Pultegroup Inc

NYSE:PHM

Earnings Call Analysis

PulteGroup's Q2 2024 Earnings Highlights

PulteGroup reported strong Q2 2024 results, with an 8% rise in home closings and a 2% increase in average sales price, reaching $549,000. Gross margin improved by 30 basis points to 29.9%, driving a 19% earnings jump to $3.83 per share. Revenue grew by 10% to $4.4 billion. Despite mixed market demand, PulteGroup anticipates closing 31,000 homes this year with a 5%-10% growth forecast for 2025. The company also reported strong cash flow and ongoing share repurchases, reflecting solid financial health and strategic positioning for future growth. The CFO transition plan begins in early 2025.

Strong Financial Results and Strategic Approach

PulteGroup displayed robust financial performance in the second quarter of 2024, maintaining its strategy of balancing price, pace, and investment to yield superior returns. The company's focused approach is evident from its 19% increase in earnings per share to $3.83. One of the most significant achievements was achieving a 27.1% return on equity over the trailing 12-month period. Key drivers behind these strong figures included a 2% uptick in the average sales price and an 8% increase in home closings.

Enhanced Operational Efficiency and Land Strategy

The company has been effective in building a more efficient and quicker-turning land pipeline, with lots controlled via option rising to 53% of total lots. They have secured nearly 13,000 lots under these terms, involving $1.5 billion in capital. This strategy is poised to meet the firm’s forecast of closing 31,000 homes this year, marking a 5% to 10% growth target for 2025. The meticulous management of land assets contributed to favorable gross margins, with substantial pricing strength driving these outcomes.

Revenue and Sales Performance

PulteGroup’s total revenue for the second quarter stood at $4.4 billion, representing a 10% increase over the same period last year. This gain was driven by an 8% increase in home closings and a 2% rise in the average sales price to $549,000. Importantly, the mix of buyer groups remained diversified, with 40% first-time buyers, 37% move-up buyers, and 23% active adult buyers. These positive results were further bolstered by strong land investment and development efforts, totaling around $1.2 billion in the quarter.

Expected Continued Growth and Strategic Decisions

Looking forward, PulteGroup expects to close between 7,400 and 7,800 homes in the third quarter, maintaining an average sales price range between $540,000 and $550,000. Gross margins are projected to be around 29% in the third quarter and between 28.5% and 29% in the fourth quarter. The company plans extensive capital returns to shareholders, with significant share repurchases and debt reductions contributing to a low debt-to-capital ratio of 12.8%. With Fitch upgrading its debt to BBB+ and Moody's offering a positive outlook, the company's financial positioning remains strong.

Challenges and Future Outlook

Although the company's second-quarter numbers are robust, PulteGroup acknowledged that demand was slightly less consistent compared to the first quarter of 2024. Factors such as elevated interest rates and competitive markets, particularly in Florida and Texas, presented headwinds. Nevertheless, the long-term outlook remains positive, driven by an underbuilt housing market and structural demand. Overall, PulteGroup's disciplined approach to managing price and pace, coupled with strong land and asset management, positions it well for continued growth.

Earnings Call Transcript 2024-Q2

[Operator]

Thank you for standing by, and welcome to the PulteGroup's second Quarter 2024 Earnings Conference Call. [Operator Instructions] I'd now like to turn the call over to Jim Zeumer, Vice President of Investor Relations. You may begin.

[James Zeumer, executive]

Great. Thanks, Rob. I want to welcome, everyone, to PulteGroup's earnings call to discuss our strong financial performance for our second quarter ended June 30, 2024. Here to review PulteGroup's Q2 results are Ryan Marshall, President and CEO; Bob O'Shaughnessy, Executive Vice President and CFO; and Jim Ossowski, Senior Vice President, Finance.

A copy of our earnings release and this morning's presentation slides have been posted to our corporate website at pultegroup.com. We'll post an audio replay of this call later today. I want to alert everyone that today's presentation includes forward-looking statements about the company's expected future performance. Actual results could differ materially from those suggested by our comments made today.

The most significant risk factors that could affect future results are summarized as part of today's earnings release and within the accompanying presentation slides. These risk factors and other key information are detailed in our SEC filings, including our annual and quarterly reports. Now let me turn the call over to Ryan Marshall. Ryan?

[Ryan Marshall, executive]

Thanks, Jim, and thank you to everyone joining today's call. PulteGroup delivered another quarter of strong financial results, which reflect an approach to the business in which we seek to balance price, pace and investment over the long term to generate superior returns. Consistent with this strategy, our financial results continue to show the power of capitalizing on the value of each lot and home we sell.

Our divisions work extremely hard to secure, and entitle and develop our land assets and worked equally hard to generate exceptional profitability while still turning our portfolio or rate. Specific to our second quarter performance, we realized a 2% increase in average sales price, an 8% increase in closings and a 30 basis point gain in gross margin, which in aggregate helped drive a 19% increase in earnings to a second quarter record of $3.83 per share.

Another quarter of overall strong financial performance, highlighted by our double-digit earnings growth resulted in PulteGroup generating a return on equity of 27.1% for the trailing 12-month period. Obviously, a key driver of our strong financial results and high returns on invested capital continues to be the company's outstanding gross margins. As Bob will discuss, gross margins in the period vetted from a favorable mix of closings but I would also highlight the pricing strength evident in our numbers.

In Q2, product options and lot premiums averaged $104,000 per home and represented approximately 19% of our average sales price of $549,000. As I'm sure you can all appreciate, options and lot premiums are high margin dollars and an important contributor to PulteGroup's outsized margins relative to peers. I know how hard our employees work to deliver such outstanding results, and I want to thank our entire organization for their efforts.

