Pulte Group Stock: The Future Of This Company Is Brighter Than Many Realize (NYSE:PHM)

Thesis

Founded in 1956, PulteGroup (NYSE:PHM) is one of the largest homebuilders in the United States. In addition, they offer financial services through Pulte Mortgage, but this is only a small part of their total revenues at ~2%. With rising mortgage costs and other factors, this is an industry that many see as risky and as a result, the stock took a relatively big hit in 2022. And when I first covered the stock earlier this year, I also thought it was risky. However, with 2023 coming in better than expected, the stock rebounded strongly and Pulte is one of the best performing stocks year-to-date. The big question now is what 2024 and beyond will look like and is Pulte still a good investment for the future and I personally think Pulte has a good chance of doubling its stock price over the next 5 years.

Q3 Results of PHM

Due to strong demand, Pulte exceeded earnings estimates on an EPS basis and experienced strong year-over-year growth in new orders. Furthermore, the dividend was increased by 25%, which is also very positive sign.

Unlike the third quarter of 2022, the margins are slightly lower, but still much higher than in 2021 and 2020, and remain in the top quartile of the industry, strengthening Pulte’s position as an industry leader. However, since they are one of the best companies in the space and still trade at a lower multiple than their peers, it is important to understand why this is the case.

I think on the one hand the market saw some of the other competitors as having higher growth opportunities than Pulte, and on the other hand the direct competitor NVR (NVR) was seen as having better capital allocation and future prospects. But 2023 has shown that the consensus may be wrong and that Pulte is better than they think. Since future liquidity is what moves markets and stocks, let’s take a look at Pulte’s outlook.

Reverse DCF

The basis for the reverse DCF is the TTM diluted EPS of $12.31 and a discount rate of 10%, which is the hurdle rate I use because it is roughly the total annual return of the S&P 500 historically. Based on these assumptions, EPS must grow by 10% over the next 10 years to justify the current share price. However, since Pulte has repurchased about 50% of its shares since 2013, its EPS CAGR is much higher. The 5Y CAGR is 33% and the 3Y CAGR is 37%, both much higher than the required 10%. The value-creating effect of share repurchases for Pulte shareholders is also evident when we look at the net income CAGR, which is only 26% for 5Y and 28% for 3Y. So as a result of the share repurchases, EPS grew at a higher rate.

While I do not think EPS growth will be that high over the next 10 years, I think a CAGR in the high teens is achievable due to their strong FCF and how shareholder friendly they are. If we assume that EPS will grow by 15% over the next 5 years due to a combination of earnings growth and share repurchases, the stock will double over that period if the EPS multiple stays the same, which is quite likely since it trades at a 7.15x P/E multiple and the 5-year average is 7.93x. When we add in the growth rate of the dividend, shareholders have a good chance to do even better. The 5-year annual dividend growth rate is also at 12.2%, which is a really strong number and further demonstrates the company’s willingness to return capital to shareholders.

Comparison with NVR, SKY and BLD

NVR, Inc. , Skyline Champion Corporation (SKY) and TopBuild Corp. (BLD) are used by me as comparable companies. In terms of price-to-book ratio, Pulte is the cheapest of the 4.

1. Pulte: 1.90x PB Ratio
2. SKY: 2.56x PB Ratio
3. BLD: 3.89x PB Ratio
4. NVR: 4.77x PB Ratio

Despite being the company with the highest year-over-year sales growth in such a challenging environment.

1. Pulte: 11.71%
2. BLD: 7.6%
3. NVR: -1.29%
4. SKY: -25.97%

Pulte also has the highest EBIT margins in its peer group.

1. Pulte: 21.17%
2. NVR: 20.58%
3. BLD: 17.13%
4. SKY: 14.10%

The only point where Pulte is at a disadvantage is with their high debt load where they have $1.96 billion in long term debt compared to $913 million for NVR, $12 million for SKY and $1.3 billion for BLD. However, when we take FCF into account, Pulte’s strong FCF is easily enough to service long-term debt and return plenty of cash to shareholders to grow the business.

1. Pulte: $2.05b FCF
2. NVR: $1.40b FCF
3. BLD: $556m FCF
4. SKY: $163m FCF

In summary, Pulte is undervalued because it has higher FCF, higher revenue growth rates, and a better EBIT margin while trading at a lower price to book ratio.

Risks for Pulte Group

A member of the Pulte family taking on Pulte is sure to draw attention, as he has a Twitter account with more than 3 million followers and posts regularly. So this is a tricky situation. Then there is always the question of where the industry is in the cycle. Industry downturns are usually a buying opportunity because the housing industry is cyclical and there will always be demand for housing, but it is not easy to say exactly where we are right now.

In late 2022 and earlier this year, many industry experts were saying that net orders and revenues would decline in 2023 as a result of declining demand and rising mortgages and costs. The reality at the end of 2023, however, is that revenues are up, net orders are up year over year, and the backlog is still strong at 13,000 homes worth about $8.1 billion, and they plan to deliver 8,000 homes in Q4 and 29,000 for FY23. However, since what matters for the share price is what happens in the future, FY24 and how orders and backlog develop will be the crucial factor.

The competition definitely had a tougher time in 2023, which speaks to the quality of Pulte’s management and capital allocation. Pulte’s long-term approach is also evident in its land purchases + development costs, which are on track to reach $4 billion this year after $4.5 billion in 2022 and $4.3 billion in 2021. They were also able to increase the average sale price to $549,000, an increase of 24%. So the inflationary environment, the cost of mortgages, the higher cost of housing are all things that could be negative for Pulte, but right now it looks like they are doing a fantastic job of maneuvering through those circumstances.

If we look at the historical price-to-book ratio, we see that every time the ratio has reached a low of about 1.2x, it has been a fantastic buying opportunity, and a multiple of 2.4x has been the peak most of the time. Thus, the ~1.9x multiple is currently an average entry point for the nation’s third-largest homebuilder, but still attractive given the growth opportunities from acquired land and housing demand.

The ability of homebuilders to perform well in times of higher mortgage rates is demonstrated by NVR, which has been one of the top performing stocks since 1993 with a 30-year total return of 62.186%. So fear of high financing costs should not be an argument against this industry.

Conclusion

The combination of a product that is likely to be in high demand for as long as mankind exists, a rapidly growing dividend and a large share repurchase program is a proven winning formula. Repurchasing 10 million shares this year, or 4.5% of shares outstanding, in a year when many were predicting a double-digit decline in sales is a remarkable achievement.

As I see a strong case for EPS growth of 15% annually over the next 5 years, I see Pulte as an attractive investment given its valuation relative to its peers and its growth opportunities. As a result, I am changing my rating to Buy from Hold as I now see a more positive outlook for the stock as Pulte’s management team has demonstrated a strong ability to execute this year even in a difficult environment.