Should I Buy PulteGroup? 3 Pros, 3 Cons

by Tom Taulli | July 15, 2013 10:25 am

Back in late 2011, homebuilder PulteGroup (PHM[1]) reached a lowly $5 a share — but while things looked bleak at the time, that thankfully turned out to be a bottom for the stock. Since then, PHM has staged a nice run, reaching roughly five times that a couple months ago.

Naturally, PulteGroupe isn’t the only homebuilder to benefit from the improved real estate market. Operators like KB Home (KBH[2]) and Hovnanian Enterprises (HOV[3]) have seen sizable gains, plus we’ve seen several IPOs in the sector[4], such as Taylor Morrison Home (TMHC[5]) and William Lyon Homes (WLH[6]).

But should you buy PulteGroup … or has Wall Street become too optimistic and valuations too extreme? To see, let’s take a look at the company’s pros and cons.

Pros

Multi-Brand Strategy: PHM has three different brands that cater to different market segments. They include the following:

Positive Trends: In May, annual new-home sales reached 476,000, the highest point since July 2008. Existing home prices have also been climbing. According to the S&P/Case-Shiller Home Price Index, the 20 top U.S. metropolitan areas posted a 12.1% year-over-year increase in April; that improvement got its start back in the beginning of 2012, and it looks like the momentum should continue. Perhaps the biggest factor is that the supply of new homes is fairly low — after all, the overall construction activity fell by about 80% from 2005 to 2011. But there are other drivers, like an increasing number of family households — which have come up nearly 4 million in the past two years.

Financial Discipline: Because of the real estate depression, PHM had no choice but to undergo an extreme restructuring. This has meant finding efficiencies with raw materials, labor and marketing expenditures. But there also has been a focus on increasing inventory turns, as well as allocating capital to the projects with the highest returns. All in all, the efforts have paid off, increasing gross margins from 18.7% to 22.9% in the past year. Of course, it certainly helps that PHM’s business has been growing at a rapid clip — in Q1, home sale revenues spiked by 35% to $1.1 billion and net income went from a loss of 3 cents per share to a gain of 21 cents a share (on a year-over-year basis).

Cons

Interest Rates: During the past month, the rate on a 30-year mortgage increased by 1 percentage point to 4.51%. While this still is a low level — by historical standards — the jump could push some buyers out of the market. True, this week, Federal Reserve Chairman Ben Bernanke indicated that easy monetary policy would continue, which sparked a nice rally in stocks. But interest rates fell only moderately.

Valuation: Shares of PHM are not cheap, trading at a hefty 27 times earnings — and without a dividend to fall back on.

Land Acquisition: This is critical for a homebuilder’s success, and PHM faces a highly competitive market right now. A variety of funds, backed by private equity operators like the Blackstone Group (BX[7]), have been buying up properties and renting them out. The result has been a boost in prices, which could make it difficult for homebuilders to purchase land at affordable prices and would put pressure on margins.

Verdict

PHM has a solid track record of dealing with all types of markets. During its 63-year history, the company has delivered more than 600,000 homes. Along the way, the company has diversified its platform, which now caters to several categories of buyers — a huge advantage amid the volatility of the real estate market.

Now, even with the jump in interest rates, it still looks like the real estate market will continue to benefit from the growth in family formation, as well as the overall improvement in the economy.

So, should you buy PulteGroup? Yes — for now, the pros outweigh the cons.

Tom Taulli runs the InvestorPlace blog IPO Playbook[8]. He is also the author of High-Profit IPO Strategies[9]All About Commodities[10] and All About Short Selling[11]. Follow him on Twitter at @ttaulli[12]. As of this writing, he did not hold a position in any of the aforementioned securities.

Endnotes:
  1. PHM: http://studio-5.financialcontent.com/investplace/quote?Symbol=PHM
  2. KBH: http://studio-5.financialcontent.com/investplace/quote?Symbol=KBH
  3. HOV: http://studio-5.financialcontent.com/investplace/quote?Symbol=HOV
  4. we’ve seen several IPOs in the sector: http://investorplace.com/ipo-playbook/2013-homebuilder-ipo-craze-continues-with-new-home-company/
  5. TMHC: http://studio-5.financialcontent.com/investplace/quote?Symbol=TMHC
  6. WLH: http://studio-5.financialcontent.com/investplace/quote?Symbol=WLH
  7. BX: http://studio-5.financialcontent.com/investplace/quote?Symbol=BX
  8. IPO Playbook: http://investorplace.com/ipo-playbook/
  9. High-Profit IPO Strategies: http://goo.gl/TXQsz
  10. All About Commodities: http://goo.gl/FfP8R
  11. All About Short Selling: http://goo.gl/t5Jzb
  12. @ttaulli: https://twitter.com/ttaulli

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