PulteGroup Retained at Neutral

We have maintained a Neutral rating on PulteGroup Inc. ( PHM - Analyst Report ) following appraisal of first quarter 2012 results.

Pulte reported a loss per share of 3 cents in the first quarter of 2012, in line with the Zacks Consensus Estimate but narrower than the prior-year quarter loss of 10 cents per share. Improved revenues, expanded margins and reduced overhead costs curtailed the loss in the quarter.

The company conducts its operations in two primary business segments – Homebuilding and Financial Services. Pulte reported total revenue of $881 million in the first quarter, up 9.4% from the prior-year quarter due to improved revenues in both the segments. Total revenues also breezed past the Zacks Consensus Estimate of $850 million. Homebuilding revenues were up 4% driven by increased new home orders due to improved overall housing demand. The adjusted gross margin expanded 180 basis points in the quarter to 18.7% of home sale revenues. It was driven by a better mix of sales, particularly move-up homes, as well as the addition of newer higher margin communities. (Read our full report at Pulte Loss Narrows, Orders Up).

With a gradual recovery in the overall economy, the homebuilding industry is finally seeing signs of stabilization in 2012. The downturn during 2006-2007 had hurt Pulte and its compatriots like DR Horton, Inc. ( DHI - Analyst Report ) , KB Home ( KBH - Analyst Report ) and Lennar Corporation ( LEN - Analyst Report ) significantly. We believe that the housing market is starting to benefit from an increase in employment rates and higher consumer confidence. Houses are more affordable now as mortgage loans come with relatively low interest rates, while renting becomes more expensive. Homebuilders like Pulte with significant land positions, broad geographic and product diversity, and better capital positions are expected to benefit the most as market conditions recover.

Pulte is taking action to improve its operating and financial performance. These initiatives include steps to manage margins, overhead and inventory; initiating new pricing strategies and reweighting its market position. These strategies would better place the company once the homebuilding market fully recovers from the past sloth. The continued reduction in overhead costs had pulled down the company’s Selling, General and Administrative (SG&A) expenses substantially in 2011 and subsequently increased margins. In fact, in 2012, the company expects overheads to be in the range of $485 million to $495 million, much lower than $520 million incurred in 2011. The company maintains a cautiously optimistic outlook for 2012 and believes that its cost reduction and operating efficiency improvement plans, combined with overall improvement in housing demand, will lead to profitability.

Moreover, the company is divesting lower-margin projects and exiting non-performing communities and lower-margin land lots which no longer fit into their operating strategy. This frees up cash to invest in other potential opportunities, generating higher returns. The company is also shifting focus towards steeply priced Pulte branded move-up homes which improves overall average selling prices.

Though there have been signs of a nascent improvement in new home demand so far in 2012, the process of stabilization we believe is not adequately broad-based. The housing market improvement has been uneven across the country. Most of the gains have, by and large, been observed in high-end communities and homebuilders are still facing impediments in raising prices in some markets. Moreover, the industry faces significant challenges from an oversupply of foreclosed homes and short sale homes. Overall demand still remains constrained due to tight credit standards which make it difficult to obtain loans for home buying. A speedy housing recovery is unlikely and it will take some time before the markets fully recover. We would therefore prefer to stay on the sidelines until we witness a meaningful recovery in the housing market.