We maintained our Neutral recommendation on PulteGroup Inc. (PHM - Analyst Report) following appraisal of the second quarter results.

We are encouraged by Pulte’s solid second quarter results and bullish growth projection for the second half, backed by gradually recovering homebuilding market.

Second quarter adjusted earnings of 13 cents per share beat the Zacks Consensus Estimates by 160% and were significantly better than an adjusted loss of $0.04 in the prior-year quarter. Improved homebuilding revenues, expanded margins and the company’s strategic initiatives led to this U.S. homebuilder’s strongest earnings performance in five years. Homebuilding revenues were up 14% driven by an increase in new home orders and average selling prices. New home orders were up 32% due to improvement in new home demand. The company is seeing a definite improvement in demand in the homebuilding sector and believes its cost reduction and operating efficiency improvement plans will lead to profitability in 2012.

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 the homebuilding sector hard. We believe that the housing market is starting to benefit from an increase in employment rates, higher consumer confidence and several years of pent-up demand. 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.

The company is continuously evaluating its assets and prioritizing markets and projects in order to allocate capital appropriately and to invest selectively in high-return projects. 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. Thus the company is freeing up cash to invest in other potential opportunities that could generate higher returns. It is also using its existing land assets more efficiently and lowering its unsold inventory levels more aggressively, which is in turn benefitting working capital and margins. The company is also shifting focus towards steeply-priced Pulte branded move-up homes, which improves overall average selling prices. A better mix of sales, particularly Pulte branded move-up homes, as well as addition of new higher margin communities drove the company’s adjusted gross margins in the second quarter of 2012 to post sixth-consecutive sequential gain.

In addition to allocating capital more efficiently, Pulte is taking other actions to improve its operating and financial performance. These initiatives include steps to expand margins, improve overhead leverage, manage inventory tightly and implement new pricing strategies. These initiatives will better place the company when the housing conditions improve in the long term.

Though there have been signs of a nascent improvement in new home demand so far in 2012, the process of stabilization 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. In addition, homebuilders are still facing impediments in raising prices in some markets. Overall demand still remains constrained due to tight credit standards, which make it difficult to obtain home loans. Thus, we prefer to remain on the sidelines until we witness a substantial recovery in the overall housing market.