Toll Brothers: Building value in luxury homes

Despite recent strength, this homebuilder is still in the early stages of recovery.

By TheStockAdvisors Mar 4, 2013 3:08PM
Home under construction copyright CorbisBy Ian Wyatt, $100K Portfolio

Toll Brothers (TOL) took a dip when the company's earnings report fell short of Wall Street's estimates. As a result, some investors sold. In my opinion, they are being shortsighted.

The stock has been a great investment in our portfolio. Even after the recent dip in the share price, we are sitting on a gain of 39%. And I think there's much more to come. The home builder posted earnings per share of three cents, well below the consensus analyst estimate of 10 cents. And revenues of $424.6 million also missed analysts' projection of $502.7 million.

First, I must say that analysts have only themselves to blame. When times are good, they all jump on the bandwagon. They ignore common sense.

Instead of exercising caution in their projections, they become over-exuberant. And I think that is exactly what happened with their estimates for Toll Brothers.

Let's look at the reality. Toll Brothers is the largest luxury home builder in the U.S. And like all home builders, they suffered mightily during the recession. But housing is on the road to recovery.

However, as you might expect, luxury homes aren't the first responders to a bullish housing cycle. The average new home price across the U.S. is $304,000, compared to $569,000 for a Toll Brothers home.

Yet Toll Brothers actually sold 746 homes in its first quarter, with increased sales in every region. New orders jumped 49% to 973 homes, while gross margin improved slightly.

It's true that over the past few years, Toll Brothers' prices and margins have declined somewhat. But that has been deliberate, as the company has expanded into smaller-margin communities where the increased volume and market share should more than make up the difference in terms of contributing to the bottom line.

Backlog -- a measure of unfulfilled orders for new homes -- has risen 66% to $1.86 billion. But pricing is also becoming more elastic, with the pent-up demand pushing increases.

The company plans to open some 70 new communities in the second, third and fourth quarters of this year. Furthermore, it expects to deliver between 3,750 and 4,300 homes in fiscal 2013, at average prices ranging from $595,000 to $630,000.

In addition to building luxury houses, Toll Brothers is spreading its tentacles, going after the condominium market, student housing and the apartment rental business. Toll Brothers is jumping into the rental market to take advantage of rising rents and dwindling supplies. 

In its quarterly report, the company said that it now has sites for about 4,000 rental apartment units and expects them to turn a profit in 2015.

The future looks bright for Toll Brothers. The shares hit a multi-year high at $38.36 on January 29 - before the earnings report. They lost a bit, but -- like the housing market -- are on their way back up.

There will certainly be fits and starts along the way to a housing market recovery. But this recovery remains in the early stages, and Toll Brothers remains a compelling investment.

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