NVR - KB Home Vs. NVR: Battle Of The Builders

2023-03-26 10:25:40 ET

Summary

• This is a strange time for homebuilders. Insatiable demands meet unaffordable financing.
• That global fallout wreaked havoc on the share price of KB Home and NVR. In fact, KB Home has yet to recover to its pre-GFC high share price of ~$80.
• Adjusted for population, the 2010s was the worst decade since before the 1960s for new single-family home construction in the USA.

Introduction

"The rent is too damn high" - Jimmy McMillan

As a wise man once said the rent is indeed quite high... In fact, it is so high that rent growth has significantly outpaced inflation over the past few years.

What's one hypothetical solution to that problem?

As simple as it sounds, building new supply might work! Crazy right?

Two companies helping to alleviate the supply shortage are KB Home ( KBH ) and NVR ( NVR ) two of the largest homebuilders in the United States. KB Home operates across a wide swath of the USA with a focus on key markets like California, Arizona, Texas, and Florida. KB Home offers a range of homes, including single-family, town homes, and condos, catering primarily to first-time, and first-move-up homebuyers.

NVR focuses primarily on the east coast from New York down all the way down to Florida through its NV Homes, Ryan Homes, and Heartland Homes subsidiaries building starter and luxury homes.

In addition to home building, both companies provide limited financial services such as insurance, mortgage, and title services.

In the following sections, we will delve deeper into KB Home's financials, growth strategy, and competitive landscape to determine which company is the better buy.

Overview

The home-building industry has been notoriously cyclical... over the past few decades it seems to always go through periods of booms and busts. Most of us are old enough to remember the extreme pain that was caused by the great financial crisis and the implosion of the residential market in the USA.

That global fallout wreaked havoc on the share price of KB Homes and NVR. In fact, KB Home has yet to recover to its pre-GFC high share price of ~$80 but it has rebounded strongly from its post-GFC lows of <$10 a share coming to ~$40 level, where it sits now.

But unlike KB Home, NVR's share price to continues to set new highs:

And while I believe homebuilding will continue to be a cyclical industry, where demand usually follows the rise and fall of real estate values, the supply dynamic has changed the game fundamentally.

We are simply dramatically underbuilt. In fact, adjusted for population, the 2010s was the worst decade since before the 1960s for new single-family home construction in the USA.

This has created a significant shortage in housing and continues to yield ever-increasing rents and home prices. The supply simply cannot keep up with demand.

The shortage has had other effects too, an increase in young couples moving in prior to marriage, as well as an increase in the average when people move out from their parents. The lack of housing has, arguably, never been worse.

That's where KB Homes and NVR come into play, as a builder they bring new supply onto the market in exchange for a profit margin on the overall construction cost. While rent control can keep rents lower for some, to fix this problem for the long-term new supply is needed.

Given the shortage, we can expect that to provide a strong tailwind of support to demand for KB and NVR. But partially counteracting that tailwind is the rising rate environment in which we now find ourselves.

Just a few short years ago 30-year mortgages could be had at sub-3% rates, now, for many those rates are approaching 7%. It's my view that in markets where housing is still relatively affordable (Texas for example), this will be less of an issue, but in markets like California, where prices are already so steep, it's uncertain how much more consumers can afford despite their desire to own.

Quarterly Update

Thus far, on the surface, KB Homes seems to be managing well, revenues in Q1 of 2023 were roughly flat year over year at $1.38B. But while revenues have remained steady net orders have decreased YoY from ~4K to near ~2K indicating reduced demand. At the same time, pricing on a per-house basis has remained relatively stable (up roughly 2% year over year) but if demand continues to slip this may put downward pressure on revenues and ultimately the stock.

NVR, for its part, experienced a 27% drop in new orders in the fourth quarter of 2022 with only 4,153 units compared to 5,685 units in the same period in 2021 showing they are weathering the market a bit better than KB Home. However, there was a small silver lining as the average sales price for new orders increased by 1% to $459,000 during the fourth quarter of 2022, as compared to the previous year.

Financials

Now that we've covered their recent performance, let's take a step back to see how they've performed over the long term versus their peers across a few key metrics: Revenue, EPS, Operating Margins, and Return on Invested Capital.

Revenue & EPS

Starting off first with revenue growth and EPS growth over the last decade we can see that KB Homes has grown their EPS rapidly (supported by a very low base) and more than tripled its revenue. As impressive as 256% revenue growth is, it actually lags far behind peers like Lennar ( LEN ) and D.R. Horton ( DHI ) which grew between 500-600% in that same time period.

NVR, like KB Home, grew its revenues relatively slower but unlike some of the other peers, it grew its earnings by over 1000%! Not too shabby.

Operating Margin

Comparing operating margins we can see that KB Home begins to falter generating a meager 15% operating margin. While this is much higher than historical levels (closer to 6%) they are still far behind D.R. Horton and NVR. Lower operating margins indicate KB Home may have room to become more efficient.

ROIC

Another area where KB Home lags is in the returns on the invested capital department. KB Home seems to consistently earn ROIC in low double digits compared to its peers which are earning in the 15-20%+ range. While KB Home has been able to increase its return on invested capital they continue to lag behind its peers. I'd again like to highlight NVR which continues to impress with a return on invested capital consistently in the 15-30% range, such strong results show they are particularly strong capital allocators.

Valuation

Finally, we come to their valuations, in the chart above we can see that NVR's superior growth, margins, and return on invested capital have been rewarded by investors as they have the highest price-to-sales and forward PE ratio among the peer group at 1.8x and 14.6x respectively. KB Home on the other hand has likewise been punished for its weaker margins and ROIC with the lowest valuation in the group at ~7.7x forward earnings and .5x sales.

Conclusion

This is a strange time for home builders... insatiable demands meet unaffordable financing. This has made the future of all the builders uncertain because nobody knows when demand will fully deplete.

Both companies' shares up significantly since Q3 of last year, KB Home is up around 50% and NVR is up around 30%. Given the interest volatility and questionable macro-environmental outlook (especially around financing), I prefer quality to speculative bets.

And with its best-in-class returns on capital and margins, NVR all but screams quality, putting it in a strong position to weather any downturn. Yes, KB Home has improved its business but they are still a ways behind NVR.

I rate NVR a Buy and KB Home a Hold.

Thank You

Thank you for taking the time out of your day to read my article. I hope you all are having an excellent March and enjoying some more sunlight since the time change. Wish you all the best, if you'd like to discuss anything mentioned in the article please feel free to chime off below and I'll get back to you with a response.

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