This Homebuilder's Improving in All the Wrong Ways

PulteGroup (NYSE: PHM  ) and its competition like Lennar (NYSE: LEN  ) and Toll Brothers (NYSE: TOL  ) could each be good plays on the housing recovery. However, there are a few key differences between PulteGroup and its peers. Unfortunately for its investors, these differences could spell major trouble for PulteGroup's performance in the future.

First, the improvements...
PulteGroup isn't performing up to its peers in other ways, but the company has gotten better over the last year. The overall housing market is recovering, and the resulting stronger pricing is benefiting PulteGroup and other homebuilders across the board.

In its recent third quarter, PulteGroup's average selling price rose 11% year over year. This result fell between Toll Brothers' improvement of 8% and Lennar's average-sale-price increase of 16%. This macroeconomic benefit isn't exclusive to the company, but it's helping to pull Pulte along.

On a more company-specific basis, PulteGroup is being more conservative with its balance sheet relative to its peers. While PulteGroup cut its debt, both Lennar and Toll Brothers reported significant increases in their net long-term debt in the last year. Lennar reported a debt-to-equity ratio of 0.8 in the most recent quarter, and Toll Brothers' ratio came in at 1.3.

By comparison, PulteGroup's net long-term debt has been cut by more than 40% in the last year. Partially thanks to this decline in long-term debt, PulteGroup's debt-to-equity ratio now stands at a highly respectable 0.5.

As great as this improvement has been, there are problems that could derail the company in the future.

What happened?
In the current quarter, PulteGroup reported that new orders fell by 17%. If PulteGroup's peers reported declining orders, this wouldn't be a huge problem, but Lennar and Toll Brothers reported no such issues. In fact, Lennar reported that new orders jumped by 14% and Toll Brothers saw a 23% increase in new orders.

For investors expecting strong earnings in the future from PulteGroup, this decline in new orders argues that challenges lie ahead.

If PulteGroup's new order challenges aren't enough, investors need to watch the company's backlog and cancellation rate, too. If you're looking for strong growth in revenue and earnings from a homebuilder, ideally you would like to see strong backlog growth in both units and dollars.

However, investors must also consider the company's cancellation rate when examining this backlog growth. Take a look at the three companies we've looked at, and tell me whether you see a problem.

 Company

Backlog Annual Revenue Growth

Backlog Annual Unit Growth

Cancellation Rate

Lennar

53%

32%

18%

PulteGroup

9%

(2%)

18%

Toll Brothers

57%

43%

5.5%

Source: SEC Filings

There are two things that virtually jump off the page in comparing these homebuilders. First, we can clearly see that both Lennar and Toll Brothers are growing their backlogs at a significantly faster rate than PulteGroup. Second, though PulteGroup is growing its backlog slower, the company's cancellation rate is just as high as Lennar's.

If we adjust each company's backlog revenue growth for its cancellation rate, we find that PulteGroup is at an even more significant disadvantage. While Lennar and Toll Brothers would still grow their revenue by 43% and 54%, respectively, PulteGroup's revenue growth would be cut even further, to slightly more than 7%.

Bottom line
PulteGroup has improved its balance sheet, but this might not matter if the company can't boost new orders and backlog growth. Lennar operates at a similar price point to PulteGroup, and it's significantly outperforming its peer. Toll Brothers dominates the high-end housing market and is outperforming the other two.

No matter how you look at it, PulteGroup has improved -- except where it really matters.

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