Company Background:

Ticker: PHM (NYSE)

MCAP : 12B
Share Price: 47.50

They have a very simple business model; they buy land, build a house on the land, and then sell it all to a
customer. The vast majority of their homes are built to order – which means that they don’t begin
building the house on the land until a customer has entered a formal agreement and provided down
payment and a means of financing on the house. They also build around 20% speculatively based on
many local market factors such as job and population growth, proximity to growing business markets.
This allows them to compete more effectively with existing homes for sale in the market. I really like this
approach as it limits the overall risk for the company if house buying were to drastically slow down,
because at that point they’d just own plots of land in their inventory which in my opinion isn’t often a
very risky thing to own.

Competitive advantages:

Pulte is one of the biggest public home building companies in the area which gives them access to more
reliable and cheaper financing, control over land, and greater geographical and product diversification
over smaller companies. They also have greater access to skilled labour required to build houses that
many smaller companies lack.

ICG acquisition – ICG preassembles housing frames and delivers them to site which significantly saves on
labour costs (and amount of skilled labour needed to hire – significant problem in the market) as well as
materials savings. CEO mentioned in earnings call that this facility will act as a model for integrating
offsite production in other areas – mentioned it was likely a year or two down the road, but opportunity
is there. Implications: will allow Pulte to improve its gross margins as well as increase production despite
the shortage of labour in the market. Will give them a distinct competitive advantage over other major
companies in the first-time buyers market (which has highest market demand) if they potentially pass on
some of the savings to customers.

Pulte is also the recognized leader in providing baby boomers with active adult complexes which have
been growing quickly in recent years. Demand in this segment is likely to continue increasing as the baby
boomer segment continues to retire and move out of high density cities.

Another advantage

Another advantage they have is the management focus on capital efficiencies. And the management
team really follows through on these goals. For example, they got a new CEO in 2016 and his main focus
was to improve capital efficiency on the balance sheet. When he joined, they had owned 99,000 plots of
land and owned options on around 40,000 plots of land. Since then, they have improved this ratio and
now own 91,000 plots of land and own options on 89,000 plots of land. This makes their balance sheet
considerably more effective from a debt perspective, enhances the returns on equity, and mitigates
downside risk associated with owning the land.
I believe this strong management really gives them an advantage from an investment perspective and
makes me very comfortable holding the company. Their main goals are to achieve strong return on
invested capital, continue their very steady payments of dividends, return cash back to shareholders
through repurchase of shares, and to have outstanding management of leverage.

Valuation:

I believe the valuation is very appealing. They are currently trading at a 7.3X price to earnings ratio
compared to the industry average of 17.34X. They have the highest operating margin in the industry, as
well as have a gross margin of 26.6% compared to the industry average of around 22%. Operating
margin is mainly driven by the managements focus on efficiencies in construction and processes, and
has been consistently above industry average. Their gross and operating margins have both been
growing in the past 3 years, and should continue to improve with expansion of offsite construction.

Price to book value ratio is 1.7X compared to industry average of around 2.3X

Earnings per share has been growing dramatically as well. :

2017: $1.45 2018: $3.56, 2019: $3.67, 2020: $5.19, 2021 on pace for north of $6 per share.

ROE: 22% compared to industry average of 16%

They have a consistent dividend yield of around 1.3% right now, they also use cash to buyback shares
very often, in total they have purchased around 2.4% of the float in first 6 months of 2021 with 1 billion
left on repurchase authorization.

Free cash flow yield 13.9%

Safety:

They have a debt to capital ratio of 22% and a net debt to capital ratio of 4.5%

Quick ratio of 1.63X make me feel very safe considering their cash alone can pay off nearly all of their
short-term liabilities

Current ratio is very high but I kind of questioned how useful it was considering their inventory is land, I
feel more the quick ratio is a better showing of true health of the company

Overall cash position of almost 2 billion and short-term debt around 1 billion

Total debt 5 billion

Total assets 12 billion

Debt/equity ratio 0.71

Projections:

Industry average earnings per share sets them at 107 per share – probably unrealistic
Price to book value re rate sets them at $65 per share.

Long term Id expect somewhere in the middle of these numbers.

Other thoughts:

I want to say the main reason for the discount now is fear of rising rates will slow down house buying. I
disagree with the impact this will have on the company mainly due to the supply deficits present in the
industry.

With 15% of US GDP coming from housing, company considerably supports the US economic growth
output.

Also considerable supply and demand discrepancies in the American housing market. Estimated over the
past decade or so that supply has been about 7 million homes short of demand. I think that this gap will
continue and Pulte will continue to see increased demand for new homes to be available in the market

Available supply of homes for sales is currently at historic lows.

Increase in investment towards first time home buyers- NAR recently stated the biggest demand and
supply gap is in this group.

Small companies struggling to keep up with labour and pricing power; this will increase Pulte’s market
share if inflation does stress industry margins as small companies wont be able to keep up

Company is exposed to financial risk coming in the form of having a period where they extend an
interest rate lock to a loan applicant until the time the loan is sold to an investor. They hedge the risk
using forward contracts on mbs’s. Not exposed to variability in cash flows of derivative instruments for
more than 60 days, and majority of mortgages are sold to secondary market in 30 days. Main risk of this
strategy occurs in cancellations if interest rates drop. At this point in time interest rates can’t drop much
further so not a major risk currently.

Overall market risks that affect business discuss:

level of employment, consumer confidence, consumer income, availability of financing, interest rate
levels, inflation levels.