Toll Brothers' Fantastic Fourth Quarter
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Tuesday morning, one of the nation’s premier homebuilders, Toll Brothers (NYSE: TOL),reported spectacular fourth quarter results. Revenues surged 48% year-over-year to $632.8 million, well ahead of consensus expectations. Earnings per share jumped to $2.35 per share from $0.09 a year ago thanks to the release of deferred tax assets. Pretax income jumped nearly 300% year-over-year to $60.7 million.
Key metrics for Toll’s business were mostly strong across the board. Net signed contracts in the fourth quarter jumped 70% year-over-year to 1,098 units, with a 75% surge in value to $684.1 million. The firm’s backlog jumped 54% to 2,569 units, with the value of that backlog increasing 70% to $1.67 billion. Stronger pricing also helped gross margins (ex-interest and write-downs) increase, up 40 basis points compared to a year ago at 24.6%. SG&A went in the same direction, falling 420 basis points to 11% of sales as a result of strong cost controls. The firm’s cancellation rate was nearly halved to 4.6%, exemplifying the need for new housing.
Two other metrics stood out, including the company’s increase in average price for delivered homes. Prices increased 3% compared to last year, and ticked up 1% sequentially, which suggests that the housing market continues to accelerate. The other metric we found bullish was the broad-based regional strength. Revenues in the West region more than doubled to $167.7 million, while the Mid-Atlantic region (the company’s largest in terms of sales) surged 37% to $204.4 million. Housing demand in the West region appears to be incredibly robust, as the unit amount of its backlog grew 174% compared to where it stood at the fourth quarter of last year.
Executive chairman Robert Toll added some fascinating results from a recent Harvard University study, stating:
Our optimism for our own and the housing industry's prospects is buoyed by basic demographics. During the last five years, population has continued to increase in the United States; however, household formations, a key driver of housing demand, have not kept pace. A recent study by Harvard University estimated that, based on historic trends, 1.8 to 2.8 million more U.S. households should have been formed since 2007 than actually were created. Recent trends suggest these formations are starting to occur.
If Toll’s correct, we should see significant sustainable strength in the market for new housing which bodes well for fellow builders such as Lennar, Pulte, KB, Ryland, and DR Horton, but also general housing plays like Home Depot (NYSE: HD) and Lowe’s (NYSE: LOW). We're not big fans of Lowe's, however. Same-store sales growth didn’t fare all that well, increasing 1.8% in both the US and company-wide, though we expect some acceleration due to Hurricane Sandy in the fourth quarter (management agrees).
Still, the pace of expansion doesn’t compare favorably to Home Depot which has been growing same-store sales closer to 4.2% due to its superior execution. As for Home Depot, the company continues to be a cash cow, as it has generated $4.4 billion in free cash flow year-to-date, returning over $3.3 billion via buybacks and $1.3 billion in dividends. Going forward, the company expects to repurchase $700 million of stock in the fourth quarter. Nonetheless, we don't like its valuation.
Although we think the fiscal cliff could have a marginal impact on home sales if no deal is reached, we think the market’s fundamentals remain strong. The prospect of a change in interest rate policy from a change in the Presidency (and the Fed) may have pushed pre-election sales, but we believe low rates going forward will help sustain the market recovery.
Overall, we found very few negative takeaways from the firm’s fourth quarter. Because credit for smaller, less capitalized homebuilders remains constrained, we like the company’s opportunity to leverage its financial liquidity to expand as the market recovers. Nevertheless, we aren’t interested in shares at their current price. With regards to names that will benefit from the housing recovery, appliance-maker Whirlpool (NYSE: WHR) remains the most undervalued, in our view.
We think the comapny will benefit from a better housing market regardless of whether the home is old or new. We believe the firm will see strong demand from new household formation and looser (or cheaper) credit, assuming the home equity and mortgage markets continue to recover.
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