Toll Brothers (TOL), the higher-end homebuilder, is expected to announce fiscal Q4 2013 earnings before the opening bell on Tuesday, December 10th.
Despite the company pre-announcing Q4 2013 quarterly results with the acquisition of Shapell on November 7th, (and the results were better than expected), the stock is still trading about where the announcement was made and has given back its gains since the announcement.
The homebuilders generally and TOL specifically have been struggling since late May 2013 after the 10-year Treasury yield had risen from roughly 1.60% to 2.20% just in May 2013 alone.
TOL is up about 7.5% over the last 12 months, and just 1% year-to-date.
We posted this article to the SeekingAlpha site in late May 2013, detailing why we reduced our exposure to TOL and LEN materially, keeping only one position in each in one long-term account.
The issue around TOL and the rest of the sector was the valuation of the group: typically thought to be fairly valued at 1.5(x) tangible book value (TBV), the recovery in the stock price from late 2011 through early 2013 took TOL to a 40(x) p.e ratio and well above the book value of $17.50 per share for most of that trading period.
Given real estate accounting, these businesses are tough to analyze, and they constantly seem to be diluting their shareholder base.
When TOL announced the Shapell acquisition, management also announced that they were doing a secondary of 6.25 ml shares, which is 3.7% of the roughly 178 million fully-diluted shares outstanding, and in my opinion was management's way of telling the Street that the stock is fully valued. (TOL has the best balance sheet in the sector, and one of the few homebuilders that are investment-grade rated, so the fact is they probably would have had a tough time from the rating agencies issuing $1.6 billion in debt with their current $2.4 billion outstanding already. My guess is that, assuming they even asked the rating agencies for their opinion, that the credit rating agencies told TOL that they would downgrade the credit to junk.)
Despite TOL's pre-announcement beating expected consensus on revenues, EPS, orders and closings, the fact is the stock has still flat-lined.
Personally, I think the valuation is still catching up to the stock price.
For fiscal 2014 and 2015 current consensus is expecting $1.51 and $2.29 for expected year-over-year growth of 80% and 52%, respectively, with respective PE ratio of 21(x) and 13(x), respectively.
From PE to growth (PEG) perspective, TOL is very cheap. From a price-to-book value perspective, the stock has been overvalued for some time.
Technically, we would be a better buyer of TOL in the mid $20s particularly if and when interest rates start to rise.
The question we ask is the trade-off between higher interest rates and income and job growth. While this recovery off the 2009 recession low is the weakest in post WW II history, higher rates may not impact high-end housing as negatively if income and job growth occurs.
This is our favorite homebuilder in the group. We want to own this stock in quantity again, just at better levels.
To give readers some idea of the difficulty in valuing the homebuilders, Morningstar had an intrinsic value on the stock of $23 for the longest time, and then pulled the valuation, presumably due to a departure of the analyst. Our internal model has an intrinsic value on TOL of $60 per share, which would normally have us pounding the table on the stock, but the dilution issues and DTA's (deferred tax assets) referenced in the above link gave us pause in terms of the quality of the earnings.
You can see in the chart below the stock has been consolidating for well over a year now, and has dramatically underperformed the S&P 500.
The stock's reaction to another sharp rise in interest rates would tell us quite a bit about its prospects over the next year. The Yellen Fed, continued QE and no inflation haven't done much for the stock despite decent housing data.
The low $20s would be a dream buy point, $25 would be ideal, and another 10% - 15% correction in TOL would get us very interested.
Additional disclosure: One small position in a long-term account