Market Watch : Deciphering KBH’s Course

A home-building stock might seem a strange way to profit from a bank credit crunch, but Kaufman & Broad Home Corp. shares have appeal partly based on those worries.

KBH is California’s biggest single-family home builder. The stock has been hammered since autumn, largely on concerns that the California housing market will weaken drastically this year.

So far, the fears have proven to be overblown. While orders for KBH homes fell 21% in the first quarter ended Feb. 28 versus a year earlier, to 1,137 units, orders so far in the second quarter are up. California orders in the six weeks ended April 8 were 60% higher than a year earlier, said R. Chad Dreier, chief financial officer for Los Angeles-based KBH. Orders in KBH’s other major market--France--are up 15% so far in the quarter, he said.

It isn’t all roses. KBH acknowledges that to sell houses today it must offer many buyers special incentives, such as mortgage buy-downs. That means that profit margins are lower. Steve Dobi, analyst at Smith Barney, Harris Upham & Co., sees KBH’s gross profit margin falling to 20% this year from 24% last year.

Overall, Dobi expects KBH to earn $2 a share this year, down from $2.36 last year. Revenue is expected to be around $1.2 billion.

Why buy stock in a company whose earnings are going down, even temporarily? The analysts who like KBH note that at $13.625 a share, the stock’s price relative to estimated 1990 earnings per share is a multiple of just 7. That’s a cut-rate price for California’s top builder of affordable middle-class housing, Dobi said.

Barbara Allen, analyst at Kidder, Peabody & Co., agrees. In a recent report, she called KBH shares “significantly undervalued,” and argued that a fair price is “a minimum of $20”--which is where the stock peaked in autumn.

The decline since, while driven by housing crash fears, also has been fueled by a 50% increase in shares outstanding (because of a convertible bond sale) and by negative publicity about quality problems at some KBH sites in California. KBH says the problems have been exaggerated. Though the firm has settled two homeowner suits and faces several others, the publicity doesn’t appear to have affected sales this spring.

Perhaps the most interesting long-term plus for KBH is the weakened state of some of its competitors. Banks and savings and loans have gotten increasingly stingy with financing, threatening many small builders. KBH, thanks to its big capital base and huge raw land holdings, doesn’t have financing problems, Dobi said. Over the next few years, “the largest builders are going to have a competitive advantage over most other builders,” he said.

The key question investors should ask: Even if KBH is cheap at $13.625, will it go lower before it goes higher? Lawrence Horan, analyst at Prudential-Bache Securities, thinks that there’s risk that California’s housing market may yet slump badly. KBH could fall as low as $8 a share in a tough market, Horan said.

So if you’re a short-term trader, KBH may be high risk. But long term, many analysts see it as a spectacular--and proven--way to play California’s continuing population boom.

K&B;’s SELLOFF

Investors have pushed Kaufman & Broad stock down sharply since autumn. April 12 close!: $13.625

Going Global: Capital Research & Management, the Los Angeles money management giant whose low-key image belies its $40-billion-asset financial muscle, is bringing an interesting new mutual fund to market. The planned Smallcap World Fund will invest in stocks of young companies worldwide.

The fund is yet another sign of many professional investors’ belief that smaller stocks will outperform big stocks in the 1990s, after lagging for most of the 1980s. Capital Research is taking the concept a step further by targeting small stocks around the world rather than just in the United States. The fund expects to split its assets 50-50 between U.S. and foreign small stocks.

Small stocks are inherently riskier than blue chip stocks, of course, but Capital Research has two strong selling points: Its American Funds Group stock funds have excellent long-term records, and the firm has long had research analysts based in key overseas cities, including Geneva, Tokyo and Singapore.

Smallcap World Fund shares will be priced at $16 a piece in the offering, and the minimum investment is 200 shares, or $3,200. The sales charge is 5.75%, and you can buy the fund only through a broker. The offering will close on April 27; after that, the fund, though open-ended, won’t sell shares again before Jan. 1.

Briefly: Household International, the financial services company, confirmed that it was the seller of a 300,000-share block of Vons Cos. last Thursday. The trade pushed the stock down $1.25 to $21.25 for the day. The rumored buyer: the Bass Group, which already has about 9% of the supermarket chain and has indicated it wants more . . . Despite the plunge in oil prices last week, investors in oil stocks seemed reluctant to sell much, bolstering some analysts’ view that the smart money still sees oil as a great long-term play. The stocks got hit Wednesday, but stabilized Thursday. Chevron rebounded 87.5 cents to $66.75, ARCO added 37.5 cents to $113.25 and Unocal inched up 12.5 cents to $29.875.

K&B;’s SELLOFF

Investors have pushed Kaufman & Broad stock down sharply since autumn. April 12 close: $13.625