As good as our second quarter numbers are, it's fair to say that as we navigated through the period, demand was a little less consistent than we experienced in the first quarter of 2024. On our Q1 earnings call, we noted buyer traffic has slowed the first few weeks of April. While subsequent Wall Street channel checks confirmed a change in short-term demand the fact remains that we are operating in a housing market that has been underbuilt relative to population, immigration, household formation for more than a decade.

The resulting housing deficit of several million homes is likely a structural reality for years to come given the zoning challenges we face in most municipalities. Our country's underlying new home supply issue has been exacerbated by the lock-in effect caused by the dramatic rise in interest rates over the last 2 years. But the market continues to experience is existing homeowners who are unwilling are more likely unable to give up the low rate mortgages originated several years ago.

As a consequence, the inventory of quality in existing homes remains below long-term averages in any markets. The supply imbalance is 1 of the reasons that I have comment in the long-term demand trends for housing in this country, but I appreciate that buyer demand will fluctuate from quarter-to-quarter. For example, the bump in interest rates in the second quarter caused some buyers to become more cautious while other software ability stretched beyond their financial capacity.

While many cities are facing a limited supply of homes for sale, we have seen an increase in existing and new home supply in select markets in Florida and Texas. These markets are now in the process of finding the new clearing price needed to work down any excess inventory. May be more impactful than rates in inventory, the feedback we are getting points to a lack of confidence among some consumers that now is a good time to buy.

High prices, higher interest rates and the resulting high monthly payments are making potential buyers more cautious in purchasing a new home. To the degree that this lack of confidence among consumers reflects affordability concerns. This isn't new. And in fact, it's something we address on a market-by-market, even community-by-community basis every day. It was more than a year ago that you first heard me say that delivering high returns requires that we turn our assets and that we won't be margin proud.

In an environment where market conditions are more competitive, we have worked to ensure that our products, prices and incentives are clearly meeting buyer needs. Consistent with this focus on turning our assets, we continue to build a more efficient and faster turning land pipeline. In the quarter, lots controlled via option increased to 53% of total lots. We are successfully building on our historic base of lots option directly with the land sellers by increasing our use of third-party land vendors.

To date, we have entered into transactions representing almost 13,000 lots and $1.5 billion of capital. As with all land-related activities, we are being disciplined in how we expand this part of our portfolio, but we are making steady progress in assembling a more efficient land pipeline. As we sit here at the midpoint of 2024, I would say that it is shaping up to be a very good year for Pulte. Relative to our expectations coming into 2024, not only did we raise our initial closing guide by 1,000 homes, we are clearly on a gross margin path well above our initial guide.

For various reasons, market conditions got a little tougher in the second quarter, but we continue to actively manage price, pace and starts to drive the best business outcome. Based on the current demand conditions and construction cycle times, we continue to start homes at a pace consistent with closing 31,000 homes this year as well as positioning the company to grow 5% to 10% in 2025, consistent with the multiyear outlook we have discussed previously.

Through the first few weeks of July, traffic to our communities has been solid. But depending on how demand conditions and absorption paces evolve up or down in each market over the balance of the year, we will adjust our start pace as needed. Now let me turn the call over to Bob for a review of our second quarter results.

[Robert Shaughnessy, executive]

Thanks, Ryan, and good morning. PulteGroup generated second quarter wholesale revenues of $4.4 billion, which represents an increase of 10% over the second quarter of 2023. The increase in revenues for the period was driven by an 8% increase in closing to 8,097 homes, in combination with a 2% increase in our average sales price to $549,000.

On a year-over-year basis, the increase in our ASP reflects modest price increases in our first-time and active adult communities, while prices in our move-up communities were consistent with last year. The increase in our average sales prices for the quarter also reflects the impact of FX, as we recorded higher closings within our move-up business, which at $650,000, carried much higher prices than our first time in -- business.

Broken down by buyer group, closings in the second quarter consisted of 40% first time, 37% move-up and 23% active development. This compares with the mix of closings in the second quarter of last year, which was 41% first-time, 34% move-up and 5% active adult. Reflecting the headwinds caused by higher rates and other market dynamics are 7,649 net news were down 4% from last year's exceptionally strong results. In particular, I would highlight that last year's Q2 orders benefited from Del Webb brand opening and build-for-rent sales that are lumpy in nature.

As has been well reported, operating conditions in select Florida and Texas markets got more competitive in the second quarter as interest rates rose during the month of April. On our first quarter earnings call this year, we indicated that buyer traffic has slowed during the first few weeks of April, and this slowdown did ultimately impact orders as we move through the period. For the second quarter, our average community count was $934, which is an increase of 3% over the same period last year.

The resulting absorption pace of 2.7 orders per community per month in the quarter is above the pre-COVID average, but down from the 2.9% we generated last year. More granularly, our net new orders in the second quarter decreased 3% among first-time buyers, increased 4% among move-up buyers and decreased 17% among active adult buyers. While we continue to see strong demand among active adult buyers, we did report a larger year-over-year decrease in their second quarter orders.

That decrease primarily reflects lower community count in the current year and some impact from the timing of openings and closings of several of our Del Webb communities. Adjusting for the impact of these dynamics, our net new orders at stores that were operating consistently in both periods shows an order decrease of only 3%. Consistent with our overall order results on a unit basis, our quarter end backlog was down 4%, 12,982 homes, although backlog value was down only 1% to $8.1 billion.

