Why it's Worth Building a Position in PulteGroup

Last week the average 30-year fixed-rate mortgage continue to slide lower to a fresh all-time low of 2.88%. While this is certainly good news for homebuyers, it has been a major boon to the homebuilder stocks.

The group's sharp rebound off its March 2020 low has been one of the key contributors to the overall stock market recovery. There are several ways to play the homebuilding space including the SPDR S&P Homebuilders ETF (XHB), but if individual stock investors had to choose just one company then Atlanta-based PulteGroup (NYSE:PHM) would be a great choice.

The stock looks poised to revisit its all-time high of $47.37 that was set shortly before the U.S. coronavirus outbreak. A lot has happened since then not the least of which has been a sharp rebound in the U.S. housing market. Favorable supply and demand dynamics along with ultra-low mortgage rates, suggest PulteGroup is on the cusp of a multi-year growth run.

What is Behind the Growth at PulteGroup?

The COVID-19 pandemic has spurred increased interest in suburban living as owners and renters seek its perceived safety compared to densely populated urban areas. With the supply of homes for sale at its lowest level in four years, many people are choosing to build a new home.

This combination of increasing demand and the limited supply is the ideal scenario for a national homebuilder like PulteGroup. However, the housing environment isn't perfect considering home prices are rather low. PulteGoup's average selling price slipped 3% last quarter to $416,000.

But as supply catches up to demand, firming home prices should be supportive of sustainable growth. There has been evidence of significant pent-up demand as states have reopened their economies. PulteGroup's June 2020 net new orders jumped 50% over the prior year to $2.7 billion. Meanwhile, its order backlog increased 12% to more than 13,000 homes.

Although the company has taken a cautious approach to land investment during the pandemic, it expects land expenditures to accelerate in the second half of the year due to the surging market demand.

What is PulteGroup's Target Market?

PulteGroup focuses largely on entry-level homebuyers such as millennials and empty nesters. It captures the two key ends of the market -- new families looking to purchase their first home and retirement-age folks looking to downsize. Since these groups combined represent a large portion of the overall home buying pool, PulteGroup can build new homes at volume.

The company controls approximately 163,000 lots which are allocated roughly equally among its First Time, Active Adults, and Move Up buyer segments. This gives it a well-diversified customer base. A lag in one buyer group can be offset by strength in another. This enables PulteGroup to favorably shift its business mix according to what it is seeing in the market.

From a geographic standpoint, PulteGroup does have exposure to some of the areas of the country that have struggled with a surge in COVID-19 cases in recent months. Warmer weather states like California, Florida, and Texas comprise a meaningful portion of the company's revenue, closings, and development lots. Florida alone accounted for 21% of fiscal 2019 revenue.

Positive headlines around the pandemic in these areas will be an important component of PulteGroup's ability to sustain a recovery while a reversion to shutdowns could prompt a downturn in the stock. Nevertheless, the company's geographic footprint is well balanced with a growing presence in the Northeast and Midwest regions.

Is PulteGroup Stock a Buy?

PulteGroup has constructed some of the best financial statements among the major homebuilders. Its gross margin expanded 80 basis points to 23.9% last quarter despite the decline in sale prices. As home prices rise, the company's profitability will only get stronger.

The balance sheet is also strong. PulteGroup ended the recent quarter with a $1.7 billion cash position after paying down debt incurred in March to boost its liquidity. This gives it a healthy net-debt-to-capital ratio of 15.5% which has been almost cut in half from a year ago.

Although the so-called easy money has already been made with PulteGroup's shares having more than doubled since March, it remains undervalued. At less than 11x forward earnings the stock's valuation is half that of the broader S&P 500 index that it belongs to.

PulteGroup is in a great position to capitalize on pent-up demand and the increased appeal of single-family new home living in the aftermath of the pandemic. Historically low mortgage rates and low existing home inventory will further drive demand into 2021. In the meantime, a ramp in land acquisition to address the inventory undersupply and rising demand will ensure PulteGroup has a foundation for multi-year growth.

PulteGroup has a lot going for it right now. We are likely to see the stock set a new record high in the coming days and resume the steady climb witnessed from October 2018 to February 2020.

Investors who build a position in PulteGroup here won't be getting in at the ground floor but will be able to participate in a steady rise as the company experiences above-market growth in the next few years.