I have qualms about giving Toll Brothers a ringing endorsement
On Tuesday morning, April new home sales, compiled by the Census Bureau, were a major disappointment on the street. All four US regions broken down in the report showed declines starting in March along with a line of successive monthly declines. Upscale new home builder Toll Brothers (TOL) was due to release its fiscal second quarter performance on Tuesday evening. It is this story. Let’s explore.
For the three-month period ended April 30, Toll Brothers posted GAAP earnings per share of $1.85 on net income of $220.6 million. That was up from $1.01 per share and $127.9 million for the comparable period a year earlier. Toll Brothers generated $2.277 billion in revenue, up 18% year-over-year as it beat the high street in both revenue and profit. The cost of home sales as a percentage of revenue fell from 78.1% a year ago to 75.9%, while the gross margin of home sales increased from 21.9% to 24.1%.
Toll Brothers shipped 2,407 units for the quarter, up 6% from a year ago. The net value of contracts signed increased by 1% to $3.1 billion, while the value of the backlog increased by 35% to $11.7 billion. Additionally, after repurchasing approximately 2.2 million shares at an average price of $48.30 per share (expense of $106.5 million) during the last quarter, the Toll Brothers board of directors renewed the existing authorization to repurchase up to 20 million shares without an expiry date.
For the current quarter, Toll Brothers now sees 2,750 units delivered, an average price per home delivered of $895,000 to $915,000 (up from previous guidance of $875,000 to $895,000) and gross margin adjusted for home sales by 27%.
For the full fiscal year, Toll Brothers is seeing between 11,000 and 11,500 units delivered at an average price per delivered home of $890,000 to $910,000 and an adjusted gross margin on home sales of 25.7%.
Toll Brothers ended the quarter with net cash of $535 million, up from more than $1.6 billion six months ago. This change of more than $1 billion in its cash position is reflected in inventories which increased to $8.979 billion, dominating current assets of $9.824 billion (which corresponds to six months ago) . This compares well to current liabilities of $2.046 billion for a current ratio of 4.8.
Total assets of $11.544 billion dwarfs total liabilities less equity of $6.165 billion. On the surface, this track record gets a passing grade, but at a basic level. Long-term debt (loans to pay plus senior notes) is $3.191 billion, which uncomfortably eclipses Toll Brothers’ cash balance, at least for me, given the size of inventory on hand. However, I will not fail this balance sheet based on this debt, as I understand that commodity prices have been volatile and that the supply of raw materials as well as labor require increased production in these days.
I just need the reader to understand that there is a risk here. If the decline in new home sales continues as monetary conditions tighten, I believe it will become more difficult to sell high-end homes at the prices Toll Brothers has guided investors to. Excluding these stocks, the Quick Toll ratio is only 0.4. Now, obviously, the company’s inventory isn’t worth zero, but in such an environment, it won’t be worth $8.979 billion either.
Rated five stars (at TipRanks), Bank of America’s Rafe Jadrosich is the only sell-side analyst I’ve noticed giving his opinion on Toll since those numbers were released last night. Jadrosich maintained his “buy” rating on the name, but reduced his target price from $63 to $56.
Readers can see that these stocks are far from overbought or oversold. The stocks sold quite hard from December to March and have traded sideways (consolidated) ever since. As the move happened more gradually than it did for the broader market and stabilized better than said market, one has to decide exactly what we see.
An optimist would see a stock that is about halfway through the development of a mug or mug with a handle pattern. A less optimistic trader might see a two-month flat base that sent down the 21-day exponential moving average (EMA) and the 50-day simple moving average (SMA). Can an investor buy here? Technically, that’s not a bad idea. Fundamentally? Toll Brothers works well. The balance sheet is subject, but for good reason.
Why I won’t buy Toll Brothers on this report has everything to do with the macro. We could consider tighter monetary conditions to be reason enough to push some buyers out of the high-end new home market and into the existing home market (which is also in decline). On the other hand, if labor markets hold (extremely questionable), existing homes and possibly new starter-type homes could find expressed interest from younger or lower-middle-class families whose real estate prices had been exhausted.
That doesn’t do anything for the top end, though. If the economy continues to slow and the country goes through an economic recession, homebuilders like Toll will find buyers, but in my opinion the margin suffers. How much? I do not know.
Receive an email alert each time I write an article for Real Money. Click “+Follow” next to my signature for this article.