Turning to production. We started approximately 8,100 homes in the second quarter and ended the quarter with a total of 17,250 homes under construction. Of the 17,250 homes under construction, approximately 6,900 or 40% of spec, including an average of 1.3 finished specs per community. These levels are in line with our targets of 40% and 1 finished spec per community and put us in a position to meet our delivery targets over the balance of the year.

As always, we are prepared to adjust our cadence of spec starts up or down in response to sustained changes in overall -- demand. Based on the units we have under construction and their stage of production, we currently expect to close between 7,400 and 7,800 homes in the third quarter and continue to expect to close approximately 31,000 homes for the full year. As noted, we realized an average sales price of $549,000 in the second quarter, which is consistent with our prior guide for pricing of $540,000 to $550,000. Looking ahead, we expect closings in the third and fourth quarters to be in that same range of $540,000 to $550,000.

While our average price in backlog is higher than our guide, we have a lot of homes left to sell in flows this year, most of which will be spec production with our first-time buyer communities where pricing is powered. We reported second quarter gross margin of 29.9%, which represents an increase of 30 basis points over both the second quarter of last year and the first quarter of this year. As in Q1 of this year, our reported gross margins reflect a favorable mix at closing and a generally supportive pricing environment for many of the spec sales we closed in the quarter.

Second quarter gross margins also benefited from opportunities we've taken in prior quarters to improve net pricing in a number of communities across our portfolio. Consistent with such actions, incentives on closing in the second quarter was 6.3% selling price, which is down from 6.5% in the first quarter of this year. While recent macro data has sparked optimism about the potential for Fed rate cuts, we don't factor such expectations into our guidance.

What we do know is that rates remain elevated, affordability is stretched and our delivery mix will be less favorable in the back half of the year. As we discussed on our Q1 earnings call, in the third and fourth quarters, we will be closing more homes in our West region, where most carry a lower relative margin profile than we did in the first half of the year. These factors, combined with our need to be price competitive to turn assets points in an expected gross margin of approximately 29% in the third quarter and 28.5% to 29% in the fourth quarter.

As stated previously, we still have posed to sell in close to meet our full year delivery guide of 31,000 units. So demand conditions over the next few months can have an impact on the results build. In the second quarter, our reported SG&A expense was $361 million or 8.1% of home sale revenues. Reported SG&A includes a $52 million pretax insurance benefit recorded in the period. In Q2 of last year, our reported SG&A expense was $315 million or 7.8% of wholesale revenue, which includes a $65 million pretax insurance benefit.

Excluding the impact of the insurance benefits recorded in the first 2 quarters of this year, we continue to expect SG&A expense for the full year to be in the range of 9.2% to 9.5% of wholesale revenues. Turning to our financial services operations. We reported pretax income of $63 million in the second quarter, which is up from $46 million in the same period last year. The 36% increase in pretax income reflects strong financial performance across all business lines, including mortgage, title and insurance.

Our performance also benefited from an increase in capture rates across all business lines including a mortgage capture rate of 86% in the quarter, up from 80% last year. In total, reported pretax income for the second quarter was $1 billion, which represents an increase of 10% over the last year. Our tax expense in the second quarter was $239 million for an effective tax rate of 22.8%.

Our effective tax rate for the quarter includes the benefit of energy tax credits and a $13 million benefit related to the favorable resolution of certain state tax data. For the remaining quarters this year, we continue to expect our tax rate to be in the range of 24%, 24.5%. Taken altogether, we reported net income of $809 million, $3.83 per share. This compares to prior year reported net income of $720 million or $3.21 per share.

On a per share basis, we continue to benefit from our ongoing share repurchase program, which, on a year-over-year basis, reduced shares outstanding by 5% from last year. Capitalizing on our strong cash flows, we continue to support the future growth of our business as we invested approximately $1.2 billion in land acquisition and development in the second quarter. This brings our year-to-date land spend to just over $2.3 billion, keeping us on track to invest approximately $5 billion in land acquisition and development for the full year.

For both the quarter and the first 6 months of 2024, the allocation of land spend was 60% development and 40% acquisition. At the end of the second quarter, we had approximately 225,000 lots under control, of which 53% were held via option. Given the strength of our land pipeline, we continue to forecast community count growth of 3% to 5% in the third and fourth quarters of this year over the comparable prior period last year.

Consistent with our capital allocation priorities, we are also continuing to return capital to shareholders. In the second quarter, we repurchased 2.8 million common shares at a cost of $314 million or an average price of $113.79 per share. This brings our year-to-date share repurchase activity to a total of 5.1 million shares repurchased at a cost of $560 million, a $110.58 per share.

In addition to repurchasing stock, we also completed a tender offer for $300 million of our senior notes in the second quarter. As a result, our debt-to-capital ratio is now just 12.8% and our notes payable have decreased to $1.7 billion, which represents the lowest level since before we acquired Del Webb in 2001. After spending more than $1.8 billion during the quarter on land investment and the purchase of our equity and debt, we ended the quarter with more than $1.4 billion of cash.

Adjusting for our cash position, our net debt to capital ratio at the quarter end was 1.8%. I'm also pleased to report that an acknowledgment of our improved operations, strong cash flow generation and outstanding balance sheet Fitch recently upgraded our debt to BBB+, while Moody's upgraded its outlook to positive. Now let me turn the call back to Ryan for some final comments.

[Ryan Marshall, executive]

Thanks, Bob. Through the first half of 2024, traffic to our communities was good and absorption pace rent slightly above historic norms. So I feel good about our opportunities in the back half of the year. To the degree that the Fed actually cuts interest rates in the coming months, I think that will provide a powerful tailwind both financially and psychologically as we enter 2025.

