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A Big Acquisition Overshadows PulteGroup's Q4 Earnings Weakness

By John Bromels - Jan 31, 2020 at 9:43AM

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Will this homebuilder's bet on offsite manufacturing pay off?

Residential homebuilder PulteGroup (PHM 3.55%) reported Q4 and full-year 2019 earnings on January 28. Results were mixed, with strong order numbers balanced against poor adjusted quarterly income and earnings numbers.  

The market didn't seem to know what to make of the results. Shares, which opened slightly higher, plunged 3% as the market had its first glance at the numbers. However, they immediately rebounded, recouping all of their losses and then some as investors digested the big news from the earnings report: Pulte is acquiring Jacksonville-based Innovative Construction Group (ICG), an offsite manufacturer of framing shells. By the end of the day, shares were up a healthy 6.4%.

Here's why this seemingly small purchase overshadowed the underwhelming numbers.

A house under construction

PulteGroup's latest acquisition is an offsite manufacturer of wood frames and roof trusses for wood frame homes like this one. Image source: Getty Images.

By the numbers

Metric Q4 2019 Q3 2019 Q4 2018 YOY % Change
Revenue $3.0 billion $2.7 billion $3.0 billion Flat
Adjusted net income $312.4 million $279.8 million $313.6 million Flat
Adjusted EPS* (diluted) $1.14 $1.01 $1.11 2.7%
New orders (net) 5,691 6,031 4,267 33.4%
Closings (# of units) 6,822 6,186 6,709 1.7%
Average price per closed unit $429,000 $426,000 $430,000 Flat

YOY = year over year. EPS = earnings per share. Data source: PulteGroup, Inc. earnings releases. Chart by author.

Annual numbers, including revenue, net income, and average selling price per unit, were essentially flat year over year. The exceptions were diluted EPS, which was up 3.1%, and new orders, which rose 9.4%, thanks in large part to the big Q4 increase.

Look who's buying

Growth in orders (both during the quarter and for the year) was strongest in Texas and the company's West region, which includes California. According to CFO Robert O'Shaughnessy on the Q4 earnings call, though, the most important factor in the big orders growth wasn't where people were buying, but who was buying: first-time homebuyers. 

Pulte divides its residential home offerings into three categories:

  • "First-time" or "starter" homes, which are smaller, less expensive, and geared toward younger homebuyers.
  • "Move-up" homes, which are larger and more expensive to accommodate growing families and higher budgets.
  • "Active adult" homes, located in communities that focus on senior citizens.

In April 2019, Pulte indicated that it was changing its strategy, which had been geared toward the "move-up" and "active adult" markets. Instead, Pulte would target more "first-time" homebuyers with offerings at lower price points. Indeed, on the call, O'Shaughnessy referenced "the ongoing and purposeful expansion of our entry-level business, particularly in the Southeast, Florida, and Texas," an effort which, according to him, seems to be paying off:

For the quarter, our first-time buyer orders increased 57% to 1,743 homes ... while pricing for first-time homes decreased by 8% to $342,000. ... This successful expansion of our first-time business is also demonstrated in the mix of our fourth-quarter closings. By buyer group, closings in the quarter were comprised of 32% first-time; 45% move-up; and 23% active adult as compared with 26% first-time; 47% move-up; and 27% active adult in the fourth quarter last year. ... Given the increased investment we have been making in assets that serve this buyer group, we believe we are well positioned to continue expanding this element of our business.

Fast, cheap, and good

Of course, an 8% decrease in pricing in a company's hottest product isn't necessarily a good thing. But that's where the company's other announcement comes in: the purchase of offsite builder ICG.

Based in Jacksonville, ICG primarily pre-assembles wooden wall frames and roof trusses, which are then delivered to construction sites in lieu of crews building them onsite. This can save valuable time on construction sites and reduce overall costs, especially labor costs.

However, what's especially exciting to Pulte's management is the prospect of branching out into additional offsite construction. CEO Ryan Marshall noted that ICG also offers pre-assembled floor systems and wants to look into expanding ICG's scope to include "installed windows and wall prep for mechanical, electrical, and plumbing."

He went on to add:

This acquisition has the potential to benefit our Jacksonville operations through faster cycle times, precision structural components and savings on lumber and other materials. More importantly, we see this facility as a model for integrating increased offsite production in other PulteGroup divisions. While likely a few years down the road, the opportunity is there to develop comparable production plants in areas where our scale in adjacent markets can support a dedicated factory.

In other words, Pulte is doubling down on its focus on first-time homebuyers and is looking for ways to cut costs to be able to make more money while keeping its price point affordable. This is something of a gamble, and as Q4's results showed, in the short term, it may result in lower (or, as in Q4, nonexistent) revenue and net income growth. But management should be applauded for picking a strategy it believes can win over the long term and doubling down on it. Smart investors should keep an eye on Pulte to see if its new strategy can lead it to outperformance

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