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$PHM PulteGroup DD

# Company Summary

PulteGroup is a residential home builder based in Atlanta and formed in 1956. They are the fourth largest homebuilder in the US after $DHI, $LEN, and $NVR. They have a number of different brands and are vertically integrated in the homebuilding process from purchasing undeveloped land to selling completed homes. They develop communities with single family detached homes, townhouses, duplexes and condos. Their target market is middle class Americans and they also develop residential communities focused on senior living in 23 different states. 45% of their customers are ‘moving up’, 31% are first time home buyers and 24% are purchasing senior living options.

When purchasing land, they claim they use well developed data models to predict socioeconomic trends for housing markets in cities and isolated communities. The auditor seemed very optimistic about their computer models as compared to $MDC, a similar homebuilder.

They sell homes in two ways:

* Speculative homes: homes that have already been built. PHM expects that these homes will be purchased based on their own analysis of the region
* Pre-ordered homes: homes that are customized by a committed buyer. The buyer puts down some principal capital that is usually non-refundable and has to prove that they are adequately covered to purchase or finance the home.

They run a mortgage issuance segment that mostly issues mortgages to their homebuyers and then sells the mortgage to some other institution in order to reduce the risk on their own balance sheet.

They control 180,352 lots in total. 5000 in the NW, 15000 in the SE, 21000 in Florida, 9700 in the midwest, 16000 in texas, and 25000 in the west. 30% of lots are developed. 91, 363 of these lots are owned, and 88,989 are optioned. 43% of owned lots are developed and 16% of optioned lots are developed. See Note 2. At the bottom of the report for more info on the regions.

**Management overview:**

I’ve heard the grandson of the founder speak, and all I can say is it was a good decision keeping him out of the CEO position. People have a good opinion of the company from what is on glassdoor. There are a few comments about management being bureaucratic and putting unnecessary pressure on employees, but these only account for a small percentage of comments.

CEO: [Ryan Marshall](https://www.linkedin.com/in/ryanmarshallprofile/). He has an accounting and business degree, but it looks like he has only ever worked for PHM. He has over 20 years at PHM and his compensation was over 13 million dollars. This seems way too high for a CEO of a company this size. He has very good reviews on glassdoor (94% approval).

CFO: [Bob O’Shaughnessy](https://www.linkedin.com/in/robert-o-shaughnessy-3617276b/). Has an accounting degree. He has a much more diverse work experience than the CEO, but it isn’t in housing. He spent 10 years at Ernst and Young, 14 years at Penske as the CFO, and then 10 years at PGH as CFO. He has past CFO experience so I wouldn’t be worried about him making irrational decisions.

## Addressable Market

This section is speculative, they do not provide a breakdown of their target markets so I had to do some reverse engineering to get to this conclusion.

Their main business is single family homes, which account for 85% of their revenue. They talk vaguely about who they target, but it is quite clear to me after looking at the homes they sell that their target market is the middle class with a bit more in savings than most. Their homes are good quality, and their senior living arrangements are standalone homes with a lot of customization and community amenities available. From my analysis I think it is fair to state that their average buyer is in the upper middle class, and the retirees who buy homes have an average amount of savings, although there is serious interest from wealthier seniors.

## Risk

PHM is directly exposed to the volatility of the housing industry. They are a middleman in real estate ownership and try to keep their inventory turnover below 36 months. The way they purchase land is akin to dollar cost averaging. They purchase land more frequently than 36 months, and their long term assets are constantly changing. This brings us to the possibility of significant reduction in real estate value. Sure they might lose paper value on their balance sheet but there is still a fixed selling price that they will generate significant operating cash flows from.

Thankfully, there is a very prominent event that is an example of the worst case scenario for homebuilders – [check this out](https://www.americanprogress.org/issues/economy/reports/2017/04/13/430424/2008-housing-crisis/) if you don’t know what I am talking about. They took a big hit because of the dropoff of demand. It took 6 years, or four housing cycles to build back to pre 2008 levels, and they had three years of negative earnings. They managed to decrease debt and took the unfavorable but appropriate approach of selling 150 million shares, an increase of 60 percent. Since then they have bought back those 150 million shares but who’s to say there isn’t another housing crisis on the horizon? I have looked closely at common and uncommon indicators and all I see is a lack of supply but there is obviously much more that I am completely blind to.

The mortgages they keep on their balance sheet are slightly worrisome, but when I think about it, if the homeowner defaults, the home will just be repossessed by PHM. So not much of a concern.

They are vulnerable to commodity price inflation, but the distribution and acquisition of these works the same way as their land purchases do. Non land inventory is purchased regardless of the price, and home prices tend to slightly outperform the general CPI so this doesn’t really concern me as it balances out the same way as land purchases.

