PulteGroup: Strong Q1 And Excellent Balance Sheet Make Shares Attractive

seekingalpha04-30

PulteGroup has been a strong performer, gaining over 75% in the past year, aided by strong quarterly results.The company's Q1 earnings beat expectations, with revenue rising by 10% and homebuilding ...

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In September, I rated PHM a buy, and since that recommendation, shares have returned nearly 50%, far outpacing the S&P 500’s 15% return. With shares near my $115-120 target, now is an opportune time to revisit shares. I remain bullish.   Seeking AlphaIn the company’s first quarter, Pulte earned $3.10, blowing past consensus by $0.74 as revenue rose by 10% to $3.95 billion. This was a strong quarter across the board as closings rose by 11% to 7,095. The average selling price was down by 1% to $538k. This was largely due to mix shift as the higher-priced Northeast had a smaller share of sales. Even with a lower sales price, homebuilding gross margins rose by 50bps to 29.6%, aided by geographic mix as the Southeast and Florida are higher margin given Pulte’s large scale there. Alongside this gross margin gain, SG&A expense was 9.4% of revenue, down 20bp from last year, aided by operating leverage and a $27 million insurance benefit. This combination of strong cost discipline and higher revenues drove the earnings beat and the meaningful YoY growth in results. EPS was also aided by the fact that the company’s share count was down 5.5% from last year. During the quarter, Pulte bought back $246 million of stock. This largely tracked free cash flow, which was $216 million in Q1. I would note that included $465 million of working capital headwinds, so PHM generated $681 million of pro forma free cash flow. As a result, I expect share repurchases to accelerate somewhat from their Q1 pace. PHM generated this free cash flow even while investing prudently in the business. Management made $1.1 billion of land investment in Q1, primarily by developing lots. This is up from $900 million last year. There is $5 billion in land investment planned this year, so Q1 was broadly on track with this goal. 51% of its land is held via option, with a target of getting this to 70%. This strategy reduces the capital intensity of its land holdings and allows Pulte to walk away from lots that prove uneconomic. Importantly, PHM is seeing strength in demand, which is why the company is making incremental investments. During Q1, net orders rose 14% to 8,379. This growth was due to both higher gross orders and a drop in cancelations to 10% from 13%, both of which are healthy signs. As a result, its backlog is up to 13,430, up 2% from last year. Pulte is one of the few homebuilders with a larger backlog today than last year, as much of the industry worked down backlogs when buyer demand softened last year. Its backlog now is worth $8.3 billion, up about 3% from last year, and this provides about 6 months of revenue visibility even if the company were to see no net orders. I was glad to see that every region PHM operates in saw orders increase from a year ago, pointing to the true breadth of demand. In Q1, Southeast closings rose by 25% to 1,445 while Florida rose by 9% to 1,917. The South and FL together are nearly half of the business. Texas was up just about 1.5% while the Northeast, its smallest region, fell by 15% to 285k. This was the one blemish in the quarter, but it was mostly a timing issue as Northeast orders were particularly strong at 441k vs 385k last year. This strong order performance makes me feel comfortable that soft NE closings were a timing, not a demand problem. Management was seeing stronger demand in Q4, and so Pulte held firm on pricing, resulting in more Q1 sales at higher prices and margins to shareholders’ benefits. Beyond strength late last year, demand increased throughout this quarter. As a result, PHM increased guidance for gross margins to be ~29.2% from 28-28.5%, and it now expects about 31,000 closing, up 8% from last year. Management upped its forecast, even as the company had mixed things to say about April. Sales momentum has increased in April, though rates are slowing traffic. The effect has been “modest,” but buyers are evaluating “timing” of their purchase. As you can see below, interest rates on mortgages have been inching back up above 7%, which is a pressure on affordability. There were likely some prospective buyers hoping rates would fall who had been delaying a purchase and are now confronting a difficult decision. Ultimately, I believe high rates are more likely to slow demand growth rather than cut demand outright. As explained in my prior write-up, due to chronic underbuilding, the US housing market has significant supply shortages, which creates a favorable net demand environment for builders.   St, Louis Federal ReserveThat said, with demand having picked up during Q1, we have seen builders, not just Pulte, increase investment activity. In Q1, real residential investment grew by nearly 14%, according to last week’s GDP report. This will alleviate some supply tightness, but the level of construction remains far below post-COVID highs and is comparable to 2018-2019 levels. In other words, we are seeing supply get “less tight,” but we still appear far from any meaningful overbuilding that could cause prices to fall in a meaningful way, in my view, absent a broader recession.   St, Louis Federal ReserveImportantly, PHM is well positioned to invest modestly more in land because it has a pristine balance sheet, with $1.8 billion of cash on hand against $2 billion of debt. Its debt-to-capital position has been steadily declining, and on a net basis, it is just 1.7%. With such a flexible, pristine balance sheet, PHM can afford to invest more in land, while also having the capacity to return all of its free cash flow to shareholders via buybacks and its dividend, which was increased in Q1 by 25% to $0.20.   PulteGroupPHM is also exposed to broad swaths of the housing market, from rate-sensitive first-time buyers, where affordability can be a bigger challenge to active adults, who may be all-cash buyers. This diversity across price points and buyer background should help PHM manage through volatility.   PulteGroup During the first quarter, it paid out a 6.5% incentive rate, mainly via mortgage rate buydowns to ~5.75%. It has focused on reducing mortgage rates, rather than cutting prices. In fact, it raised prices in more than half of its communities. Its guidance assumed this level of incentives persists, though I see a risk it rises slightly in a higher-for-longer rate environment. Overall, Q1 was quite solid, and I was happy to see management raise guidance even with the rate picture deteriorating during April. Its strong backlog gives me confidence we should see at least 30,000 closings this year, though I do worry it gives a bit more on incentives if mortgages stay above 7%, which could reduce gross margins by a further ~30bp. That still implies about $13-13.5 in EPS, assuming a further ~4-5% share count reduction this year. Even after their rally, shares are just 8.6x earnings. For a builder with a flawless balance sheet, significant scale, and meaningful operations in the faster growth Sun Belt, I view this attractively. PHM has a similar multiple to KB Home (KBH). However, KB has more net debt, more aggressive growth investment, and greater exposure to rate-sensitive first-time buyers.  As such, I believe PHM is a lower-risk company than KBH, and it should manage through downturns and periods of volatility with more ease. At roughly the same multiple, I would rather own Pulte, as it offers better risk-to-return opportunity. That is why I view KBH as a “hold” and rate PHM a “buy.” I do not expect multiples to get past 10x, given fears around housing’s vulnerability to rates. Still, as results continue to come in strong, I expect shares to get towards $130, providing about 15% upside even after this large rally. Investors should continue to buy PHM.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2431381621"}