The following analysis on KB Homes is from the latest issue of my Short Seller’s Journal. You learn more about this newsletter here: Short Seller’s Journal information.

KBH’s FY Q3 ended August 31st, which means the numbers captured the trend in new home sales over the summer (June, July, August) based on contracts signed in the late spring through mid-summer. I have argued that the housing market hit a wall in July/August and KBH’s results support this claim.

Revenues fell 13.6% YoY and 10% from its FY Q2. Operating income was destroyed, down 45% YoY, with net income down 41% YoY. Net income benefited from a jump in equity income from unconsolidated joint ventures and a big drop in the GAAP income tax, both non-cash and both non-factors in the cash profitability of KBH. Interestingly, the culprit that torpedoed KBH’s numbers was price cutting. Deliveries were down 7% YoY and 8% from Q2. But the average selling price was cut 8.3%.

While both factors affect profitability, cutting prices while costs continue rising hammer margins. KBH’s operating margin fell to 11% from 17% YoY. While new orders rose and the value of new orders, the value of the backlog was hammered 35.4% YoY and 20.3% QoQ. With respect to the new orders, I expect that the cancellation rate cited by Redfin that I referenced above will erase a material percentage of those new orders.

The Company has not released a 10-Q yet so I can’t look at the cash economics of the quarter (cash from operations). The Company pegged its full-year guidance at the high end of the guidance given at the end of Q2 ($6.31 billion in revenues for the full year). We’ll see about that.

Despite the revenue and net income “beat” plus management’s attempt to put lipstick on the pig with positive guidance and a reference to the share buyback program, the stock was drilled for 5%. It affected all of the homebuilders as well. The stock is breaking down quickly:

The stock has dropped below all of the key moving averages except the 200 dma, which was at $43 on Friday. Once it falls below the 200 dma, the real fun will begin. It will also mean that investors are finally accepting the fact that the new home sales market is heading south. Think about this: absent the aggressive price cutting in Q3, deliveries and new orders would have been a disaster. As it is, the price cuts likely pulled forward a material amount of new orders into the quarter, a portion of which will cancel.

The stock is technically oversold using the RSI and MACD. If the 10yr yield falls over the next couple of weeks, it might stimulate homebuilder buying by hedge fund algos. But liquidity continues to drain from the banking system while the Fed postures to keep rates higher than expected for longer than expected. One more thing. At some point there will be big inventory write-downs. KBH has already slashed prices for four quarters consecutively In Q3 prices were cut 8% YoY and 4% from Q2. It will have to continue slashing prices, particularly as unsold homes from canceled contracts become spec homes that just sit collecting cobwebs.