Before turning the call back to Jim, I would draw your attention to a release we issued a couple of weeks ago about 1 of our newest community openings and our first in Utah in more than 20 years along with representing PulteGroup's reentry into my home state, Utah is the seventh greenfield new market entry we have initiated over the past few years. Through the first half of 2024, we increased home sale revenues by 10% and grew reported earnings per share by 25% over the last year.

Over the same period, we increased our land investment by 31% to $2.3 billion, while increasing year-to-date share repurchases and dividend payments by 37% to $645 million. We also retired $300 million of debt. PulteGroup has executed extremely well and with expectations of closing 31,000 homes for the full year, we are in an excellent position to drive strong results going forward. And finally, before opening the call to questions, I want to briefly address the press release we issued yesterday announcing our CFO succession plans.

After a truly impactful 13-year career with PulteGroup, Bob O'Shaughnessy is initiated a transition toward retirement at the end of 2025. Step 1 in this process is that Bob will relinquish his title as Chief Financial Officer effective early February of next year. I'm pleased to say that Bob will then remain with us for another 10 months as Executive Vice President. During that time, he will support a smooth transition of CFO responsibilities as well as continue to oversee our financial services business, our strategic partnerships and our asset management committee.

Since its founding, PulteGroup's greatest strength has always been the talented people who work here, reflecting this depth of exceptional people. I'm proud to announce that Jim Ossowski, currently Senior Vice President of Finance, has been named as the company's next CFO. Jim has had an outstanding 22-year career at PulteGroup during which time he has served as VP of Finance and Corporate Controller, VP of Finance Homebuilding Operations, Area VP of Finance and Director of Corporate Audit.

In his current role as SVP of Finance, he manages our critical asset management committee and FP&A function. Jim has been promoted to Executive Vice President and CFO effective February of 2025. At that time, Jim will report directly to me and will have responsibility for our accounting, tax, audit, risk management and treasury functions. In announcing these changes now, we ensure having plenty of time to implement a seamless transition of responsibilities. Now let me turn the call back to Jim.

[James Zeumer, executive]

Thanks, Ryan. We're now prepared to open the call for questions. So we can get to as many questions as possible during the remaining time of this call. [Operator Instructions] and I'll ask Rob to again explain the process and we'll open the call for questions.

[Operator]

[Operator Instructions] Your first question comes from the line of Stephen Kim from Evercore ISI.

[Stephen Kim, analyst]

Congrats on the results, and congrats to Jim and Bob, it's -- I'm glad to hear that we got a great transition going. So congrats everybody. I wanted to ask a couple of questions. If I could start off just by talking about your gross margin outlook. You indicated that you're going to be doing more in the West, I think, which is a little bit lower margin.

And you also talked about, on a longer-term basis, increasing your land banking initiative. I was wondering if you could give us a sense if you were to isolate the land banking -- the increased use of land bankers, I know that this is going to take a little time to kind of flow through all your results. But once that has happened, and you reached the targeted level that you think land banking is going to represent in your mix, how much of a margin impact overall do you think that, that alone would represent relative to where you are today?

[Ryan Marshall, executive]

Yes, Stephen, it's Ryan. Thanks for the question. And maybe the first part of the question about the margin in the balance of the year related to the West. We mentioned last quarter and it's continued into this quarter, the West has performed better than it had in kind of prior periods. So we've got a heavier mix of West Coast closings coming through. Those margins on a relative basis are a little bit lower. And so we've factored that into the margin guide that we've given for Q3 and Q4.

The margins are, I think you'll agree, incredibly strong at the levels that we've guided to. As it relates to land banking, we're making great progress, the goal that we've kind of laid out is to get from the historical 50% options that we've been running at, the 70% that incremental kind of 20% move was going to be done with land bankers. We're -- I highlighted in my prepared remarks, we're making great progress.

It's steady, it's deliberate, and we're absolutely on the path to get to 70%. In terms of the trade between margin and return, that's what we typically look at is we're looking -- what we're ultimately looking for is we're looking for transfer of risk. And with that, we typically see somewhere between 200 and 300 -- 200 to 300 basis point trade between margin and return. Every deal is unique. So to paint it with any more of a broad brush on that, I think, wouldn't be fair. And then the closing comment I'd make is, and I know you know this, Stephen, but we underwrite the return not to margin. Return is what we believe ultimately drives shareholder value.

[Stephen Kim, analyst]

Absolutely. And that's very helpful, that 20% increase in the 200 to 300 basis points, which is also pretty standard across the industry. So that's helpful. Wanted to talk about cycle times because also when you talk about returns, being able to build more quickly and, therefore, more efficiently also helps you in your return goals.

Can you talk -- can you update us on where your cycle times sit today relative to, let's say, a pre-pandemic kind of a situation? And if you think there's additional opportunities there and wrapped up in that, can you give us an update on ICG. It's been a while since we've kind of heard you talk about it. You've had it now for about 4 years, I think. Just give us a sense for sort of where that fits into the overall cycle time progression?

[James Ossowski, executive]

It's a great question, Stephen. So cycle time days in the quarter on closings were 123 days, so that's a pickup of about a week from where we were in Q1. I would tell you today, we've got a number of divisions where the cycle times are at or below kind of that 100-day target that we set for ourselves. But we do still have some divisions where it's elevated. I'd say trade availability is probably what's holding some of those divisions back.

Looking forward, as we look to the end of the year, we'll probably be slightly elevated over that 100-day target that we set, but we're working hard, and we think we can get there in the first half of '25.

