Second quarter financials
PulteGroup, Inc. (PHM), one of the largest homebuilders in the country, reported second-quarter net income of $36 million (EPS of $0.09) after accounting for the following charges: $30 million ($0.08 per share) as a result of a contract dispute at an already completed luxury development, $23 million ($0.06 per share) because of the repurchase of $434 million of senior notes during the quarter and $13 million ($0.03 per share) because of corporate relocation. In the same quarter of the previous year, the company had reported net income of $42 million ($0.11 per share). The company's CEO, Richard J. Dugas, Jr, stated that the housing market in the United States continues to rebound strongly and there are unmistakable signs of a sustainable long-term recovery. The recent rise in interest rates have had little effect on consumers who continue to receive good value against the backdrop of limited supply and rising prices as well as high rentals.
Revenues from home sales increased by 19% to $1.2 million compared with $1 billion for the same quarter of the previous year. The increase in revenue was sustained by a 9% growth in average sales realization to $294,000 as well as a 9% increase in closing volumes to 4,152 housing units. The increased sales was made possible by an increase in prices and a shift in product mix towards more up-market houses.
The pretax income from homebuilding operations was $22 million after adjustments for exceptional items compared with $24 million in the previous year. Adjusted gross margins on home sales amounted to 23.9% an increase of 3.6% year-over-year and 1% over the preceding quarter. Selling, general and administrative expenses were $151 million (including corporate relocation expenses) compared with $124 million in the previous year. New orders for the quarter were 4,885 homes down 12% over the previous year and with the value at $1.5 billion, down 5% over the same quarter of the previous year. On a per unit basis, the backlog grew by 13% to 8,558 homes valued at $2.7 billion, compared to 7,560 homes and a value of $2.2 billion in the previous year. Financial services generated pretax income of $16 million, about the same as the previous year, benefiting from increased mortgage origination though this was offset by a small decline in mortgage capture rates.
Separately, the company announced a quarterly cash dividend of $0.05 per share as well as a share buyback authorization for an additional $250 million that would raise the total to $352 million.
Market reaction to the earnings report
After the announcement from the Department of Commerce that new home sales had grown by 35% last month, investors were expecting a good second-quarter performance from home builders. Unfortunately, the PulteGroup's earnings release showed earnings of $0.09 per share that were well below the consensus estimate of $0.30 per share and shares of home builders took a beating. In all fairness, if you adjust for the exceptional and one off items, the EPS works out to $0.25 per share. Moreover, the growth in average selling price, the number of closings and the unit backlog growth all seem to suggest that there are better days ahead. However, the good news was partly offset by the unexpected decline in net new home orders.
The growth strategy
From all indications, the housing market in the country has started to boom with home prices growing, low inventory levels and demand in excess of supply. The benefits of home ownership also now outweigh the benefits of renting. It is therefore difficult to understand why PulteGroup is cutting down on debt and returning capital at a time when it should be investing aggressively in growth to take advantage of market conditions. Rising interest rates are not holding back the recovery of the housing market and, while being conservative is to be commended in normal circumstances, the strategy of using price instead of volume for growth can sometimes be difficult to execute.
The bottom line
Though the consensus estimates of analysts for the stock target price is in excess of $20 against the current price of $15.67, I believe that there will be an extremely limited upside in the near future and the dividend yield of 1.2% does not compensate. I would suggest looking for an alternative if you are looking to add or initiate exposure in the homebuilding sector.