday. The rate tumbled 35% in a year. And existing sales, a much bigger slice of the market, also slipped in August.