[Ryan Marshall, executive]

Stephen, it's Ryan. Again, I'll take the ICG question. We're pleased with how ICG is performing. We've got 2 active plants, both located in the southeast part of the U.S. They do a mix of our business along with other single-family homebuilder business, and we have a decent amount of commercial business that runs through those plants as well, predominantly in the frame package for apartments.

That's -- if there was a part of the ICG business that's lagging and it would be that commercial business with the slowdown in apartment -- new apartment development or new apartment projects starting, we do have a physical location secured and owned -- actually more than secured, we own a location for our third ICG plant. We have not started construction on that yet.

We're just finalizing some of the design parameters for that new location. So as we have more details on that, we'll be sure to share it. We're pleased with not only the cycle time benefits we get out of ICG, the quality pickups, better safety, we also think we get better cost just in the way that we're able to buy particularly -- as it flows into the ICG plant. So happy with how that business is performing.

[Operator]

Your next question comes from the line of John Lovallo from UBS.

[John Lovallo, analyst]

You spoke about the uptick in inventory on the existing home side in certain markets like Southwest Florida and I think Texas, you mentioned. Are these levels concerning to you? Are there any markets where that inventory is concerning? And are you seeing more of an impact on your move-up business versus your entry level? Or how would you kind of characterize that?

[Ryan Marshall, executive]

Yes, John, it's a good question. Probably the 1 market that's higher than what we'd ideally like to see would be Southwest Florida. There, we've seen inventory -- resale inventory levels approach about 9 months. With the benchmark or the kind of equilibrium rate being 6 months. So we're a tad elevated. I wouldn't consider it concerning. That's been a very strong market for a long time. I think it continues to be a really desirable place for retirees and second homeowners.

So I think that market had unprecedented price appreciation Part of the reason that I think we're seeing some of the elevated inventory levels. The market will go through a bit of an adjustment. It will find a clearing price, and I'd expect inventory levels to come back to kind of a more normal range. There are a few markets in Texas that I think are in similar situation, Austin, Dallas would be the 2 that I would probably highlight.

That -- I have also seen unprecedented growth in population jobs and resulting home price increases. But other than the 9 months of inventory in Southwest Florida, there's probably nothing that I'd characterize as concerning.

[Robert Shaughnessy, executive]

One thing I might add to that. It's worth it to remember if they're selling a home more often than not, that's also a buyer. So it's not really net supply add to the market. It can influence pricing as much as anything else. And retail has always been our biggest competitor. We always have -- we have the advantage today of being able to offer rate incentives to the buyers. So for the demand that's there, we are a compelling choice first of that resale inventory.

[John Lovallo, analyst]

Okay. That's helpful. And then just on the cash flow, is $1.8 billion still the cash flow guide for the full year? You guys did, I think, $246 million of buybacks in the first quarter, another $314 million in the second quarter. How are you kind of thinking about that cash flow in the back half and the ability to repurchase more shares?

[Robert Shaughnessy, executive]

Well, certainly, our cash flow guide is still current. And I think we've historically not given a view as to how much we're going to be repurchasing in the forward periods. We've let our kind of actions speak for themselves. You can and should expect to see us continue to be in market.

[Operator]

Your next question comes from the line of Anthony Pettinari from Citigroup.

[Anthony Pettinari, analyst]

Congratulations to Bob and Jim. You indicated your guidance doesn't anticipate lower rates. And I'm just wondering, if benchmark mortgage rates were to fall 50 bps or 100 bps, is it possible to quantify what that would do to gross margin holding all else equal? And then maybe kind of a harder question to answer, do you get a sense that there's meaningful group of prospective buyers that are kind of on the sidelines until we get a move in rates?

[Robert Shaughnessy, executive]

Yes. It's an interesting question, and I wish I had a perfect answer for you, but a lot of it will depend on what is prompting that decline in rates, right? We've talked about this before. If the economy is healthy, lower rates are good because it means that the consumer's wallet is still healthy and they still have a job and the lower interest rate environment allows them to save some money.

I think in that environment, we would expect to see margins a tailwind because our incentive load likely goes down. If it is in concert with that, we're worried about recessionary impacts, GDP, not healthy jobs, not as solid as they are today. That has another influence. The other thing that this is supply, right? We talked about it in some markets. It's a little bit more competitive.

And so there could be a scenario where we've made it clear we want to sell homes, and we're going to find the price that's going to get there. While we may be able to save a little bit of money on the incentive for the financing, we may be in a position where we're giving some of that in some other form of incentive. So like I said, I don't know, Ryan, if you want to comment, but the broader environment is important to that is just what happened to rates. We've always said rates are interesting, but they are only 1 element of the consumer equation.

[Anthony Pettinari, analyst]

Okay. That's helpful. And then sorry if I missed this, but in terms of stick and brick costs in the quarter and then what your maybe second half gross margin guidance assume or contemplates, can you just give us kind of color on those trends?

[Robert Shaughnessy, executive]

So the stick and brick costs in the second quarter were $80 per square foot. That's flat with the first quarter of this year. As we look ahead, we expect inflation to be manageable maybe low single digits over the balance of the year backings.

[Ryan Marshall, executive]

And that's incorporated into the guide that we've provided.

[Robert Shaughnessy, executive]

Maybe worth highlighting I think Jim's referencing primarily vertical. The land costs, we've talked about kind of high single-digit increases through '24 also embedded in that guide.

[Operator]

Your next question comes from the line of Michael Rehaut from JPMorgan.