One unconventional risk they face is the lack of skilled laborers. The average age of construction workers has increased by [two years in the past seven years](https://sgchorizon.com/construction-industry-workforce-getting-older). There are more and more people going to post secondary school trying to make more money and do less work each year. This really does pose a significant risk to PHM in the long run. Less human capital supply means higher wages means lower margins means less operational cash generation means more debts and less cash means ultimately a more unstable and unhealthy business. No matter what happens otherwise in the economy, I think this could be their biggest long term risk.

Their ‘in your face’ optimism in their annual report isn’t captivating me. They also say that they think past stock price performance compared to the DOW home constructors index “represents a meaningful analysis for investors” ([Page 19](https://www.sec.gov/ix?doc=/Archives/edgar/data/822416/000082241621000007/phm-20201231.htm) above the stock performance chart). Again, this is really immature for the auditor to say this. They have competitive financials and a good company, so there is no reason for the auditor to go so overboard when they prepare reports. This stuff always makes me suspicious.

## Revenue Breakdown / Company segments

96% or revenue is from all homebuilding operations. This figure is 10.7 Billion:

* 45% of their customers are not making their first purchase. This section excludes seniors.
* 31% are first time home buyers.
* 24% are purchasing senior living options.

The remainder is from their financial services. This figure is 0.362 Billion.

Their average annual output of homes was 24600 last year. It has been growing slowly in the past three years at about 2% YoY.

## Industry position

Some of their competitors are $DHI, $LEN, $NVR, $TOL, $LGIH, and $KBH to list a few. PHM has the lowest P/E and PEG, and their P/S AND P/B are average out of their competitors. Their D/E and margins are competitive, but they are lagging with their ROE/ROA/ROI. Free cash flow is currently at about 30% of the market cap but this is not usually the case.

They have an estimated 6.1% market share in American residential construction.

## Base stats

Market Cap: 14.33 B

Total Debt: 3.2 B

Cash & Liquid assets: 1.6 B

Goodwill: 163 M

Total Assets: 12.2 B

Equity: 6.6 B

Revenue: 11.5 B

Earnings: 1.5 B

Operating Cash Flow: 1.7 B

Financing cash flow: -1.9B

Enterprise Value: 15 B

Shares Outstanding: 263 M

EV/Sales: 1.05x

ROE: 24.7%

## Overview/Growth and Developments

Growth: Revenue took a turn for the worse in the late 2000s, but since then it has almost returned to pre 2008 levels. The growth has been very steady

Margins:

* Margins seem to hover between 8-13%, and there hasn’t been much change over the years. The values are the same before 2007

Net reinvestment:

* They have a BBB- Credit rating
* A lot of capital expenditures go towards land that is either held and sold or developed
* Not much R&D that would benefit them.

Share buybacks:

* Share buybacks have been good since 2008. They have shown that they are capable of taking action to add shareholder value
* Their massive issuance in 2008 also shows that they are willing to raise capital and diminish shareholder value if it is needed for the business.
* The implications are mixed here. If I am looking from a shareholders perspective, then I would be skeptical of their excessive issuance in the past, but if I was looking at it as a long term business owner, it shows responsibility and willingness to sacrifice their reputation if it can keep their business strong.
* They have bought back almost all of the shares they issued in 2008.

Costs:

* They are consistently putting more money into paying off debts than they are taking out debt.
* One thing to consider in their operational costs is they are forced to pay market prices for commodities. They don’t keep a lot of inventory so these costs may become harder to manage unless they raise home prices along with the CPI. They have a 24-36 month lag behind the CPI in pricing their marketable assets because of the nature of the building contracts with their buyers.
* They had their second most successful year in 2020, and instead of massive bonuses they decided to:
* Repay all 700M drawn on their revolving credit facility
* Repurchase $75M in shares
* Increase dividends by 17% (Why so much? Invest back into the business or buy more shares)
* Committed to an early completion of notes due 2026-7 (Done Mar ‘21)

Debts:

* They have 411M in financial services debt and 2.752B in Notes payable.
* The notes payable is adequately spread over 15 years. The highest interest is 7.9% due 2032 and the average interest rate is 5.5%. As long as their operations are at least half as strong, their debt won’t be a problem. Interest expenses and retirement on these on average will cost them 180M/year
* Financial services debt is of no concern with an average interest rate of 3%.

Assets:

* Assets have grown since 2011.
* They have just under 13 B in assets
* They currently have less assets then they did in 2005-06
* Most of their assets are in PPE but they still keep 3.2 B in current assets.

