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PulteGroup on a Tight Rope

PHM LEN

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

PulteGroup’s third quarter 2012 adjusted earnings of 27 cents per share beat the Zacks Consensus Estimate by 35%. Earnings were significantly better than the adjusted earnings of $11 cents in the prior-year quarter, driven by improved home demand and pricing, gross margin expansion and solid overhead leverage. Pulte’s homebuilding revenues rose 12.7%, driven by an increase in new home orders and average selling prices.

New home orders were up 27% year over year based on the improvement in new home demand. The average selling price rose 5% as Pulte raised prices in almost 70% of its markets in the quarter. 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 for the remainder of 2012.

With a gradual recovery in the overall economy, the homebuilding industry is finally seeing signs of stabilization in 2012. The overall U.S. housing market has seen a meaningful increase in the volume of new home sales for the first nine months of 2012 with industry-wide sales tracking roughly 25% above prior-year levels. 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 record low interest rates, while renting has become 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 freeing up cash to invest in other potential opportunities, which could generate higher returns. Pulte is also utilizing its existing land assets more efficiently and lowering its unsold inventory levels more aggressively, which in turn are benefiting the working capital and margins. Moreover, while the company monetizes non-profitable existing assets, it is disciplined in adding new land positions. The company is also shifting its focus toward steeply priced Pulte branded move-up homes, which will likely improve the overall average selling prices.

In addition to allocating capital more efficiently, Pulte is taking other actions to improve its operating and financial performance. These initiatives include improvement of overhead leverage and implementing new pricing strategies. These initiatives will better place the company when the housing conditions improve in the long term.

Though the housing market is showing signs of stabilization in 2012, management believes that the process is erratic and not yet adequately broad-based. A speedy housing recovery is unlikely and the timing of the markets to fully recover and return to a more historically typical operating environment is uncertain.

Pulte carries a Zacks #2 Rank (short-term Buy rating). Peer company, Lennar Corporation (LEN - Analyst Report) also carries the same rank, thus highlighting the positive momentum in the housing industry.

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