Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
"Sales of previously owned homes ticked up in March from a month earlier but were below year-earlier levels as tight inventory levels, rising mortgage rates and high prices made for a sluggish start to the spring selling season."
That's how The Wall Street Journal (subscription required) described the state of the housing market on Monday -- beginning to thaw in the spring weather after a long winter, but still far from blazing hot. This lukewarm forecast seems an odd time therefore to decide to recommend a housing stock. And yet, this morning, a few analysts did.
No fewer than eight separate analysts raised their price targets on shares of PulteGroup (PHM -0.80%) today, and two of them upgraded the stock, according to StreetInsider.com (subscription required). What's got Wall Street so excited about Pulte this morning? Let's find out.
Wall Street is building a bull case for Pulte stock. Image source: Getty Images.
March was no aberration -- but Pulte was
The housing market as a whole may not have shown significant improvement last month, but PulteGroup -- America's third-largest private homebuilder, according to Professional Builder magazine -- did.
Pulling back the magnifying lens a bit: Existing home sales grew strongly in February, while new home sales "cooled," reports WSJ. Rounding out the quarter on which Pulte reported, sales of both existing and new homes declined in January.
And yet, in its fiscal Q1 earnings results yesterday, Pulte said that it grew its sales 21% year over year (to $1.9 billion) in this dismal market, and more than doubled its profits per share ($0.59). CEO Ryan Marshall lauded the results as "an exceptional start in 2018," and boasted that Pulte is "in position to grow our business while continuing to generate high returns" (emphasis added).
What comes next?
According to Marshall, "mortgage and financial market volatility" have failed to diminish "robust buyer demand" for new houses built by Pulte. The CEO took this as evidence of "the strong underpinnings of this housing recovery which is being bolstered by sustained economic growth, good job trends, favorable demographics and a limited supply of homes for sale."
And that last point may be key to Pulte's success. If there aren't a lot of homes to sell, that would naturally raise prices and dissuade buyers from buying (especially when combined with rising mortgage rates, which make homes even more expensive to buy). At the same time, a limited supply of houses to sell creates strong demand to build new houses to grow the supply -- demand that Pulte can feed.
What analysts are forecasting
In its upgrade today, Buckingham Research predicted that Pulte will earn a total of $3.20 per share by the end of this year, and then grow those profits 11% to earn $3.55 per share in 2019, "with potential upside" to that number.
Based on this, Buckingham believes PulteGroup stock is worth $28 taking the bearish investor's view, or $50 if one feels bullish, and has set its price target in the middle of that range: $40 a share. (B.Riley/FBR, which also upgraded Pulte stock to buy this morning, likewise set a $40 price target on the shares. Other analysts who simply shifted their price targets value the stock at anywhere from $27 to $44.)
But here's the thing: Buckingham's earnings target for Pulte is actually below the norm on Wall Street, where consensus expectations are for Pulte to earn $3.31 per share this year, and $3.68 per share in 2019, according to data from S&P Global Market Intelligence. Thus, it's conceivable that Pulte stock could actually come closer to maxing out Buckingham's earnings target than the analyst is forecasting.
Pulte stock looks cheap
How should you value PulteGroup stock? Every investor's approach is different, but if it's any help, here's how I look at it:
With $8.5 billion in market capitalization and $3.2 billion in net debt, PulteGroup has an enterprise value of $11.7 billion. Free cash flow for the past 12 months of $755 million exceeds reported net income of $526 million, and indicates strong quality of earnings at Pulte. Divide the FCF number into the enterprise value, and Pulte stock has an EV/FCF ratio of roughly 15.5.
For a stock that analysts are forecasting will grow earnings at better than 27% annually over the next five years, that's a very cheap valuation. For that matter, even if you value Pulte on its GAAP earnings, the stock's valuation of 22 times debt-adjusted market cap is a pretty reasonable price to pay for 27% growth.
Long story short: Put me in the bulls' camp on this one. Pulte stock is cheap enough to buy.