WACC: 8.5%

Long term growth rate: They will grow with the housing market, but also shrink with it. 3.5-3.8% organic growth per year is reasonable.

Legal: Nothing

Recent/expected developments:

* They have 13657 homes in production currently, with 10421 of those already sold.
* No expected developments

## Industry advantages

Suppose this data driven model they talk about really can predict socioeconomic trends in neighborhoods or to-be neighborhoods. This would offer huge profitability advantages for them, but unfortunately so far their margins and growth are pretty in par with the industry.

They do have an advantage as a publicly traded company of their size. Lots of access to capital and large capital reserves make it easy for them to have many operations simultaneously in different parts of the country.

They have a healthier history internally compared to competitors. Their finances have stayed intact even in the worst case scenario and they have shown a better than average ability to rebound after hardship. This is because of the financial maturity and responsibility management has taken over the years and hopefully this is a culture that continues in the business.

## Sell side VS Buy side

I am more bullish on this one, but here are two arguments for two different opinions. I will limit them to five points each:

**Sell:**

* They did not hesitate to reduce shareholder value in 2008 instead of alternate debt financing. This shows that they are willing to do it again.
* Prevailing sentiment is split – there is a possibility of a massive real estate crash in the near future
* Economic conditions are favorable right not, but it is expected that they will not be as favorable in the future
* Some of their corporate paper is sold at quite a high yield, which may be grounds for default if they do not sell shares or more debt in the event of financial difficulties.
* The demand for skilled workers is and will be rising, making it more difficult for PHM to acquire valuable human capital without raising wages.

**Buy:**

* They have steady organic growth
* Management has shown more than once that they are responsible. In bad times they are capable of sacrificing shareholder value for more shareholder value in the future. In good times they make good on future obligations early and don’t get too euphoric with expansions and bonuses.
* Their asset and debt structures are very attractive – with adequate coverage of debts and not a lot of outstanding obligations
* They have great ability to generate lots of capital in good times and store that capital away.
* The economic conditions indicate a shortage of residential housing, so even if there is an economic catastrophe in the near future, PHM and other homebuilders will still be needed to fill a 5.5 million house void in the country. This figure is only going to grow too without federal intervention which either way is advantageous for PHM.

## Valuation

Assuming a dividend growth of 1 %, a 3.8% expected growth from the company and an 8% rate of return, the [Gordon model](https://www.investopedia.com/terms/g/gordongrowthmodel.asp) gives them a $10.7 valuation per share. Their intrinsic value calculated from the DCF model is between $70-100, giving an average margin of 35%. Of course the DCF model makes the assumption that OCF and investments will be stable and follow my predicted growth rates, so this is a subjective valuation no matter how accurate I think it may be.

## Valuation Market Comparison

The average intrinsic values I have found for the industry show that the industry is overvalued by about 15%, giving PHM a potential relative valuation of 50% undervalued.

## Opinion

I would give $PHM a buy rating. They have a strong, cash generating business model. There is more risk associated with owning them than a comparable consumer staples business, but there is also much more potential reward and in my opinion the reward is more likely to be realized than the risk. This is something I would be comfortable holding in my [portfolio](https://www.reddit.com/r/ValueInvesting/comments/oeedlq/my_value_portfolio/?utm_source=share&utm_medium=web2x&context=3).

## Notes and sources

**Notes:**

Note 1. I am not a financial advisor nor am I a current shareholder of $PHM as of the time this was posted. This is my opinion and not a recommendation for you to purchase any securities without doing your own research

Note 2: Regions:

Northeast:

*Connecticut, Maryland, Massachusetts, New Jersey, Pennsylvania, Virginia*

Southeast:

*Georgia, North Carolina, South Carolina, Tennessee*

Florida:

*Florida*

Midwest:

*Illinois, Indiana, Kentucky, Michigan, Minnesota, Ohio*

Texas:

*Texas*

West:

*Arizona, California, Nevada, New Mexico, Washington*

Sources:

Their 10-K on the SEC website, Macrotrends, Glassdoor, Yahoo finance, Finviz, Wikipedia, $PHMs website and their subsidy websites.

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5 Comments

  1. I work at a big-box home improvement store, and from what issues I help customers who buy Pulte homes fix, I can tell you this company builds absolute piles of crap. That doesn’t mean much in the way of stock, but I thought I’d tell people their products are 💩.

  2. KB Homes announced great returns and got destroyed by 5%. The overall market that actually moves stocks are terrified of their own shadow when it comes to anything housing. Until the paperhand pussies grow a pair, TOL, KBH, Pulte, UWMC are in for a rough ride.

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