Cleveland Research Company Stock Pitch 2016 - Finalist

KB Home
“Uniquely Yours”
Reid Rupp | Ethan Retcher | Sean Hynes | Max Lewis
Cleveland Research Company – 2016 Stock

Executive Summary
Industry and Company Overview
Valuation
Final Thoughts
4
6
12
19
Appendix 21

Summary | Overview | Valuation | Final Thoughts |
Appendix
4
 KB Home (KBH) is a moderately-priced home-building company with
highly-customizable options that primarily targets first-time home-owners
 With mortgages nearing their lowest rates in 30 years and
unemployment decreasing with stagnant wage growth, more people will
be buying their first homes
 KB Home is focused in southern California, but has expanding revenues
across the country
 We recommend KB Home as a BUY with a 12-month price target of
$28.11, which represents an upside of 96.16% over the current price of
$14.33
Executive Summary

6
Highlights
 Housing supply is nearing a decade low
 Houses need to be built
 Constant job growth, not wage growth
 People buying first-time homes
 U.S. Mortgage Rates nearing an all-time low
incentivize home building and purchasing
 Retail Fixed Investment (housing) is on an upward
trend of faster growth than GDP
RFI to real GDP growth
30-Year Mortgage Interest
Rate
Housing Supply (for sale/sold)
Industry Overview
3.00%
3.50%
4.00%
4.50%
5.00%
5.50%
6.00%
6.50%
7.00%
Jan-03
Nov-03
Sep-04
Jul-05
May-06
Mar-07
Jan-08
Nov-08
Sep-09
Jul-10
May-11
Mar-12
Jan-13
Nov-13
Sep-14
Jul-15
3.5
4.5
5.5
6.5
7.5
8.5
9.5
10.5
11.5
12.5
Mar-06
Nov-06
Jul-07
Mar-08
Nov-08
Jul-09
Mar-10
Nov-10
Jul-11
Mar-12
Nov-12
Jul-13
Mar-14
Nov-14
Jul-15
Mar-16
-2.00%
-1.50%
-1.00%
-0.50%
0.00%
0.50%
1.00%
1.50%
201220082004
Appendix

7
Description & Operations
 Headquartered in Los Angeles, CA
 Operates in seven states and DC
 Builds customizable single family-homes,
townhouses, and condominiums geared
towards first-time home owners
Operating States Housing Market Segments
First-Time
Move-Up
Active
Adult
Quick Hits
 Founded in 1957
 More than 550,000 houses built
 Reduces risk of oversupply by pre-selling
homes
 Other (smaller) revenue streams include
insurance and financial services
Company Overview
Appendix

Historic Price Chart
$0.00
$20.00
$40.00
$60.00
$80.00
$100.00
$120.00
$140.00
1/2/03
1/2/04
1/2/05
1/2/06
1/2/07
1/2/08
1/2/09
1/2/10
1/2/11
1/2/12
1/2/13
1/2/14
1/2/15
1/2/16
8
Key Statistics
 All-Time High: $126.24
 Has not recovered from pre-housing
crisis price
 Stock price is up 17.52% from beginning of
the year
 21.43% higher EPS in Q1 than were
projected
 -17.74% Off 52-week high
0
5
10
15
20
25
0
5
10
15
20
4/9/2015 7/9/2015 10/9/2015 1/9/2016
Millions
StockPrice
52-Week Trading Ranges
Company Overview
Appendix
Management
 Stability at the top: Average tenure of senior
corporate officers is 14 years
 President & CEO, Jeffery Megzer has spent
his career in the home-building industry
 Chairman of Board of Directors, Stephen
Bollenbach, has decades of experience at
multiple companies including President of
Hilton Hotels and VP of the Walt Disney
Company

M&A Takeover Candidate
 Being a moderately-sized company (market-
cap of $1.5B) with fast-growing net income
and EPS in an industry with growth potential
makes KBH an attractive takeover candidate
 Potential M&A candidate is PulteGroup
(PHM)
 PHM needs more California exposure
and price diversification
 KPMG found the biggest drivers for
M&A in 2016 will include expanding
customer base and expanding
geographic reach
 M&A Market is set to continue the trend of
record-high activity in consumer sector
 Biggest deals this year have been
consumer companies (i.e. Anhueser-
Busch InBev SA/SAB Miller Plc)
 Still set-up to succeed if it remains
independent—all calculations and
projections are based on KB Home
remaining independent
Q1 Highlights
Current Events
 53% increase in Q1 net income
 All 4 regions experienced double-digit %
increases in deliveries
 Repurchased 9% of shares outstanding to
increase book value of stock by 5.49%
 Trading at an extreme discount for P/E
(15.1) compared to industry average (26.93)
 Capitalizing on low input prices as crude oil’s
continued struggle lowers steel prices
 Continues to expand in areas of lowest %
Revenue—recently finished construction of a
community near Orlando, FL
 6 new communities planned to open in Q2
 Energy efficiency is becoming more highly-
valued across the nation
Drivers and Growth
Potential
Appendix
9