[Michael Rehaut, analyst]

I also want to offer my congrats to Bob and Jim. First, I wanted to circle back to the comments around the shift of the business over time to more lot optioning and just wanted to kind of clarify the comments earlier, you said that when you kind of move from a regular perhaps owned land position to a lot bank land position. I just want to make sure we understood that right, that it kind of shifts 200 to 300 basis points of gross margin, take that out of gross margin, but shift it into return on equity, if we heard that right.

And if we're talking about a 20% shift of the business, effectively 200 to 300 bps times 20%, we're talking about 40 to 60 bps impact of moving from gross margin to ROE. Just want to make sure that we're understanding that correctly. And if there's any other factors that we should consider in that longer-term move to more lot optioning and land banking?

[Ryan Marshall, executive]

Mike, it's Ryan. I think the way you've articulated is accurate. So I think your understanding is right. I would reiterate that the 50% that we have in our business today of land options. Those are land options with the underlying seller, and that's been the case for the last 7 or 8 years. So that's not a change. And going forward, we'd expect that to remain in that kind of 50-ish percent range. So the incremental optionality taking us from 50 to 70, that's the piece that will have more land banking in it.

[Robert Shaughnessy, executive]

Yes. Maybe just 1 point of clarification. I'd rather we're speaking to the IRR on the transaction as opposed to our return on equity. Like our equity gets influenced by lots of other things ultimately when you kind of get to the parent level. But on a deal-by-deal basis, banks versus nonbank, it is roughly a 200 to 300 basis point cost and margin and then a roughly 200 to 300 basis point benefit to the return on that transaction.

[Michael Rehaut, analyst]

Right. that's very helpful. And I think it's important to clarify that. Secondly, maybe looking at the balance sheet, I believe you still are kind of running below your target levels, which, correct me if I'm wrong, I believe are the 20% to 30% debt-to-cap ratio, net debt more or less around 0 the last several quarters.

How should we think about the potential to maybe even getting that leverage back to your targeted range? What's the potential for that? I think as you're kind of entering perhaps even in more of a tailwind type of macro backdrop to the extent that rates start coming down, how should we think about the balance sheet and the ability, particularly as you're shifting more and more towards lot optioning? What is the right amount of leverage. And to the extent that there's a potential to increase share repurchase as we've been thinking about this with other companies. How should we think about that for Pulte in the next several years?

[Ryan Marshall, executive]

Yes, Mike, the way that I'd ask you to think about capital allocation is we look at the needs of the business first and foremost. And that starts with how much investment do we want to put into land? How much investment do we want to put into dividends? How much investment do we want to put into share repo and as evidenced in over the last couple of years, we've even been retiring debt.

So we look at the collective needs of the business and then we think about how are we going to finance that. The business is performing incredibly well, and we've been generating great cash flow and that cash flow put us in a very favorable position where we haven't needed the levels of debt that we've historically used in the business. So I think we can all agree that having an appropriate amount of leverage in a business is advantageous and efficient from a return standpoint.

That's part of the reason that we set kind of our target rate at 20% to 30%. But we're not going to let the tail wag the dog here. We look at how we want to run the business, think about the capital that we need for that and then we look at how we're going to finance it. And in the position that we're in, we're in a great position to have lower leverage, lower debt and still do all of the things that we want to do strategically from an investment standpoint.

So I take the position that we're in from an overall debt level any day of the week and twice on Sunday. Could the business absorb or handle more debt certainly but again, the #1 priority is how do we want to run the business and then we go figure out how to finance it. Bob, anything else do you want to add to that?

[Robert Shaughnessy, executive]

No, other than that furthering Ryan's point, we -- as we get a more efficiently on pipeline, i.e., more optionality, I think we get to a point where our cash flows better match our earnings so less of the cyclicality of the balance sheet and the impact on cash flows from inventory changes, which say that the environment we operate today is going to generate a lot of cash so it is not likely that we would be leveling from here.

[Operator]

[Audio Gap]

attribute the slowdown and the higher inventory in those markets, too? Like what's driving that? And then the comments on the price discovery process, where are we in that process? Have you seen prices correct already? Or is that something you would expect going forward?

[Ryan Marshall, executive]

Yes, Ray, thanks for the question. I think what's created some of the increase in inventory is the unprecedented rise in price, which has caused some owners to become sellers for whatever reason. Those high prices have created a bit of an affordability challenge that prospective buyers are struggling to kind of digest at this point.

As I mentioned on 1 of the prior questions, I think what happens here, there'll be a little bit of a kind of price market clearing price adjustment process that will happen over time. I think it takes a terribly long time. But over the next probably 3, 6, 9 months, I would expect that market to kind of work through some of the buildup of inventory.

I'd point you to as an example, Austin. If you looked at the Austin market going back probably 2 years ago, a couple of years post-COVID unprecedented job growth, combined with unprecedented rise in sales prices, all of a sudden, the market kind of came to a bit of a slowdown. We saw build in inventory. It took about 6 months for the market to kind of work through some of that inventory and it settled back into kind of a more normal run rate growth rate. So my expectation would be probably for something similar to happen as it relates to Southwest Florida.

[Unknown Analyst]

That's really helpful. And then just on the gross margin guidance for the second half of the year, I think you were previously expecting sort of consistent 29% and through the back half, the expectation for the change in the outlook for the fourth quarter for sort of the exit rate, is that driven entirely by mix? Or are there other factors that are changing that expectation for the fourth quarter?

[Robert Shaughnessy, executive]

Yes. It's really a combination of 2 primary things. One is it's the mix that we've highlighted. And to a degree, we saw that coming. So it was in the 29 area that we had given back at the end of the first quarter, but that has continued. So we've got a bigger mix kind of number than we saw 90 days ago.

