On Dec 4, we upgraded PulteGroup, Inc. (PHM) to Neutral on the back of better-than-expected third-quarter results announced on Oct 24.
Why the Downgrade?
Pulte’s third-quarter earnings of 45 cents per share surpassed the Zacks Consensus Estimate by 32.3% and grew 50% year over year driven by margin growth and pricing power. Revenues of $1.58 billion beat the Zacks Consensus Estimate and increased 21.4% year over year driven by higher pricing which made up for the order shortfall. Estimates largely moved upwards after the better-than-expected third-quarter results, encouraging us to return to a Neutral recommendation on the stock.
Overall, we appreciate Pulte’s solid long-term fundamentals, strong cash position and improving profitability. Pulte’s strategic initiatives to allocate capital more efficiently, expand margins, improve overhead leverage, increase inventory turns and implement new pricing strategies bode well for solid margin growth.
Moreover, Pulte’s margin performance has been strong. Adjusted homebuilding gross margins expanded by 300 basis points (bps)–400 bps in all the quarters of 2013, driven by improved pricing, better mix of sales (shift toward higher-margin Pulte and Del Webb brands) and efforts to reduce construction costs. Gross margins are expected to continue to improve in the next 2–3 quarters.
However, Pulte’s net orders have been weak in 2013. The company has intentionally slowed down sales pace across some of its communities (which is lowering its community count) due to lack of land development and scarcity of finished lots. Housing inventory, both existing and new homes, remain tight in most markets. Instead, the company is focusing more on driving price and margin in most communities. This strategy hurt net order growth significantly so far in 2013, with orders growing only 4% in the first quarter but declining 12% in the second and almost 17% in the third.
Moreover, the recent increase in interest/mortgage rates has generally slowed down order pace and traffic. With the recent improvement in economic conditions and the housing market in general, mortgage rates are edging upwards to more normalized levels since May. Accordingly, the sharp increase in interest rates shocked many customers and a few put off their purchase decision; thus increasing cancellation rates and lowering orders in the past 2–3 quarters.
Though Pulte’s pricing and profits are improving, the below-average order growth raises concern.
Moreover, recent increases in mortgage rates, changes in federal lending procedure and the lack of overall economic recovery could hurt the demand for new homes.
Other Stocks to Consider
Pulte carries a Zacks Rank #3 (Hold). Some better-ranked homebuilders include MRV Engenharia e Participa (MRVNY), M/I Homes, Inc. (MHO) and Meritage Homes Corporation (MTH). All the three stocks carry a Zacks Rank #2 (Buy).
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