10
Energy Efficiency Rating
 KB Homes are 40% more efficient than the
typical new home, and 70% more efficient
than a typical resale home
 KB Home has consistently been lowering its
HERS score since 2007. As this trend
continues KB Homes will be more and more
energy cost efficient
 Received 6th straight ENERGY STAR
Partner of the Year—Sustained Excellence
awardBuilt To Order
 KB Home has 26 design studios in the
markets in which they serve
 These studios are key to the distinct home
buying experience
 This studio personalization allows customers
to design the home that they want
 KB Home has streamline production and
delivers 100% complete and on time
0 50 100 150
Average KB home
Typical New Home
Typical Resale
HERS Index
50
70
90
200720082009201020112012201320142015
KB Home's National
Average HERS
Differentiating
Factors
Appendix

12
Drivers Historical and Projected EPS
Earnings Consensus vs. Actual Earnings
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
35.00%
-$3.00
-$2.50
-$2.00
-$1.50
-$1.00
-$0.50
$0.00
$0.50
$1.00
$1.50
$2.00
2010 2011 2012 2013 2014 2015 2016 2017 2018
EPSYOYGrowthRate
EPS
 5 years of underachieving earnings, but
growth is now headed in the right direction
with a 17% growth in YOY revenue in Q1
 2015 beat estimates from an increase of
demand of lower entry housing, which is a
trend set to continue in 2016
 Energy efficient investments starting to pay
back from initial capital expenditures
 Increased corporate buybacks
 Continued growth in established
communities
-$2.50
-$2.00
-$1.50
-$1.00
-$0.50
$0.00
$0.50
$1.00
$1.50
2010 2011 2012 2013 2014 2015
EPS
EPS Estimated EPS
Earnings Overview
Appendix

Natural Deleveraging
 Recovering from debt taken on during the
recession
 Mature communities growth is paying down
debt
Debt Metrics
Continued Increase in Profit Margins Margin & Growth Rate
50.00%
55.00%
60.00%
65.00%
70.00%
75.00%
80.00%
85.00%
0.10x
0.12x
0.14x
0.16x
0.18x
0.20x
0.22x
2014 2015 2016
Debt/Capital
TotalDebt/EBITDA
-180.00%
-80.00%
20.00%
120.00%
220.00%
320.00%
420.00%
520.00%
620.00%
-20.00%
-15.00%
-10.00%
-5.00%
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
2010 2011 2012 2013 2014 2015 2016 2017 2018
Profit Margin Profit Margin Growth Rate
 After having begun recovery from the 2008
housing crisis, the profit margin has grown
and is projected to continue this growth into
the future
Deleveraging and Margin
Analysis
Appendix
13

 Increasing cost of land
 Labor Shortages
 Increased scrutiny of mortgages
since post recession
 Uncertainty in global economic
outlook
 Highly-levered company,
increased risk (exemplified by
high WACC)
 General volatility of the housing
market
 D
 d
 Low priced entry level housing
 Industry leader in energy efficient homes
 Building in high growth states
 Offers wide variety of housing options
 Decreasing inventory of houses on
the market
 Increasing housing prices
 Historical low mortgage rates
WS
TO
Positioning Analysis
Appendix
14

Decrease in cost to buildDecreasing Incremental Cost
Decrease in time of production
 A major step for KB Homes has been
lowering the additional costs associated with
making a more energy efficient home
 From their first net-zero energy home
to their most recent, incremental cost
to build has been reduced by 50%
 MAKE THESE LEFT CHARTS BAR
CHARTS WITH AN ARROW
POINTING DOWN
Decreasing Incremental Time
 Another incremental cost of a more eco-
friendly home is an increased length of the
production schedule.
 From their first net-zero energy home
to their most recent, the time of
production for a more energy efficient
home has been reduced by 70%
Maintaining Affordability and
Ease
Appendix
15
Old New
New
Old

