PulteGroup Strong On Land Acquisitions, Costs Hurt Margins

PulteGroup Inc.’s (NYSE:PHM) prudent investments in new land positions will continue to result in higher volumes, revenues and profits. The company expects to realize higher returns on invested capital, increase the use of land options where possible and accelerate inventory turns.

In the first nine months of 2017, the company spent $773 million in land acquisition. PulteGroup is on track to spend approximately $1.1 billion on land acquisition and $1.6 billion on land development (up around 10%) in 2017.

Apart from prudent land investments, the company is adopting initiative to improve its operating and financial performance. These initiatives include improving overhead leverage, increasing inventory turns and implementing new pricing strategies. These initiatives have helped drive profits. Earnings in the quarter increased a solid 40% from the year-ago level. The upside was supported by higher demand despite disruptions caused by hurricanes Harvey and Irma.

As part of its cost-reduction program, PulteGroup made significant workforce reductions and curtailed overhead costs and inventory. Moreover, aggressive debt repayment due to an improved financial position has lowered its interest costs. In addition, PulteGroup’s strategic pricing programs allow buyers to select the lots and options that they value the most, resulting in higher levels of house options and lot premiums. The company is also adjusting contents of its homes and is building smaller floor plans to curtail construction costs.

Also, the latest positive housing data reassures the industry’s strength, courtesy of solid economic growth amid supply shortages and ongoing recovery from hurricanes in Florida and Texas. Consistent job growth along with seemingly high homebuilders’ confidence is driving the momentum.

In fact, the Zacks Homebuilding Industry has gained 66.9% year to date, outperforming the S&P 500 market’s gain of 17.6%. Moreover, a good industry rank (top 26% out of more than 256 industries) signals that the companies in this space are likely to benefit from broader factors in the near term.

Concerns

Rising land and labor costs are threatening margins as they limit homebuilders’ pricing power. Labor shortages are leading to higher wages while land prices are on the rise owing to limited availability. This is denting homebuilders’ margins. Home sales’ gross margin decreased 80 basis points year over year to 23.9% in the third quarter of 2017.

PulteGroup’s homebuilding operations are located in many areas that are subject to natural disasters and severe weather conditions. Natural disasters and inclement weather conditions could delay deliveries, increase costs by damaging inventories, reduce the availability of materials and dent demand for new homes.

Share Price Movement

Shares of PulteGroup have gained 85.7% year to date, outperforming 67.8% gain of the industry it belongs to. The price performance has been backed by an impressive earnings history. PulteGroup surpassed earnings in all of the past four quarters, the average beat being 8.09%.

Though earnings estimates for 2017 declined 3.5%, it increased 2.2% for 2018 over the last 60 days. This indicates analysts’ apprehensions about the stock in the immediate future but the stock’s growth story might impress over the long term.

Zacks Rank & Stocks to Consider

PulteGroup carries a Zacks Rank #3 (Hold).

A few better-ranked stocks in the sector are Patrick Industries, Inc. (NASDAQ:PATK) , United Rentals, Inc. (NYSE:URI) and Armstrong World Industries Inc (NYSE:AWI) .

United Rentals sports a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

The company is expected to see a 22.1% rise in 2017 earnings.

Patrick Industries carries a Zacks Rank #2 (Buy) and its earnings are expected to grow 24.5%.

Armstrong World Industries also carries a Zacks Rank #2. The company’s earnings are expected to grow 21.8% in 2017.

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