Every time I write an article for Seeking Alpha, I feel like I have to start by apologizing. I’m sorry, but I’m a value investor. Value investing is based on the assumption that the point of owning a stock in a company is to share in the profits of that company, and that those profits must exceed a certain minimum for the risk the investor is taking. So I exclude stocks that just generate revenue growth, like AMC (CMA press release)…
Total revenue for the quarter ended December 31, 2021 will be approximately $1,172 million, compared to $163 million for the quarter ended December 31, 2020.
… but cannot earn money:
The net loss for the three months… will be between $195 million and $115 million.
This press release sent AMC shares up 5%. Pulte (NYSE:PHM)on the other hand, announced yesterday that it earned $637 million for the fourth quarter, or $2.51 per share, compared to $1.53 per share a year ago, and $0.20 better than the estimate by Wall Street analysts (Looking for Alpha). The stock rose a meager 1% and was down for part of the day. Eh?
Pulte is expected to earn nearly $10 per share for each of the next five years
But Pulte didn’t just announce an excellent Q4; he also predicted a terrific 2022. On his earnings conference call with Wall Street analysts, he laid out details of earnings of around $10 a share. And I expect Pulte to maintain that EPS near $10 for the foreseeable future. Here are the details; I’ll follow with the key assumptions behind the forecast.
Pulte’s Demand Story – Home Sales and Home Prices
Pulte management forecast on the earnings call that it will sell about 31,000 homes this year at an average price of $515,000, for homebuilding revenue of $16 billion, up more than 20% compared to last year and more than 50% compared to 2020. Why this huge jump? Management got the answer during its conference call:
The impacts of COVID that don’t seem to be diminishing are the desire to live as a single family and the ability to work from home indefinitely… We’ve seen a strong desire for homeownership across all markets and buyer groups. At one end we have mature millennials who are generating extraordinary first-time demand and product movement, while at the other end we have empty nesters who are downsizing or retiring in their next stage. of life.
These are the drivers of demand in the short term. The most important long-term driver is simply a national housing shortage, shown in this image:
American homebuilders have underbuilt since the 2008 financial crisis. We the people need more homes!
Yes, there are certainly negative aspects for housing demand. The two big ones are:
- US population growth has slowed significantly and will likely slow further. Fewer newcomers means less housing needed. But lots of people around the world want to live here, so growing up again is always an option.
- Interest rates have risen and could rise much more, making monthly mortgage rates higher. But wages are also rising faster than normal, offsetting some of the higher costs.
Net/net, I assume US housing starts will remain at their current annual rate of 1.1 million for the next 5 years. I also assume that Pulte maintains its current 2.75% share of US home construction, so its gated homes should be fairly stable going forward.
Pulte’s Profit Margin Story
Pulte expects its ’22 gross margin – profit margin before overhead – to be around 28.5%. This graph shows that this year’s gross margin is exceptionally high:
There are two reasons for the current high gross margin:
- House prices have skyrocketed, so houses built on old purchased land will be very profitable. This advantage should last for at least several years because, at any time, Pulte has a land reserve equal to more than 6 years of annual sales.
- Competition in residential construction is relatively healthy. No manufacturer is giving away the store to grab market share, unlike many other American industries today. There are no signs that this situation is changing.
Net/net, I expect Pulte to gradually return to more normal profit margins, a process that will take at least a few years.
Two other profit margin ratios are worth noting. One is the ratio of operating expenses to sales.
You can see that management has become more efficient over time. I cautiously assume that rising labor costs will slightly reduce this efficiency ratio over the next few years.
The other ratio to note is Pulte’s tax rate. It was running at 22-23%, but management expects it to be 25% this year due to the loss of one or two tax benefits. I maintain the rate of 25% in the future.
The Pulte Stock Buyback Story
The concepts are simple:
- The fewer shares outstanding, the fewer other owners there are to share the profits with.
- The lower the P/E ratio, the more shares that can be redeemed with the same amount of dollars.
Pulte clearly gets the first point, as this chart shows:
It also gets the send point. Pulte’s P/E ratio is currently at a low of 5 and hasn’t been much higher recently. The company returned $1.0 billion to shareholders last year. 86% of the return was in the form of share buybacks, only 14% was dividends. I expect a gradual increase to a $1.5 billion annual return to shareholders, and a similar 85% share of that return used for buyouts. The result should be a 5-6% annual reduction in shares outstanding, and should be higher if shares do not increase significantly.
Valuation – It’s hard to conclude that Pulte’s stock isn’t cheap
Yes, Pulte’s dollar earnings could very well peak this year as its profit margins return to more normal levels. The table above shows that I expect net income to grow from $2.4 billion this year to $1.8 billion in 2025. But the decline in the number of shares should only result in a modest reduction in EPS, from $10 this year to around $9 in 2025.
At Pulte’s current stock price of $53, that means 15-20% earnings yield (E/P) going forward. These are very attractive returns for quality management, a solid balance sheet (almost no net debt), a highly demanded product and stable competition. If you’re a value investor, Pulte sounds like a great story. If you are a growth or momentum investor and have gone this far in the article, I commend you for being open-minded and suggest that you compare the risk/reward on Pulte to the names you own.