Comparable
Companies
Name Ticker
Share
Price
% of 52
Week
High Market
Cap.
Enterpris
e
Value
EBITDA
(TTM)
Revenue
(TTM) P/E P/B
EV/EBITD
A PEG
EPS
(TTM)
Estimated
EPS
Forward
PE
Profit
Margin
NVR, Inc. NVR 1717.56 98.68% 6,821 6,932.1 647.7 5,159.0 19.3x 5.5x 10.7x 0.48 88.26 110.79 15.7x 20.30%
Pulte Group, Inc. PHM 17.21 95.03% 6,166 7,820.3 879.6 5,982.0 13.0x 1.3x 8.8x 3.50 0.57 0.20 11.4x 11.32%
Toll Brothers Inc. TOL 28.80 97.36% 4,843 7,750.3 467.5 4,246.4 14.0x 1.2x 16.9x 0.95 0.41 0.46 10.7x 22.10%
CalAtlantic Group, Inc. CAA 33.05 96.52% 4,121 7,725.4 442.1 3,538.1 13.0x 1.1x 17.4x -14.40 1.04 0.50 9.4x 24.20%
TRI Pointe Group, Inc. TPH 11.47 72.01% 1,888 2,865.7 323.5 2,400.6 9.1x 1.1x 8.9x 0.11 1.28 1.23 9.7x 23.10%
Taylor Morrison Home
Corporation TMHC 14.05 69.05% 1,775 4,601.4 278.1 2,976.8 26.4x 0.0x 16.6x -0.42 0.16 0.23 9.2x 19.10%
Meritage Homes Corporation MTH 35.82 76.45% 1,532 2,397.8 221 2,592.6 12.3x 1.2x 10.8x -1.04 3.09 3.63 10.5x 19.60%
MDC Holdings Inc. MDC 24.40 96.33% 1,225 1,753.5 102.9 1,909.0 17.7x 1.0x 17.0x -1.97 1.41 2.08 12.0x 17.20%
Cavco Industries, Inc. CVCO 88.26 82.83% 771 731.5 48.5 676.3 29.0x 2.3x 15.4x 0.94 3.04 3.13 28.2x 20.50%
KB Home KBH 14.45 97.50% 1,219 3,548.6 154.6 3,130.3 15.1x 0.8x 22.7x 1.20 0.88 1.32 10.9x 16.60%
1st
Quartile 14.25 75.34% 1,223 2,236.7 141.7 2,277.7 12.8x 0.9x 10.2x -1.27 0.53 0.40 9.6x 17.05%
Median 24.40 95.68% 1,831 4,075.0 300.8 3,053.6 14.6x 1.2x 16.0x 0.29 1.16 1.28 10.8x 19.95%
Mean 29.72 88.18% 3,036 4,612.7 356.6 3,261.1 16.9x 1.5x 14.5x -1.07 10.01 12.36 12.8x 19.40%
3rd
Quartile 34.44 97.40% 5,174
7,731.6
512.6 4,474.6 21.0x 1.5x 17.1x 1.01 3.05 3.26 12.9x 22.35%
Appendix
16

Revenue Projections WACC Calculation
0
100,000
200,000
300,000
400,000
500,000
600,000
700,000
800,000
900,000
2016E 2017E 2018E 2019E 2020E
Projected Unlevered Cash Flow
Present Value Discounted W/ WACC
WACC Analysis
Book Value of Debt:
$
3,549,836
Market Value o fEquity:
$
2,338,746
Total Capital:
$
5,888,582
Beta: 2.15
Market Risk Premium: 5.98%
Risk Fre Rate 1.72%
Cost of Equity 14.57%
Cost of Debt 12.00%
WACC 10.49%
Future Revenue
Appendix
17

 It is expected that millenials want to rent rather than own—BofA study
results show otherwise
 The Street is starting to catch onto the trend, but too slowly
 Barclays raised target price by 20%
 RBC raised target price by 7%
 Our research and analysis of KB Home leads us to believe there is
higher upside opportunity here than Barclays and RBC believe
Beating Street
Consensus
Appendix
19

 With their recent growth and continued recovery from the 2008
recession and housing crash, KB Home has an immense upside and is
primed for growth
 With their modest-pricing combined with their emphasis on eco-friendly
housing, we believe that KB Home is extremely attractive to the modern
first-time home-buyer
 Their continued focus on geographical revenue expansion shows
ambition toward future growth endeavors
 We recommend KB Home as a BUY with a 12-month price target of
$28.11, which represents an upside of 96.16% over the current price of
$14.33
Final Thoughts
Appendix
19

