If You Build It, They Will Buy

Shares of KB Home (KBH) rose 7% to $77.25 on Friday after the home builder reported a 78% profit surge and blew the roof off Wall Street's expectations for the year. "Consumer demand in our market remains vibrant, fueling strong growth," said Chairman and Chief Executive Bruce Karatz in a statement accompanying the release.

No kidding. Late Thursday, the Los Angeles-based company posted net income of $181.5 million, or $2.06 a share, for the three months ended May 31, up from $102.1 million, or $1.20 a share, for the same period last year. Analysts tracked by Thomson First Call had a consensus estimate of $1.78 a share.

Revenue jumped 36% to $2.13 billion. Unit deliveries leapt 20%. The average selling price climbed 14% to $247,800.

As of May 31, the company's backlog of future revenue had climbed 52% to $6.79 billion. Total net orders rose 15% to 12,290, the highest quarterly level in the company's history.

With that kind of visibility, KB Homes raised its 2005 earnings forecast to $9 a share from previous guidance of $7.88. The new number represents a 58% jump from the $5.70 a share KB Home earned in 2004. All per-share amounts reflect the 2-for-1 stock split on April 28.

Gushing reviews from Bank of America Securities and Citigroup Smith Barney added to the euphoria that pushed the stock to its all-time high.

After raising his earnings estimates and pushing the target price to $82 from $70, Bank of America's Daniel Oppenheim wrote, "There may still be upside to estimates given that both our estimate and management guidance represent lower earnings growth than we've seen in the first two quarters of the year. [Also], we expect the company to update its previously stated goal of $10.00 per share in earnings in 2007 and expect management will indicate that 2007 earnings are likely to be significantly above that." (Oppenheim doesn't own shares of KB Home; Bank of America has an investment-banking relationship with the company.)

Stephen Kim of Smith Barney took it a step further and raised his rating to Buy from Hold on KB Home and five other builders: Beazer Homes (BZH), Hovnanian Enterprises (HOV), Meritage Homes (MTH), Pulte Homes (PHM) and Ryland Group (RYL).

"Certainly the risks are greater today than a few years ago," says Kim, "But the fact of the matter is demand is not weakening. Margins will be higher over the next six to 12 months based largely on units they have already sold and are selling today. I think the estimates were way too low and that talk of a bubble alone does nothing more than create a temporary buying opportunity for investors who realize that the valuations already incorporate much of the risk." (Kim doesn't own shares of KB Home; Citigroup Smith Barney has a non-investment-banking relationship with the company.)