A surge in the U.S. economy that has been led by the recovery in the housing sector has seen a flurry of investments in related stocks. Toll Brothers Inc. (TOL, Financial), nation’s premier builder of luxury homes, announced its fourth quarter as well as its fiscal Year 2014 results on December 10, 2014 that involved some notable gains along with some risks to consider. In this post, I have tried to capture the excerpts from Toll Brothers’ quarterly results so as to give a detailed picture to existing and potential investors.
Decoding the results
The 2014 fourth-quarter earnings per share (EPS) of TOL showed a solid 31.48% increase, i.e., from FY 2013’s fourth quarter reported EPS of $0.54 per share to $0.71 per share this quarter. The net signed contracts also rose by 16% in dollars and 10% in units with the average price per unit of net contracts signed being $757,000 compared to $717,000 in FY 2014’s third quarter and $721,000 in FY 2013’s fourth quarter. The company also witnessed a stable increase in revenue, to $1.35 billion, exceeding the expected revenue by almost 2.3% and the revenue of FY 2013’s fourth quarter by 29%. The primary reason behind this growth was company’s aggressive pricing policy along with a steady increase in the number of its homebuilding deliveries at the backdrop of the sluggish recovery of the housing sector.
The negatives to acknowledge
A bird’s eye view of FY 2014, however, painted a different picture altogether on account of missed expectations resulting in the downgrading of the price target from $36 to $30 by analysts. The company’s total backlog as on October 31, 2014 totaled 3679 homes and the reported Q4 backlog value was of $2.72 billion reflecting an increase of 3% as opposed to FY 2013's fourth-quarter-end backlog of $2.63 billion. However, this is not something that is highly impressive because of the fact that the units have stayed flat y-o-y in spite of increase in value. Also, the homebuilding gross profit margin declined by 130 bps sequentially. In addition to the aforesaid, selling, general and administrative (SG&A) expenses as a percentage of revenue increased 10bps to 8.9% despite higher revenues, excluding $1.4 million in Shapell acquisition costs.
Toll Brothers has been experiencing considerable volatility on the exchange and has fluctuated in the range of $39.95 on March 4 to as low as $28.92 on October 13th. Even after the announcement of results the stock saw a dip of 8 percent on the same day, highlighting the volatility. However, glancing at the above results, the pressure on the company to keep up with the rising costs despite increasing revenues, cannot be overlooked. Also, the acceleration of the growth of Toll Brothers seems to be flattening year-over-year. Yet again it is important to take note of the continuous increase in the company’s revenues which have been, in fact, exceeding expectations. Considering all of the above, Toll Brothers does not seem to be a particularly risk-averse choice yet investors could book good profits.
The acquisition of Shapell homes gave Toll Brothers greater strength in the Californian region in the reported quarter. This has also been a reason that in terms of units delivered and booked in 2014, Toll Brothers scored a better performance than in 2014. As this article on Seeking Alpha points out, the actual number of new units signed at Toll Brothers core business has gone down in the mid-single digits.
Final words
Coming too valuation, Toll Brothers has an edge over its competitors as it is reasonably valued at a PEG ratio of 0.75 and trailing P/E of around 17.81. This is quite cheap in comparison to its peers which have been trading at a higher multiple, owing to the housing recovery. However, the housing recovery is facing certain hiccups and that propagates ambiguity regarding the prospects of Toll Brothers. As such, investors need to be cautious of signals in this industry as stats would dictate the phases of the recovery.
Toll Brothers has access to considerable capital and as such, it has the requisite strength to take on projects and leverage from the pent-up demand. As the management itself mentioned, there is a demand for 1.5 million new homes every year and the supply has been in the range of 500000 to 1 million homes a year. Thus, there is unsatisfied demand in the market and that has pushed up the average selling prices of these homes and will continue to do so in the coming years. In keeping with that, I believe that Toll Brothers is destined to gain from this huge demand. Also, its pipeline instils great confidence and makes it a reasonable buy.