Pro Forma Income
Statement
Appendix
Income Statement
(In thousands, except per share amount)
Historical Projected
Fiscal Year Ended November 30, 2011 2012 2013 2014 2015 2016E 2017E 2018E 2019E 2020E
Total revenues $1,315,866 $1,560,115 $2,097,130 $2,400,949 $3,032,030 $3,637,390 $4,216,809 $4,804,959 $5,379,682 $5,916,080
Homebuilding:
Revenues 1,305,562 1,548,432 2,084,978 2,389,643 3,020,987 3,625,184 4,205,214 4,793,944 5,369,217 5,906,139
Construction and land costs 1,157,280 1,332,045 1,737,086 1,985,651 2,539,368 3,008,903 3,490,328 3,978,973 4,456,450 4,902,095
Selling, general and administrative expenses 220,591 236,643 255,808 288,023 342,998 435,022 504,626 575,273 644,306 708,737
Operating income ($103,074) ($20,256) $92,084 $115,969 $138,621 $181,259 $210,261 $239,697 $268,461 $295,307
Interest income 871 518 792 443 458 458 458 458 458 458
Interest expense 49,204 69,804 62,690 30,750 21,856 21,856 21,856 21,856 21,856 21,856
Equity in income (loss) of unconsolidated joint
ventures (55,839) (394) (2,007) 741 (1,804) (1,804) (1,804) (1,804) (1,804) (1,804)
Homebuilding pretax income ($207,246) ($89,936) $28,179 $86,403 $115,419 $158,057 $187,059 $216,495 $245,259 $272,105
Financial services:
Revenues 10,304 11,683 12,152 11,306 11,043 12,205 11,595 11,015 10,464 9,941
Expenses (3,512) (2,991) (3,042) (3,446) (3,711) (3,487) (3,313) (3,147) (2,990) (2,840)
Equity in income of unconsolidated joint ventures 19,286 2,191 1,074 686 4,292 2,325 2,209 2,098 1,993 1,894
Financial services pretax income $26,078 $10,883 $10,184 $8,546 $11,624 $11,043 $10,491 $9,966 $9,468 $8,994
Total pretax income (181,168) (79,053) 38,363 94,949 127,043 169,100 197,549 226,461 254,727 281,099
Income tax benefit (expense) 2,400 20,100 1,600 823,400 (42,400) (55,803) (65,191) (74,732) (84,060) (92,763)
Net income ($178,768) ($58,953) $39,963 $918,349 $84,643 $113,297 $132,358 $151,729 $170,667 $188,337
21

Pro Forma Balance Sheet
Appendix
Balance Sheet
Assets
Cash and cash equivalents $415,050 $524,765 $530,095 $356,366 $559,042 $598,175 $640,047 $684,850 $732,790 $784,085
Restricted cash 64,481 42,362 41,906 27,235 9,344 0 0 0 0 0
Receivables 66,179 64,821 75,749 125,488 152,682 182,665 212,343 241,960 270,901 297,098
Inventories 1,731,629 1,706,571 2,298,577 3,218,387 3,313,747 4,110,523 4,781,271 5,450,648 6,104,726 6,696,851
Investments in unconsolidated joint ventures 127,926 123,674 130,192 79,441 71,558 71,558 71,558 71,558 71,558 71,558
Deferred tax assets, net 0 0 0 825,232 782,196 732,196 682,196 632,196 582,196 532,196
Financial services assets 32,173 4,455 10,486 10,486 14,028 11,595 11,015 10,464 9,941 9,444
Other assets 75,104 95,050 107,076 114,915 112,774 181,869 210,840 240,248 268,984 295,804
Total Assets $2,512,542 $2,561,698 $3,194,081 $4,757,550 $5,015,371 $5,888,582 $6,609,271 $7,331,926 $8,041,097 $8,687,037
Liabilities & shareholders' equity
Accounts payable $104,414 $118,544 $148,212 172,716 183,770 $246,631 $286,876 $327,039 366,284 401,811
Accrued expenses and other liabilities 374,406 340,345 356,176 409,882 513,414 623,841 723,026 823,698 922,070 1,013,884
Notes payable 1,583,571 1,722,815 2,150,498 2,576,525 2,625,536 2,678,047 2,731,608 2,786,240 2,841,965 2,898,804
Financial services Liabilities 0 0 2,593 2,517 1,817 1,317 817 317 0 0
Total liabilities $2,062,391 $2,181,704 $2,657,479 $3,161,640 $3,324,537 $3,549,836 $3,742,327 $3,937,294 $4,130,318 $4,314,499
Preferred stock: $1.00 par value $0 $0 $0 $0 $0 $0 $0 $0 $0 $0
Common stock: $1.00 par value 115,171 115,178 115,296 115,387 115,548 115,548 115,548 115,548 115,548 115,548
Additional paid-in capital 884,190 888,579 788,893 668,857 682,871 682,871 682,871 682,871 682,871 682,871
Retained earnings 519,844 450,292 481,889 1,391,256 1,466,713 2,113,125 2,639,823 3,166,011 3,681,518 4,139,917
Grantor stock ownership trust (118,059) (115,149) (113,911) (112,106) (109,936) (108,436) (106,936) (105,436) (103,936) (102,436)
Treasury shares, at cost (932,337) (934,136) (718,565) (446,476) (447,043) (447,043) (447,043) (447,043) (447,043) (447,043)
Accumulated other comprehensive net income (loss) (18,658) (24,770) (17,000) (21,008) (17,319) (17,319) (17,319) (17,319) (17,319) (17,319)
Total Stockholders' equity 450,151 379,994 536,602 1,595,910 1,690,834 2338746 2866944 3394632 3911639 4371538
Total liabilities and stockholders' equity $2,512,542 $2,561,698 $3,194,081 $4,757,550 $5,015,371 $5,888,582 $6,609,271 $7,331,926 $8,041,957 $8,686,037
22

