KB Home (KBH) recently reported strong fourth quarter and full year 2021 results with EPS of $1.91 beating estimates by $0.14 and revenue of $1.68 billion missing estimates of $31.05 million. However, the highlight was the company’s gross margin forecast for fiscal year 2022. Prior to the results, sell-side consensus estimates for gross margins for fiscal year 2022 were around 21.7% or d an improvement of approximately 10 basis points from fiscal 2021 levels. However, the company has forecast gross margins of between 25.4% and 26.2% for fiscal 2022. significant rise in the company’s share price as sell-side analysts rushed to revise their estimates higher.
In retrospect, it wasn’t terribly hard to predict and to be fair there were reports (link1, link2) that sell-side consensus estimates were conservative and potential for significant improvement in gross margins over the course of fiscal 2022. Company peers like Meritage Homes (MTH) have already seen their gross margins improve from pre-pandemic high teens to 20s in recent quarters. In the third quarter of 2021, new orders for KB Home were recorded at an average price higher by approximately 11% compared to the closing ASPs for the home. So once these new orders started to convert into home closing revenue, there was a good chance that most of the incremental revenue from higher prices would trickle down to the bottom line and margins would shrink. improve.
Although the estimates on the sell side have adjusted higher and the stock has had a good run up, I think it still offers a good buying opportunity for long-term investors based on my forecast. .
The company ended fiscal 2021 with 217 active communities and its full-year uptake was approximately 6.3 orders per month per community. Management has guided between 20% and 25% increase in the number of communities by the end of FY2022. I think this is a reasonable target given the investment of approximately the company’s $2.5 billion in land acquisition and development last year. Even assuming the company increases its number of communities at the bottom of this guidance, the company will reach approximately 260 communities by the end of FY2022. On the uptake front, we will see some decrease compared to a very strong last year given expectations of interest rate hikes in the second half of this year. So I assumed that uptake would decrease to ~5.8 orders per month per community in FY2022. But this drop in uptake will be more than offset by the increased number of communities and we will likely see a year-over-year increase in net orders for fiscal year 2022.
Thus, we will have new orders for approximately 16,600 homes in fiscal year 2022. [Calculation: Average community count = (217+260)/2 =238.5. Net orders for the year = Average community count * monthly absorption * 12. Using monthly absorption of 5.8, we have net orders for the full year = 238.5 x 5.8 x12 = 16,600 (approximately.)]
Due to supply chain issues, the number of homes closed was lower than new orders in fiscal year 2021 and the ratio of homes closed to new orders was around 0.83. I expect supply chain constraints will continue in fiscal 2022, but will become less severe as many building products companies and homebuilders have made some adjustments to meet high demand levels. . I assumed that the home closings against the new orders ratio would be around 0.92 for fiscal year 2022. This gives us home closings of 15,272 for fiscal year 2022.
For the ASP close, management’s forecast is between $480,000 and $490,000, which is reasonable given that the average price per home in the company’s backlog was around $470,000. $ in the last quarter and that it was booking new orders at an average price of approximately $501,000 during the same quarter. . I assumed ~ ASP$485,000 for closings in fiscal year 2022.
This gives us residential construction revenue of approximately $7.4 billion for the full year. [Calculation: 15,272 x $485,000 = $7,406 bn.]
On the margin front, management guided gross margin for the full year between 25.4% and 26.2% and general and administrative expenses between 9.4% and 9.9%. Halfway through, this gives us an operating margin of 16.15% for the full year. Interestingly, on the earnings call, management said it expects gross margins between 22% and 22.6% in the first quarter of 2022 and then further improvement as the year progresses. . This implies that we may see even higher margins in the second half of this year and probably next year. So the margin expansion we are seeing could also continue in fiscal 2023, which bodes well for the stock.
Using operating margins of 16.15%, we have $1,196 million in residential construction operating profit for next year. Financial Services pre-tax income was approximately $38 million for FY2021 and I have also assumed a similar level of contribution for FY2022. Other pre-tax income/expense is not material. Using these assumptions and a tax rate of approximately 25% (as guided by management), we have net income for fiscal year 2022 of approximately $925 million. Using an average diluted share count of 90.8 million (same as last quarter), we get full year diluted EPS of $10.19.
The company’s tangible book value at the end of the last quarter was approximately $3,019 million or approximately $33.25 per share. Add EPS of about $10.19 per share for the year and subtract an annual dividend of $0.60, we get a 2022 year-end tangible book value per share of about $43 per share. KB Home peers like Meritage Homes are trading at a tangible price-to-book ratio north of 1.5x. KB Home’s multiple also hit these levels after the company guided a type of margin expansion similar to that of MTH. If the company is able to maintain these valuation levels, we can see its stock reach ~$64 (=1.5 x $43) by the end of the year (or ~30% upside). Given the likelihood that the company’s gross margins will continue to improve in the second half of this year and that fiscal 2023 could see further year-over-year margin increases from FY2022, I think there is a reasonable chance that the company can maintain its P/TBV at ~1.5x levels. Even if we are conservative and only assign a multiple of 1.3x P/TBV, we still get a price target of $55, which implies an upside of around 11%. So I think there is still a reasonable upside and the stock is a good buy at current levels.
The biggest risk to housing inventories is the upcoming interest rate hike in the second half of this year. I have factored in its impact and assumed lower absorption in FY2022 compared to FY2021. However, if the impact is greater than I assume, my revenue estimates may turn out to be optimistic .