PulteGroup: Housing Prices May Have Bottomed, But Price Appreciation Will Be Tough

| About: PulteGroup, Inc. (PHM)

Shares of home builder PulteGroup, Inc. (NYSE:PHM) have doubled since the beginning of the year on the back of some favorable news from the housing market. The company's stock is a major winner in percentage terms compared to its peers so far this year. Though there seems to be consensus that housing prices have bottomed, the next question among investors is whether price appreciation can be expected.

For three consecutive months, the S&P/Case-Shiller Home Price indices witnessed improvements, with May recording a 2.2 percent gain for both the 10-city as well as 20-city indices, according to S&P Capital IQ. While this seems to be good news for investors, there is concern that this could be the result of a limited supply of distress sales. Builders also gained with thin inventories in many of the regions and resorted to cutting down on the concessions they were offering to buyers earlier. Clearly, this has lifted the gross margins of home builders and provided them with renewed confidence.

S&P Capital IQ analyst Michael Souers, however, believes, "We think sustained price improvement will be a challenge, given the likely acceleration of foreclosures in the back half of this year, along with the potential increase in sellers responding to higher prices (and putting their homes on the market)."

The PulteGroup stock witnessed 40 percent upside in the first quarter to $8.85 from $6.31, rising by another 20.9 percent in the second quarter to reach $10.7. Based on the closing price of $12.48 on August 10, the stock surged 98 percent since the beginning of the year. In comparison, Lennar Corporation (NYSE:LEN) advanced 38.3 percent in Q1, rising by another 13.7 percent in Q2, while the stock surged 59 percent year-to-date. During the same periods, Toll Brothers Inc. (NYSE:TOL) gained 17.5 percent, 24 percent, and 49 percent, respectively.

It's clear that PulteGroup's stock surge has significantly outpaced that of its peers, thereby calling for fresh valuation. The majority of home builders posted robust Q2 numbers and were also optimistic about their impending growth potential. But the macroeconomic environment poses a cautionary flag in the absence of labor market improvements and consumer confidence. This could likely put pressure on a sustained improvement in the housing market.

Indeed, the July employment data indicated favorable trends in non-farm payrolls that snapped four days of the stock market's losing streak. But the overall report seems to be more disappointing, given the higher rate of jobless claims, rate of labor force participation and employment-to-population ratios, indicating a continually badly-damaged labor market.

Additionally, the increase in year-over-year wages of just 1.7 percent is only sufficient to keep pace with inflation. Though consumer confidence bounced slightly in July after four straight months of decline, it remained at recessionary levels. Analysts believe consumers also seemed disinclined to take on additional debt burdens, given the modest increase of 4.4 percent in the savings rate in June over May's 4 percent.

After the 2007-2008 housing bubble financial imbroglio, there has been no let up in lending standards and standards continue to remain tight at the banks. June provided disappointing existing home sales that slipped 5.4 percent with new home sales coming in at 350K, well short of the 370K analysts were expecting. This was also 8.4 percent lower than May following an upward revision of the previous three months' numbers. Building permits and pending home sales also slipped sequentially. This only suggests likely slower sales in the future, thereby hurting appreciation.

After a sales drop of 9.5 percent in 2011, PulteGroup is estimated to post 12 percent growth in revenues on a housing market recovery, as also market share gains. The company operated in 7 percent fewer communities in order to streamline its operations and improve its margins. Net new orders increased 32 percent in Q2, supporting near-term revenue upside.

Analyst Michael Souers says: "We see SG&A costs as a percentage of total revenue below 12% in 2012 on strong cost controls. Following a 2011 loss of $0.55 a share, including asset charges, we see EPS of $0.38 in 2012 and $0.66 in 2013." Yet, the analyst reiterated the stock as a 'Sell' on valuations, since the stock is trading at a price to book ratio of 2.3x, well above its peers.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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