Seeking Alpha
Debt, CFA, Portfolio manager, preferred stocks
Profile| Send Message| ()  

As many readers know, I have been more constructive on the real estate market lately, seeing more positive signs coming out of the residential and commercial sectors. One means of investing in the possible bottoming and growth (mildly anemic, but growth nonetheless) is through the homebuilder sector.

The most recent upgrade in the homebuilder equity space came from Credit Suisse:

Credit Suisse analysts on Wednesday upgraded homebuilders Ryland Group Inc. (RYL) and PulteGroup Inc. (PHM) to outperform from neutral, and increased their price target to $23.50 from $20 for Ryland. The bank is maintaining its $11 price target for Pulte. Credit Suisse said the move is based on the results of a May survey of real estate agents, which found the "continuation of healthy buyer traffic trends and an improving home price environment". The Swiss bank also said the two firms are poised to benefit "as rising orders and margins drive a return to profitability as early as the second quarter", backed by the homebuilders' strong cost reduction efforts.

Homebuilders have been on fire this year; The Standard & Poor's Supercomposite Homebuilding Index has climbed 28 percent this year, outpacing a 6.8 percent gain in the broader S&P 500. Graphically, the larger builders including PulteGroup, Lennar (LEN), D.R. Horton (DHI) and KB Homes (KBH) have shown the following performance year-to-date:

(click to enlarge)

As a result of this run-up, it is hard to call the homebuilder segment anything but fully/over valued.

(click to enlarge)

Two things stand out when looking at the industry:

  1. Equity prices have factored in growth that could be difficult to achieve, and
  2. Income investors have a hard time getting involved in the sector as the dividend yield leader is KB Home with a 1.3% dividend yield.

So what we have is a fully valued equity market and virtually non-existent dividends. This leads to looking at the rest of the capital structure for investment opportunities.

In this leg of the real-estate / homebuilder analysis, PulteGroup will be looked into.

PulteGroup, Inc., based in Bloomfield Hills, Mich., is one of America's largest homebuilding companies with operations in approximately 60 markets throughout the country.

Pulte has the following financial snapshot:

(click to enlarge)

It is obvious from the company's financial snapshot as to why it is high yield. The company has, however, been showing improvement in its margins:

Looking at the company in terms of lots owned, the company has 128,000 lots owned, which roughly equates to 8.4 years supply, which is somewhat above average and is somewhat disconcerting. The company also has slightly more than 2,000 spec homes on the books.

The company, like most in its industry/peer group was hard hit in the housing downturn and continues to be fundamentally weaker than prior to the bubble burst but it is getting some traction on rightsizing its portfolio (cutting the number of communities) and returning to profitability.

PHM Chart

PHM data by YCharts

While I believe the equity will have the ability to appreciate over time, it appears to be fully valued - as I stated before. As the company has no preferred stock, the only other part of the capital structure to look for value is the bonds.

(click to enlarge)

The cheapest bond in the complex, in my opinion, is the 7.625% 2017 from a pure relative value/spread basis as the curve from the 2015s to the 2017s is worth 125 basis points and it trades wide to 5yr CDS (398bps). It must be said, however, that the bond does not often trade. While the 2017s present value, many readers don't like paying a premium for debt, which leaves an investor with two options - the exchange traded 2046s and the $1000 par 2032s. Of these two options, the 2032s are more appealing on a yield/discount basis, but the are also less liquid and therefore an investor could see spreads gap out and bids dry up in a market/credit event. While the same might be true for the exchange listed debt, it is less likely.

Bottom Line: PulteGroup is on the road to recovery. As with the majority of their peers, they are rightsizing and repositioning their portfolio, property and approach to building. As I have stated in a couple of recent articles I have written on real-estate and homebuilders, it looks like the bottom of the market is in place. It also appears that the market has, at this point, fully valued the equities and now they will be trading plays (on sentiment, datapoints and as a proxy for the economy). Investors should consider climbing up the capital structure into bonds as they will benefit from further fundamental strengthening of the group and provide investors with a cash flow stream.

Source: PulteGroup - Framing A Homebuilder Portfolio Nail By Nail

Additional disclosure: This article is for informational purposes only, it is not a recommendation to buy or sell any security and is strictly the opinion of Rubicon Associates LLC. Every investor is strongly encouraged to do their own research prior to investing.