Up and down PulteGroup's (NYSE:PHM) second-quarter earnings report, the company posted great results. Revenue was up from the one-two punch of more home closings and higher prices, and it maintained its momentum with a growing backlog.
If you squint at just the right angle, though, there is one operational metric in this report that gives the slightest whiff of a slowdown in the housing market. Let's take a look at the homebuilder's most recent earnings results and see why this small number and broader market forces could be a sign of a slowdown.
By the numbers
|Metric||Q2 2018||Q1 2018||Q2 2017|
|Revenue||$2.57 billion||$1.97 billion||$2.02 billion|
|Net income||$324.1 million||$170.7 million||$100.7 million|
The headline numbers for PulteGroup were really good on every front. Revenue was up 27% year over year as closings and average selling prices increased 13% and 9.5%, respectively. Higher selling prices and controlled overhead expenses brought sales, general, and administrative costs as a percentage of revenue to 9.2%, which gave PulteGroup an operating margin of 14.8%. That is well above its operating margin over the past five years and puts the company on track for its best margin performance this decade.
Even on the operating side of the business, there was a lot to like. Aside from the higher closings and average selling price numbers, net new orders outpaced closings and gave Pulte an end-of-the-quarter backlog of $5.2 billion.
The only operating metric that was a slight negative was the fact that net new orders this past quarter were down 1% compared to this time last year. Management noted that it experienced some softness in new orders around May. That coincides with data from the National Association of Realtors that showed the inventory of existing homes on the market over the previous six months was the lowest in decades and existing home sales slipped. Higher borrowing rates and even higher home prices have finally started to exert some pressure on demand.
This is only one month of slower sales for Pulte, and it is only one negative data point in an otherwise great earnings report, so it may not be too much of a concern yet.
What management had to say
On the company's conference call, CEO Ryan Marshall took stock of the tailwinds PulteGroup has enjoyed over the past few years and addressed some of the things that led to slightly slower orders this past quarter.
It would be unwise for us to take all of the credit for the strength of the operating and financial gains. We recognize the favorable macro conditions that continue to surround and support our industry. As you would expect, when market dynamics include sustained demand and limited supply, prices will typically increase. This has certainly been the situation in housing for a number of years and has only continued as builders seek to pass through higher labor and material costs.
The ability to raise price is obviously positive, but affordability concerns are real, especially given mortgage rates which have been volatile. We continue to see increased traffic to our websites and to our communities, but the traffic to contract conversion rates eased a little during the quarter, particularly among first time and move-up buyers when mortgage rates rose in May. And while trends improved as the quarter progressed, buyers clearly want to see value in their purchase. This serves as a good reminder that affordability still matters.
Pricing in a slowdown?
Even though PulteGroup posted good earnings results and analysts have upgraded its stock in recent months, shares are down about 14% since the beginning of the year. It seems as though Wall Street is pricing in the possibility that the housing market is going to slow down. The fact that housing inventories are now on the rise and Pulte reported a year-over-year decline in net new orders seem to be the first real signs of fatigue in this long housing boom.
It's too soon to say whether this is just a temporary bump in the road or the start of a prolonged slowdown. Certainly, rising interest rates and astronomical home prices are going to put a damper on demand, but there is also strong economic growth, wage growth, and a large demographic -- millenial first-time buyers -- that will support demand.
The thing that investors should be mindful of as this shift happens is how Pulte and others allocate capital. If the housing market does indeed slow down, it won't be good to be holding several years of lots in inventory. It will be worth watching over the next few quarters to see if these market shifts indeed signal a trend.