Toll Brothers (TOL) and its homebuilder peers have been notable stock market laggards in 2013, but I am bullish on Toll Brothers going into 2014. Toll Brothers' stock price had a big run coming into 2013 and some good news was already priced-in. For Toll Brothers, 2013 started on a good note, but hit a snag mid-year as interest rates spiked and drove up mortgage rates. As a result, home-buyers turned more cautious. However, I believe that the headwinds in 2H 2013 are transitory and the company is well positioned for 2014. In this article I will discuss the 5 take-aways from Toll Brothers' 4Q Fiscal 2013 results.
Leveling of Demand
The key phrase from the earnings call was "leveling of demand." Toll Brothers said that the financial performance in the 19 weeks since August 1 had been flat compared to the previous year. This period included the beginning of the current quarter.
The pause in the housing market is not new news. We all know that mortgage rates have gone up, housing prices have increased and the government shutdown impacted consumer sentiment.
The "leveling of demand" comment is the phrase that I will remember from this conference call. It is clearly a reflection of the past, but the key question is whether it is also a leading indicator.
Management views the leveling of demand as a lagging indicator and is optimistic going forward:
"We believe this leveling of demand will prove temporary based on still-significant pent-up demand, the gradual strengthening of the economy and the improving prospects of our affluent customers." (TOL 4Q 2013 earnings call, Seeking Alpha)
Expectations For Modestly Higher Prices
In 2013, Toll Brothers, like many homebuilders, took advantage of market conditions to raise prices. This worked out well in the first half of the year, but contributed to the leveling of demand in the second half.
Going forward, it will be interesting to see if Toll Brothers can keep pricing firm through the 2014 spring selling season or if it will cut prices to boost volume.
In 4Q Fiscal 2013, the average price of delivered homes was $703,000 compared to $651,000 three months prior and $582,000 in the prior year.
The average price per unit of net contracts signed was $721,000 in 4Q Fiscal 2013 compared to $706,000 in 3Q and $623,000 in 4Q Fiscal 2012 (source: TOL press release, December 10, 2013).
The 4Q Fiscal 2013 results were skewed higher by a few high price apartments at the Touraine in New York City.
Going forward, management's 2014 guidance called for an average price of homes delivered in the $670,000 to $720,000 range. Management said that about 60% of the deliveries for next year are already in the backlog.
Given the past pricing dynamics, management does not seem too aggressive about its pricing expectations going forward.
CEO Douglas Yearly said the following about pricing and incentives going forward:
"So the incentive right now is about $17,500 per house, which is 2.6% of the sales price of the home. One year ago, that number was just over $24,000 per house, which was about 4% of the sales price of the home. We are not adding incentives. We will, obviously, evaluate what, if anything, has to happen as this market continues and as the spring season is upon us. As we've said many times, our decisions on incentives and pricing in general is tied to backlog and the length of time it takes to build the next home. So as we build backlogs, and it's a 9-, 10-, 11-, 12-month delivery for the next home, we are less interested in incentivizing, and that's how we run the business. There are more contractors coming back to the industry. We are beginning to burn through some of our backlogs as sales have been flat over the last few months, but we will evaluate that decision community-by-community as it comes up. But you are correct. Right now, we are not adding incentives, and we do not anticipate that we will need to do that." (TOL 4Q 2013 earnings call, Seeking Alpha)
Management Still Positive On The Housing Cycle
It seems that we are past the low in the housing cycle, but some analysts and investors think that the leveling of demand over the last few months indicate that the housing market is at the peak of a short term mini-cycle within the long term recovery.
Chairman Bob Toll addressed this theory:
"No, I don't think, in the past, our experience has been to see mini cycles within the broader cycle. It's just been a broader one. This recent flatness brought on by whatever, but primarily, I believe, from Washington, D.C., is a new phenomenon and not something that we're used to. The limited supply is a very real thing. You've got a market that fell apart, basically, in '07 and stayed apart until '11. And during that time period, of course, there is no land being put in for approval. It's relatively little. And this is the same story that you've seen from '68, '74, '80, '81, '82, '88, '89, '90, the same movie has been playing, and it'll play again. And that is, because of the lack of supply, because nothing was put into the pipe when things were bad, when just a little demand comes, the price gets bumped up pretty rapidly because there is no supply, no inventory to take care of the demand. When that price pops up, then you create more demand that because people like the Duke Brothers, say, "Hey, they're trying to corner the Orange market. Let's get into it." And so you have the beginning of the next bubble take place. We're far from that right now, so that's one thing we don't have to worry about. But I think you're going to see the prices increase the same as they have in those last recessions that I just mentioned." (TOL 4Q 2013 earnings call, Seeking Alpha)
Analysts Are Cautious
One of the analysts on the earnings call said that more people will be watching the spring selling season than the Super Bowl.
If the sentiment of the analysts represents the sentiment of the broader market, then there is a lack of conviction about the rebound in the housing market.
If "buying low and selling high" means "buy the pessimism and sell the optimism" then the caution could be a good entry point.
The only problem is that the valuation is not cheap. Toll Brothers is trading at ~1.8x book value and 20x forward earnings.
Shapell Homes A Sign Of Management's Optimism
A few weeks ago, Toll Brothers announced the acquisition of Shapell Homes. The acquisitions gives Toll Brothers access to greater inventory in upscale California markets. It is a sizable acquisition and reflects management's optimism about the rebound in the housing markets.
Toll Brothers generated good results in fiscal 2013, but ended the year with a leveling of demand. Both the good news and the recent pause have been known by the market for a while (Toll already pre-announced results).
Nobody knows how to interpret the leveling of demand. Is it a lagging or leading indicator?
Analysts are cautious and management is optimistic.
Currently, I believe that the out-of-consensus view is to be bullish. I am looking at housing-related plays as I believe that the rebound still has a lot of room to run.
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