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On Sep 17, we downgraded our recommendation on PulteGroup, Inc. (PHM - Analyst Report) to Underperform from Neutral following weak second-quarter results.

Why the Downgrade?

Pulte announced weak second-quarter results on Jul 25, missing the Zacks Consensus Estimate for both earnings and revenues. Pulte’s second-quarter 2013 earnings of 26 cents per share more than doubled from last year, but lagged the Zacks Consensus Estimate of 29 cents by 10.3%. Revenues also missed the Zacks Consensus Estimate due to disappointing net order growth.

Net orders declined 12% due to a lower community count as the company has been intentionally slowing down sales in some markets due to the 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, has affected net order growth in the quarter. Despite seeing strong demand, the company purposely closed sales in more than 50% of the open communities in markets like Arizona, Nevada and Southern California in exchange for better pricing. In these markets, the company sold 400 fewer units in the quarter which contributed significantly to the order decline. Pulte’s net order decline was a sharp contrast to double-digit increases reported by other large homebuilders.

Rising mortgage rates also had a negative impact on order trends in 15% of Pulte’s communities. Though pricing increased sharply in the quarter, the net order decline raises concern.

In fact, the company saw a similar net order trend in July as well with no major change in traffic levels and sign ups /cancellation trends. Net orders are expected to remain soft in some future quarters.

Moreover, recent increases in mortgage rates, changes in federal lending procedure and the lack of overall economic recovery could hurt demand for new homes.

Other Stocks to Consider

Pulte carries a Zacks Rank #5 (Strong Sell). Another homebuilder, MeritageHomes Corporation (MTH - Snapshot Report), carries a Zacks Rank #2 (Buy) and is worth considering. Building products companies, Masco Corporation (MAS - Analyst Report) and PGT, Inc.  (PGTI - Snapshot Report), also carry a Zacks Rank #2 (Buy).

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