And really, we've highlighted the market's gotten a little bit choppier and so we see that there's likely to be a little bit more incentive. We told you we've got homes to sell and close. And so we're projecting that into our guide as well. I think it's worth highlighting the range that we've given now is a little bit lower, but it includes that same point that we had been at the beginning -- at the end of the first quarter.

So I don't want anybody to misconstrue. We don't see a big change in market. This is really just kind of circumstance.

[Operator]

Our next question comes from the line of Alan Ratner from Zelman & Associates.

[Alan Ratner, analyst]

For my congrats to Bob and Jim as well. So I'm actually going to take kind of the opposite side of the margin question because I actually think the guidance is pretty similar to your prior guide when you kind of consider the moving pieces with the upside this quarter, what seems like a bit of a mix shift in the back half of the year.

And I guess I was hoping you might reconcile that a little bit with the comments on Texas and Florida because those 2 states are a pretty sizable part of your business, over 40% of closings. And it sounds like you're kind of bracing maybe for a little bit of an incentive war, that's probably too strong of a word, but in the back half of the year in order to generate some volume. So I guess, my question or interpretation of the guidance is it feels like you're not necessarily factoring in that much of an incentive headwind in the back half of the year. So can you just kind of talk through that a little bit?

[Ryan Marshall, executive]

Yes, Alan, I think Bob's prior answer to Ray's question help to address that. Now I'd combine that with the comment that I made that we're not going to be margin proud. It's important for us to turn our assets, the demand environment and specifically, consumer confidence and affordability has been a little bit choppier. So the combination of a little bit more West Coast mix with a few markets where we think we're going to have to add in a few incremental incentives.

We've given kind of some incremental or some more kind of finite range and where we think margins fall in Q4. The guide for Q3, we left unchanged at approximately 29%, and we just put a range around the fourth quarter to accommodate for some of the things that I just described.

[Alan Ratner, analyst]

Okay. That's helpful. It just seems like it's pretty -- not too dissimilar from the outlook 3 months ago, even though maybe there's a little bit more conservatism in your outlook from what it sounds like, at least in those 2 states...

[Robert Shaughnessy, executive]

One other point, I mean we've got 13,000 units of backlog, the vast majority of which are going to deliver over the next 6 months. So we could see a lot of that. And to your point about forward incentive load, we already know what the incentives are on those homes. So it's really just an decrementally...

[Alan Ratner, analyst]

Got it. That's helpful. Second question is just a bit of a bigger picture, higher-level question. Some of your peers have kind of put out reset long-term absorption targets for the business and kind of raise that maybe from where the businesses have run historically. And those are for various reasons, maybe more of a spec mix, more entry level or just kind of just better efficiencies.

I'm curious, as you look at your return focus and obviously, the very strong margins, but the commentary about not being margin proud, is there an opportunity longer term to take the absorption run rate of your business higher compared to where it's run historically? And how much margin, if any, do you have to give up to achieve that?

[Ryan Marshall, executive]

Yes, Alan. I think the thing that I would probably reorient the focus would be around how difficult it is to have entitled land in this country. We're in an environment that is largely not in my backyard anti-growth environment both municipalities. So the land that we have entitled and we're able to develop become somewhat of a precious commodity, and we're treating it as such.

And we're treating it as such and balancing pace and price to drive the best returns that we can because we fundamentally believe that's what creates shareholder value. And I think the last decade of performance from this company demonstrates just that. Growth is a very important part of our story. And it's part of the reason that in our last quarter, we laid out a multiyear growth target of 5% to 10% over a multiyear period. So for 2024, we're going to be at the higher end of that range for the business that we'll deliver in 2024.

And then in my prepared remarks, I highlighted that for 2025, we'd expect to be kind of within that range. So the way we've been investing capital, the way that we've been thinking about kind of community level absorption and total volume deliveries out of the business are very much aligned with that 5% to 10% multi-year growth target. And I'd probably leave it there as opposed to going into by community absorption rates.

[Alan Ratner, analyst]

Makes a lot of sense. I appreciate the comments.

[Operator]

Your next question comes from the line of Sam Reid from Wells Fargo.

[Richard Reid, analyst]

One more question on Florida here. Just wanted to maybe hear your perspective or your latest perspective, I guess, I should say, on the insurance market. You generally build houses that are further inland obviously, to the latest building codes. But are you finding that higher insurance rates across the state are also potentially a driver behind some of the buyer trepidation there? Just wanted your perspective on that.

[Ryan Marshall, executive]

Yes, Sam, it's -- I think it's something that the entire country is grappling with, not just Florida. I think we've seen insurance rates go up in a number of states. Certainly, the issues are maybe more acute in the Florida markets. We are fortunate that we've got our own insurance agency. They do an amazing job. We have high capture and they're able to provide -- not only provide insurance coverage but to do it at a very attractive rate for the buyers that are buying in our communities.

To your point, our homes are built to this up-to-date code. They're more resilient, both in terms of building materials but also in terms of how they handle rain events and kind of rising water type events because of the way that we manage land development, on-site retention, drainage, et cetera. So I think it's not to be dismissed, but it's not something that's having an impact on our ability to sell homes.

The other thing that I would kind of highlight at least with a lot of Florida buyers, typically, you've got somebody that already lives in Florida. They're selling the home in Florida, and they might be moving to another location. So they've had insurance. They've been paying on a relative basis, higher insurance rates. And so there's not necessarily a shock there. There's also, as it relates to buyers that are coming in from outside of the state of Florida.

They may be on a relative basis to where they're leaving, they might be paying higher rates, but there are other benefits that they might be picking up in terms of lower property tax rates, no state income tax. So there is some -- you don't have to shovel snow and things like that. So there's some puts and takes to insurance rates.

