Has Housing Turned the Corner?
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
When it comes to the housing market, most people would have you believe that it's going to be multiple years before there is a recovery. However, looking at a recent earnings report by Toll Brothers (NYSE: TOL), you would get the sense that the market has already turned the corner, and is headed for better days.
Toll Brothers specifically competes in the higher end housing market, and you can see the strength in this part of housing from their most recent earnings report. The company reported second-quarter revenues up 17% and unit sales up 14%. In addition, net signed contracts increased 51% in dollars and 47% in units. Equally impressive is the company has a current backlog of $1.5 billion and 2,403 units, representing an increase of 49% in dollars and 37% in units versus last year.
The company's CEO, Douglas Yearly Jr., said, "It appears the housing market has moved into a new and stronger phase of recovery as we have experienced broad-based improvement across most of our regions over the past six months." Given the significant increase in signed contracts, backlog dollar volume, and number of units, it seems as though the CEO is not overstating that the housing market has moved into a new phase and one that most analysts are not willing to accept. The real question seems to be if this recovery will be centered around certain companies, or whether it will be a broad-based recovery that improves the fortunes of multiple homebuilders?
On that score, it appears on the surface that Toll Brothers has a superior position over some of its competition, in particular when it comes to earnings growth in the future. Looking at a few direct competitors, DR Horton (NYSE: DHI) is only expected to show 5% earnings growth in the next several years, and PulteGroup (NYSE: PHM) is also expected to see tepid earnings growth as well. When you compare these expectations to the fact that analysts expect over 23% growth in earnings from Toll Brothers, it seems that Toll Brothers and a few select builders will benefit more than the overall industry.
When trying to choose an investment in this industry, using the traditional P/E is misleading as P/E ratios are usually higher before a true recovery occurs. Given that DR Horton has the lowest forward PE and still shows a ratio of over 26 times earnings, you can see that the common investor might be misled into believing these stocks are more expensive than they truly are. In all three cases, analysts expect a tremendous increase in earnings from 2012 to 2013, which should help bring the forward P/E ratios down to a more reasonable level. What most homebuilders need to focus on is preserving cash until this recovery takes hold.
Since homebuilders' balance sheets determine which companies survive to prosper, it makes sense to compare how much cash versus debt each company has. Looking at Toll Brothers, DR Horton, and PulteGroup, you can see that each company carries a significant amount of cash and their cash burn rates are relatively modest.
|
Name |
Avg. Cash Burn Last 4 Quarters |
Cash & Investments |
Long-Term Debt |
Number of Months at Current Burn Rate |
|
Toll Brothers |
($81.86 million) |
$900 million |
$1.79 billion |
11 quarters |
|
DR Horton |
($15 million) |
$720.5 million |
$1.76 billion |
48 quarters |
|
PulteGroup |
$40.671 million |
$1.3 billion |
$3.09 billion |
N/A |
You can see that though Toll Brothers has recently shown negative cash burn, even if this continued the company could survive on its current cash and investments for nearly 3 years. DR Horton is in an even better position from a cash burn perspective, and PulteGroup actually shows positive average cash flow. The biggest difference between these three is only Toll Brothers is expected to show significant growth in the next few years.
Though Toll Brothers appears to carry the highest forward P/E ratio, the company carries the highest EPS growth expectation and from their most recent earnings report has reason to be optimistic. The company noted several other positive developments that were some of the best in over six years. The company's per-community net signed contracts were the highest for any quarter since 2006. In addition, the company's non-binding reservation deposits are running 39% ahead on a gross basis. The company expects to deliver between 2,700 and 3,200 homes for the full year at an average delivered price of $560,000 to $580,000. A recent issue with cancellations in contracts seems to also be dissipating. Toll saw a cancellation rate of just 2.4% versus 6.2% in the first quarter, and rates over 7% in the last two quarters last year.
I have a long-term outperform call on My CAPS for TOL that so far is one of my best picks. Given the optimism in the recent earnings report, I see no reason to change that call.
MHenage has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.
