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On Jun 19, we maintained a Neutral recommendation on PulteGroup Inc. (PHM - Analyst Report). While solid first-quarter 2013 results and improving housing fundamentals raise optimism, the overall weak economy and tight mortgage lending standards keep us sidelined.

Why the Neutral Recommendation?

On Apr 25, this leading national homebuilder announced first-quarter earnings of 21 cents per share, which beat the Zacks Consensus Estimate by 31.3%. Moreover, the company swung back to earnings from the prior-year quarter’s loss of 3 cents per share.

The earnings were driven by solid gross margin expansion and significant overhead leverage which made up for a somewhat lukewarm net order growth in the quarter.

Total revenue also beat the Zacks Consensus Estimate and grew 31.8% year over year. The company’s strategic initiatives to expand margins, improve overhead leverage, increase inventory turns and give higher returns helped it to better capitalize on the improvement in the broader housing market.

Pulte’s Homebuilding revenues rose 32.1% driven largely by better average selling prices (ASPs) as the net order growth was slightly muted. Though net orders grew only 4% in the quarter, it is not a matter of concern as the company is intentionally slowing sales pace. Instead, it aims to raise prices and drive margins in most communities.

Estimates mostly moved upwards after the announcement of the solid first-quarter results. The Zacks Consensus Estimate for 2013 increased almost 20% and that for 2014 went up almost 4% over the past 60 days.

We believe that homebuilders like Pulte, which enjoy significant land positions, broad geographic and product diversity and better capital positions, will take maximum advantage of the housing recovery. We also believe that Pulte’s cost reduction and operating efficiency improvement plans combined with further improvement in housing demand will boost profitability in 2013.

Notwithstanding the improving trend, demand for new homes in the U.S. remains at historically low levels due to the currently weak economic conditions and tight mortgage lending standards. Consumers will remain cautious until the employment scenario improves; home prices appreciate further and access to the credit markets eases. Sustainable increases in housing and housing demand for the long term will require the overall economy to strengthen; including further job growth which we believe will take time.

Rising input costs is also a concern due to the increasing costs of raw material and labor.  As housing starts accelerate, both labor and construction material costs continue to experience upward pricing pressure, which could prove to be a major deterrent for margins in the future quarters.

Other Stocks to Consider

Pulte carries a Zacks Rank #2 (Buy). Other stocks in the homebuilding sector that are performing well include D. R. Horton Inc. (DHI - Analyst Report), Ryland Group Inc. (RYL - Snapshot Report) and Meritage Homes Corporation (MTH - Snapshot Report). All three stocks carry a Zacks Rank #1 (Strong Buy).

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