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On Aug 22, we maintained a Neutral recommendation on PulteGroup Inc. (PHM - Analyst Report) despite its dismal second-quarter 2013 performance as we have faith in the company’s long-term fundamentals and potential for further margin growth.

Why a Neutral Recommendation?

Pulte announced weak second-quarter results, missing the Zacks Consensus Estimate for both earnings and revenues. While earnings of 26 cents per share more than doubled from the prior-year quarter’s earnings of 11 cents, it lagged the Zacks Consensus Estimate of 29 cents by 10.3%. While total revenue grew 19.6% year over year to $1.28 billion, it lagged the Zacks Consensus Estimate of $1.39 billion by 7.9%. We believe the company missed the Zacks Consensus Estimate for both earnings and revenues due to weak net order growth.

Net orders were weak due to lower community count as the company has been intentionally slowing down sales in some markets due to lack of land development and scarcity of finished lots. The company is focusing more on driving price and margin rather than pushing up unit volumes; which we believe affected net order growth in the quarter. Though pricing increased sharply in the quarter, the net order decline raises concern.

Following the dismal second-quarter performance, estimates were mostly revised downwards. Accordingly, the Zacks Consensus Estimate for 2013 went down 13.3% while that for 2014 declined 12.3% over the last 30 days. Accordingly, Pulte carries a Zacks Rank #5 (Strong Sell).

Moreover, the recent rising mortgage rates and possibilities of changes in the federal lending process create an overhang.

However, Pulte’s margin performance has been strong. Adjusted homebuilding gross margins expanded 360 basis points (bps) year over year and 100 bps sequentially in the second quarter. It was driven by improved pricing, better mix of sales (shift toward higher margin Pulte and Del Webb brands) and efforts to reduce construction costs. Gross margins are expected to continue to improve in the next 2-3 quarters.

Overall, Pulte’s solid long-term fundamentals, strong cash position and improving profitability are encouraging. Pulte’s strategic initiatives to allocate capital more efficiently, expand margins, improve overhead leverage, increase inventory turns and implement new pricing strategies bode well for solid margin growth in future quarters. We thus, remain Neutral on the stock despite the near-term weakness.

Other Stocks to Consider

Some homebuilders are currently performing well and are worth considering. These include Hovnanian Enterprises Inc. (HOV - Snapshot Report), Ryland Group Inc. (RYL - Snapshot Report) and Meritage Homes Corporation (MTH - Snapshot Report). All these companies carry a Zacks Rank #2 (Buy).

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