Pulte Homes has a strong foundation and room to roar

According to JP Morgan homebuilding and building products analyst, Michael Rehaut, overall, inventory on average is down 13% YOY and 55% from peak levels.  Pulte Homes is one of the nation’s largest home builders offers various home designs, including single-family detached, townhouses, condominiums, and duplexes under the Pulte Homes, Del Webb, and Centex names.  As of June 30, 2013, they conducted  operations in approximately 50 markets located throughout 28 states

When interest rates spiked in May, the homebuilders were sold off with the expectation that higher rates would curb home buyers. Pulte sold off  25% from a high of $24 to $18.  It rebounded slightly to about $20.25  until they reported 2nd quarter earnings on July 24th.  PHM missed analyst expectations and cratered another 16.8% until a swarm of insider buying stemmed the collapse. The most significant buy was director Thomas Folliard’s purchase of 20,000 shares at $17.11 at a cost of $342.2K.  This isn’t a large purchase by any means but it’s respectable especially considering this more than doubled Mr. Folliard’s holdings of Pulte according to the Form 4 he filed with the SEC.

Do these insiders know what they are doing?  Is it time to buy Pulte Homes? Insiders have certainly been aggressive sellers of the stock until now.  Will that end now that the earnings black out is over?  You have no way of knowing this so it’s foolhardy to base buying and selling decisions on insider activity alone. One of the things that I harp on in the Investment Survival Workshops, is that you have to develop your own investment thesis.  The best tool I know for doing this is something I created called  Stock Checklist. Creativity is not a skill that’s highly regarded in investment analysis. Insider buying is definitely positive now.  Plus 1 on the checklist.

The chart certainly looks good. Our proprietary charting analysis showed bullish divergence at $16.06 on July 31.  That was the first buy signal  since the low of $3.5 per share October 2011.  Pulte since then rose 700% to its May high. I’m certainly not expecting a move like that but then John Paulsen who made a fortune shorting sub-prime recently said buying a house was his single best investment idea.   Maybe buying a lot of houses is not a bad idea.  Pulte certainly has a lot of  homes for sale. We give it a +1 for chart.

JP Morgan is neutral on the stock with a December 14 price target of $19.  The rest of the street is pretty divided.  Out of 22 analysts following it, 8 have it a buy or strong buy, and twelve have it a hold with 2 a sell.  That’s a neutral reading for me.  Remember I’ve changed my methodology on the checklist after the Apple debacle.  When all analysts have something as a buy, it’s time to sell.  No one is left to buy it.  At this point in time, the street is evenly divided on Pulte’s prospects. What’s curious about Mr. Rehaut’s analysis is that he expect earnings to decline in 2014 to $1.04 per share from this year’s estimate of $1.31. The average consensus estimate according to Thompson Financial has earnings rising to $1.32 Stock checklist score is 0.

Market direction remains favorable although the tech sector as evidence by Internet stock is approaching the lunacy valuations of 1999.  I’m still very constructive on the market in spite of this.  Plus 1

10 Q and K.  Management wrote, “The overall housing market continues to gain strength as the combination of low interest rates and affordable home prices have kept monthly mortgage payments very affordable relative to the rental market. In addition to increasing sales volumes in many parts of the U.S., house prices have also been increasing as the result of increased demand and low supply of existing and new home inventory in many markets. Despite a recent moderate rise in interest rates, we have experienced increased traffic and have been able to raise prices in the majority of our communities. While we believe higher interest rates are inevitable and may have a moderating effect on demand and pricing, we believe this impact will be outweighed by the other factors driving increased demand as overall new home sales in the U.S. remain low compared to historical levels.”

Although earnings went down in the most recent quarter versus the prior year, cash flow from operations rose by 58%.   Orders declined 12%.  The Company notes that it continues to focus on price over pace. This is what impacted the sell-off in the stock after the most recent earnings report.  Operating margins improved 450 basis points YOY.  This really is the critical call in the investment. Do you believe in management’s explanation and strategy?  I do and I give it a +1.  If insiders go from buying to selling without a rise in share price, though, I’m liable to change my opinion

Sector outlook– Clearly this is a macro call and I don’t how you can be anything but positive on the home building sector.  While the rest of the country is recovering from a recession in 2008, the home building industry is recovering from a depression.  Following a group leading performance in 2012, up 188% vs. the group’s 94% rise, PHM is actually negative for the year 2013 when the S&P is up 18%.  Pulte stated that the recent rise in rates has not yet had a material impact on traffic or cancellation rates.  The jury is out on this but I don’t believe the Fed will allow rates to rise sharply enough to stem the home building industry.  I do expect some administration jawboning if home prices continue to rise as sharply though. I’m giving it a plus 1.

Cash flow Although earnings went down in the most recent quarter versus the prior year, cash flow from operations rose by 58%.  I score it +1

 Peg Ratio is an impressive 0.31.  Another +1

Recent events- home building stocks have been laggards this YTD after leading the market in 2012.  That should be no surprise as one year’s winners are often the next year’s losers. I think the recent earnings disappointment coupled with the malaise of the group, have set expectations low enough to award somewhat patient investors like me.  Another plus 1

Catalyst  I can’t tell you what the catalysts could be.  Most times you won’t be able to tell.   I have to score that a )

Pulte looks like a well-managed company that survived a depression.  Obviously it would have been brilliant to buy it below $5 but companies that survive a depression come out the other side stronger.  Like Nietzsche said, “what doesn’t kill you, makes you stronger.”  Pulte will get back to its 2005 bubble highs but it will take some time. Right now the Company has a strong foundation and room to roar.