Insiders Are Moving Into PulteGroup

 | Jul 31, 2013 | 5:00 PM EDT  | Comments
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Two insiders at $6.3 billion market cap homebuilder PulteGroup (PHM have recently bought stock in the company for around $16.50 per share. After rising sharply in 2012 on reports of a stronger housing market, many homebuilders have cooled this year and PulteGroup is no exception. The stock has suffered a 12% correction, year-to-date, against a rising market (the stock is still up about 150% since the beginning of last year). The stock dropped about 10% in late July after missing earnings for the second quarter of 2013.

Specifically, adjusted earnings per share of $0.26 were a bit below consensus of $0.30. Pretax income actually came close to doubling compared to the second quarter of 2012 -- after we add back noncore income and expenses (off of 20% revenue growth) -- but analysts had been expecting an even stronger performance from the company. PulteGroup generated about $340 million in cash from its operations during the first half of 2013, and with the company making very few capital expenditures relative to that figure, management was able to use this cash to partially pay down PulteGroup's senior notes and other debt.

At its current valuation, PulteGroup trades at 22x its trailing earnings. This figure shows that the markets expect the housing market to continue to offer high prices in the near term, allowing for homebuilders to continue their high growth. Despite having overestimated the company's adjusted earnings for last quarter, Wall Street analysts remain bullish on the name: Their forecasts for 2014 imply a forward P/E of only 12. Over the next several years, the five-year PEG ratio is only 0.4, so it is clear that in the eyes of the sell-side PulteGroup (as well as the homebuilding industry in general) has high upside potential.

Investors, however, would probably want to avoid placing too much confidence in analysts -- particularly following the company's recent miss. A trailing P/E of 22 is not particularly high, but PulteGroup would still be dependent on high housing demand in order to justify the current valuation.

We would note that the tight connection between the housing market (and, therefore, demand for PulteGroup's homes) and the overall economy results in a beta of 2.2. One implication of this is that high earnings growth would likely only continue until the next recessionary phase in the current business cycle.

Two similarly sized homebuilders are D.R. Horton (DHI) and Lennar (LEN). These two stocks are valued at similar levels to PulteGroup on a forward earnings basis, with P/E multiples in the 12-13 range, though of course this is due to analysts expecting these companies to experience high growth on their bottom lines as well. D.R. Horton saw its pretax profits more than double in the second quarter vs. a year earlier, with impressive revenue growth as well. Lennar did even better in percentage terms, with pretax income more than tripling in its most recent quarter compared to the same period in the previous fiscal year. It should be noted that these two stocks are somewhat popular short targets: 16% of D.R. Horton's float is held short as of the most recent data, and the corresponding figure for Lennar is 21%.

It's possible to read these insider purchases as a reaction to PulteGroup's recent decline specifically, as these insiders believe that the company remains on track to hit analyst targets for the next couple of years. This would position the stock as a potential "growth at a reasonable price" pick.

Of course, in order for the company to do that well, the homebuilding industry as a whole would have to prosper. At least in forward earnings terms, the stock doesn't seem to offer many advantages to its peers. Homebuilders do appear risky, but for investors whose portfolios aren't already overexposed to macro conditions, they might be worth investigating.

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