[Richard Reid, analyst]

No, that helps. And then just maybe switching gears and touching on land really quickly here. And this is more of a clarification question. It sounds like you're talking to more of a high single-digit increase in land costs this year. At least that's what's hitting your P&L and flowing through the gross margin.

First of all, I just want to make sure I'm hearing that correctly. And then does that represent any change from your earlier your commentary? Because I believe the original expectation was for that to be closer to, let's call it, mid- to high single digits. Just want to make sure we're thinking of that correctly.

[Robert Shaughnessy, executive]

Yes. Apologies if we weren't clear. We haven't changed our cost estimates for land. I may be guilty of saying high single digits versus mid- to high single digits. It means the same thing. And I apologize, it's somewhere between 5% and 10%.

[Operator]

Your next question comes from the line of Mike Dahl from RBC Capital Markets.

[Michael Dahl, analyst]

Congrats Bob and Jim. Bob, I guess you're not free of us all quite yet. A couple of quick ones from my end. You characterized the July traffic as solid. Obviously, some moving pieces around rates over the past month and then normal seasonality, you would flow. I think your absorption would typically be down kind of mid-teens quarter-on-quarter in the third quarter.

Just given all the kind of attention from investors and analysts like can you give a little more clarity on kind of how the beginning of 3Q has looked? And are you trying to characterize this as kind of against what was choppy, solid is consistent with what you'd expect that are worth. How would you further clarify that?

[Ryan Marshall, executive]

Yes, Mike, it's always tricky when we're giving qualitative descriptions about 3 weeks of traffic in July. So we try to choose our words carefully. The second quarter, I think you've heard from us and our virtual from others that have reported. It was choppy throughout the quarter. But things in early July, 3 weeks in, have been solid, and we're pleased with kind of how the business is performing.

And probably the biggest thing that I'd want you to focus on is kind of our reaffirmation of how we view the business for the entire year, our start rate, what we believe we can deliver and kind of how that sets us up for kind of 2025. So certainly, 3 weeks of kind of data in July, I know they're important. I know there's a lot of focus on it. But I think the bigger picture of what's the full year of '24 are going to look like, how are we thinking about 2025. Those are the things that I think are probably more important.

[Michael Dahl, analyst]

Yes. Okay. Understood and fair. And then just sorry to keep going on kind of the Florida and Texas stuff, but just as kind of a level setting exercise. If we look at the orders, your Florida orders were down 9%, your Texas down 8% in the quarter. Is there any way you could give us some additional perspective on in those challenged markets in Southwest Florida and Austin, Dallas? How was the order performance in those markets, specifically in the quarter?

[Ryan Marshall, executive]

Yes. Mike, the only thing that I'd probably kind of point to there, Bob talked about in his prepared remarks, some of the Del Webb impact in the quarter. Both of those markets are big markets for Del Webb. So beyond some of the community count transition, the community count transition that we're having with some closing and new Del Webbs opening, I wouldn't really go any more granular than that.

[Operator]

Your final question comes from the line of Susan Maklari from Goldman Sachs.

[Susan Maklari, analyst]

Good morning, everyone. Thanks for squeezing me in. My first question is, you mentioned in your comments that the consumer is a bit more insure a bit more cautious. How would you generally characterize the health of them as you come into the third quarter and think about the back half? And what do you think is causing that increased caution? Is there anything that you're hearing from your salespeople on the ground that seems to be a more motivating factor in there for them?

[Ryan Marshall, executive]

Yes, Susan, good morning. Thanks for the question. I think it's really around 2 things. One, psychology and consumer confidence. So when rates uptick in early -- kind of early April, I think that had a real impact in kind of the confidence level of consumer when it comes to is now the right time to buy. We do some surveying on our website with prospective buyers when we ask that question. How do you feel about now is a good time to buy. And it was right in that time period that we saw kind of a noticeable change in kind of response to that question.

So Susan, I think, is just the rate change and the things that people are hearing in the news and reading in the newspapers. Some of it is impacted by affordability, how much is attributable to 1 versus the other hard to know. So I think the prospect that potentially rates might come down later in the year. I think that similarly could play into consumer confidence of biopsychology in a positive way.

[Susan Maklari, analyst]

Okay. That's helpful. And then you also mentioned that you recently reentered Utah. As you think about the -- your current geographic footprint and seeing that 5% to 10% growth target over time, how do you think about the current markets that you're in, are there more markets that perhaps could fit your profile for some of the products that you offer? And anything else that's interesting to you out there from a market or geographic perspective?

[Ryan Marshall, executive]

Yes, we're always looking at where is the population going? And are there new growth cities that could create interesting opportunities for us. With the 7 markets that we've entered over the last 2 or 3 years, I think we've -- we're in all of the markets that we need to be in today. Could there be opportunities down the road? Sure, I never kind of close that off, but we don't have any kind of remaining major growth cities that I think we've got to get into.

And then as it relates to kind of the cities that we're in and the growth targets, we're pleased with how all those cities are performing. And they're small -- relatively smaller businesses today and kind of our view of growth in those new markets, that's all embedded into our 5% to 10% growth rate.

[Operator]

And that concludes our question-and-answer session. I will now turn the call back over to Jim Zeumer for closing remarks.

[James Zeumer, executive]

Thank you. Appreciate time this morning. We're certainly around and available in the end of the day. If you have any questions, please submit them. And otherwise, we will look forward to speaking with you on our next call.

[Operator]

This concludes today's conference call. Thank you for your participation. You may now disconnect.