Pro Forma Statement of
Cash Flows
Appendix
Statement of Cash Flows
Cash flows from operating activities:
Net income (loss) ($178,768) ($58,953) $39,963 $918,349 $84,643 $113,297 $132,358 $151,729 $170,667 $188,337
Adjustments to reconcile net income (loss) to net cash provided by (used in)
operating actitivites:
Equity in (income) loss/(gain) on wind down of unconsolidated joint ventures 36,553 -1,797 933 -1,427 -2,488 -2,488 -2,488 -2,488 -2,488 -2,488
Distributions of earnings from unconsolidated joint ventures 8,703 3,316 1949 364 0 0 0 0 0 0
Amortization of discounts and issuance costs 2,150 3,016 5347 7,124 7,738 7,931 9,265 10,621 11,947 13,184
Depreciation and amortization 2,031 1,622 1857 2,420 3,411 4,532 5,294 6,069 6,827 7,533
Deferred income taxes -3,612 1,152 0 -825,232 43,036 43,036 43,036 43,036 43,036 43,036
Loss on early extinguishment of debt 0 10,278 10448 0 0 0 0 0 0 0
Stock-based compensation 8,054 6,713 5699 9,099 17,143 22,999 26,869 30,801 34,645 38,232
Inventory impairments and land option contract abandonments 25,791 28,533 3581 39,431 9,591 9,591 9,591 9,591 9,591 9,591
Changes in assets and liabilities:
Receivables -2,220 24,994 -11153 -31,283 -20,463 -20,463 -20,463 -20,463 -20,463 -20,463
Inventories -12,345 30,347 -563189 -780,131 34,852 34,852 34,852 34,852 34,852 34,852
Accounts payable, accrued expenses and other liabilities -253,547 -2,143 59763 35,504 1,991 1,991 1,991 1,991 1,991 1,991
Other, net -2,275 -12,461 1316 -4,909 1,888 1,888 1,888 1,888 1,888 1,888
Net cash provided by (used in) operating activities ($347,545) $34,617 ($443,486) ($630,691) $181,185 $217,166 $242,193 $267,627 $292,493 $315,693
23

Discounted Cash Flows
Projected
Discounted Cash Flow 2016E 2017E 2018E 2019E 2020E
Years 1.0 2.0 3.0 4.0 5.0
Revenue 3,637,390 4,216,809 4,804,959 5,379,682 5,916,080
Less: Operating Expenses 3,456,130 4,006,548 4,565,262 5,111,221 5,620,773
Operating Income 181,259 210,261 239,697 268,461 295,307
Taxes @ 35% 63,441 73,591 83,894 93,961 103,357
Tax Effected EBIT 117,818 136,669 155,803 174,500 191,950
Plus: Depreciation 4,532 5,294 6,069 6,827 7,533
Change in working capital 647,912 528,198 527,687 516,147 461,760
Less: Capital Expenditures (5,100) (7,140) (9,996) (13,994) (19,592)
Unlevered Free Cash Flow 765,163 663,022 679,564 683,479 641,651
Present Value at a Discount 10.49% 692,517 543,102 503,804 458,599 389,658
Present Value of a Projection Period 2,587,680
WACC Analysis Target Price 28.11
Book Value of Debt: $ 3,549,836
Market Value o fEquity: $ 2,338,746
Total Capital: $ 5,888,582
Beta: 2.15
Market Risk Premium: 5.98%
Risk Fre Rate 1.72%
Cost of Equity 14.57%
Cost of Debt 12.00%
WACC 10.49%
Appendix
24

Cleveland Research Company Stock Pitch 2016 - Finalist

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