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PulteGroup (PHM) Shares Up 43% YTD: Will the Rally Continue?

Zacks Equity Research

PulteGroup, Inc. PHM has gained 42.6% so far this year compared with the Building Products – Home Builders industry’s rise of 48.1%. The company is benefiting from land acquisition, decline in mortgage rates and moderate home prices. However, declining backlog as well as rising labor and land costs is raising concern.

Let’s delve into the factors that substantiate the company’s Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Factors Driving Growth

PulteGroup is currently focusing on land investments and entry-level buyers for returning more free cash flow to its shareholders. Consistent strength in the economy and job growth are expected to offset the negative impact of rising material costs in the future.

With nearly $1.2 billion to be spent on land acquisitions, the company expects to realize higher returns on invested capital, increase the use of land options and accelerate inventory turns. It emphasizes on investing in shorter-lived smaller land assets while expanding the use of land option agreements when possible. This enables the company to mitigate market risk. It has spent $305 million and $473 million on land acquisition in the first and the second quarter of 2019, respectively.

The U.S. housing market started gaining strength since the beginning of 2019, after witnessing fluctuations in second-half 2018. Declining mortgage rates and moderate home prices have been driving PulteGroup and other homebuilders. The overall performance of the homebuilding industry is positive owing to ongoing traffic trends that indicate higher inclination of buyers. The trend indicates a slow but steady housing recovery. Moreover, as more and more millennials are leaving their parents’ home, a spike in household formation is likely to translate into higher demand for new homes.

Moreover, PulteGroup is benefiting from growing demand for entry-level homes. The company has been reaping benefits from the successful execution of strategic initiatives to boost profitability, with focus on entry-level homes. In view of these strategic efforts, the company managed a 14% year-over-year jump in per-community absorption among first-time buyers in second-quarter 2019. Also, the 7% year-over-year increase in second-quarter order growth was led by 30% surge in first-time buyer orders.

Hurdles to Cross

Rising land and labor costs as well as declining backlog is a major concern for the company. Labor shortages are leading to higher wages, while land prices are inflating due to limited availability. More inflation is anticipated, going ahead. This is denting homebuilders’ margins. PulteGroup expects homebuilding gross margin in third-quarter 2019 in the range of 22.8-23.3% (compared with 24% in the year-ago quarter), considering housing market dynamics and higher incentive level.

Notably, the company’s backlog dipped 0.4% year over year in units. Also, the potential housing revenues from backlog fell 1.8% from the prior-year quarter’s tally to $5.11 billion.

Key Picks

Some better-ranked stocks in the Zacks Building Product’s industry are D.R. Horton, Inc DHI, KB Home KBH, and M.D.C. Holdings, Inc MDC each sporting a Zacks Rank #1 (Strong Buy).

D.R. Horton has an average earnings surprise of 5.9% in the trailing four quarters.

KB Home has an expected earnings growth rate of 64.9% for 2019.

M.D.C. Holdings three-five year expected earnings per share growth rate is pegged at 9.9%.

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