In anticipation of next week's fiscal second-quarter earnings releases from KB Home and Lennar Corporation, J.P. Morgan's lead home building analyst has dropped his earnings estimates for both.

Michael Rehaut put out research notes this morning (June 21) dropping 2nd-QTR earnings estimates on KB to a loss of $0.10 per share from a gain of $0.47 and on Lennar to a loss of $0.15 per share from a gain of $0.15. In KB's case, Rehaut is projecting $50 million in land charges, as well as lower gross margins, a drop of 20% in orders and a 24% drop in closings. For Lennar, Rehaut sees $60 million in land-related charges as well as lower margins, a drop of 30% in orders and a drop of 30% falloff in closings.

Rehaut also took down his estimates for the fiscal year, dropping them below the consensus estimates on Wall Street. On KB, he wrote, "Our lowered FY07E to $1.10 from $2.65 (Street: $1.66), is driven by our outlook for $92 million more of land charges, or $0.74/share. We are also lowering our core gross margins (ex-charges) estimate by 80 bps to 17.2%." On Lennar, he said, "Our lowered FY07E to $0.80 from $1.80 (Street: $1.33), is driven by our outlook for $120 million more of land charges, or $0.48/share. We are also lowering our core (ex-charges) gross margins estimate by 110 bps to 15.5%."

On a brighter note, Rehaut reported that the building research team at J.P.Morgan had discerned some moderation in the growth of inventories, which now sits at about 50% of last year's pace. "This, combined with the 20-30% YOY declines in starts and permits, as well as continued aggressive spec reduction efforts by the builders, drives our view that a major incremental rise in supply is unlikely. Moreover, while premature to call a trend, in our view, we note that growth in several key markets ­ Orlando, Tampa, Phoenix, Las Vegas, and Sacramento ­ continued to moderate so far in June, while Edison, Philly, and Riverside started to moderate slightly."

Rehaut also projected that while some builders will fall below the 2.0x debt ratio, they should be able to negotiate "breathing room" with lenders.He estimates that the average for the public builder group will hold at 2.5x through 2008 and that builders should be able to produce strong cash flow as they hold back on new projects and work through existing inventory.

"While a positive catalyst is not likely to emerge over the next 2-3 months, we believe the stocks, at 1.0x P/B, largely reflect the current negative trends, as well as anticipate an incremental 10% hit to equity from land charges, and thus downside is relatively limited, in our view" Rehaut wrote in the note on leveage. "Moreover, given our outlook for fundamentals to begin stabilizing over the next 2-4 quarters, we believe the risk/reward over this period is compelling, and recommend investors opportunistically begin building positions."