Toll Brothers - Despite Improved Operating Conditions The Valuation Is Demanding

Jun. 2.14 | About: Toll Brothers (TOL)

Summary

Toll Brothers reports solid results as demand remains solid despite leveling off.

A further improvement in the housing market is anticipated.

Yet the current valuation is already reflecting a lot of future good news.

Toll Brothers (NYSE:TOL) reported its second-quarter results over the past week.

The homebuilder is pleased with ¨solid¨ demand over the past year, although it has been relatively flat following the strong growth in 2011. The company is confident that the housing sector is currently in a leveling stage, before further upward momentum will drive sales in the coming years.

Second Quarter Highlights

Toll Brothers reported second-quarter revenues of $860.4 million, a 67% increase from last year.

The jump in top-line sales boosted earnings which rose from $24.7 million to $65.2 million, with GAAP earnings improving to $0.35 per share.

Looking Into The Results

The jump in revenues is explained both through an increase in the volume being built as well as pricing. Revenues rose by 67% which was explained by a 36% increase in the number of units to 1,218 deliveries. Average selling prices improved by more than 22% to $706,000.

Comforting to investors, signed contracts came in at 1,749 units representing $1.27 billion worth of value. This resulted in a very strong book-to-bill ratio of 1.48, only adding to the backlog of the company. The current backlog contains 4,324 units worth $3.21 billion.

Gross margins improved by just 30 basis points to 23.6% of sales despite the strong market conditions. The acquisition of Shapell Homes resulted in 1.2% pressure on margins. Overall operating margins improved from 3.2% to 7.9% as selling, general and administrative expenses fell by 390 basis points to 11.5% of sales.

The Financial Position

Toll Brothers held nearly $365 million in cash and marketable securities at the end of the quarter, and had access to another $1.35 billion in credit facilities. Total debt stands at $3.46 billion which results in a net debt position of around $3.1 billion.

For the first half of the year, Toll generated revenues of $1.50 billion on which it net earned $111 million. The company has now reported trailing revenues of $3.2 billion on which it earned about $250 million.

At $36 per share, Toll Brother's equity is valued around $6.5 billion. This values equity in the firm at roughly 2 times annual revenues and roughly 26 times trailing annual earnings.

Given the growth opportunities and the leverage employed, Toll Brothers does not pay a dividend.

Further Growth Anticipated

As mentioned in the introduction, Toll Brothers is confident that the housing market is currently in a leveling off phase. Strong growth should be seen going forwards based on few current inventories as well as an increase in household formation and a solid economy.

The company is expanding across the nation in cities and areas like Boston, New York, Washington and Philadelphia. Expansion in markets like California and Texas last year will provide strong future growth, as the company is able to raise prices across the board in these areas.

To facilitate further growth, Toll Brothers acquired Shapell Homes in February of this year in a $1.6 billion deal. 119 home deliveries generated $102 million in revenues in the second quarter for Toll Brothers.

Implications For Investors

Toll had a decent quarter with both revenues and earnings coming in ahead of consensus estimates. The company maintained its expectations to close 5,100 to 5,850 homes. The company has raised its anticipated average selling price towards 690 to 720 thousand dollars. This could translate into a revenue guidance of $3.52 to $4.21 billion which is rather wide given that the company is already halfway into the year.

This also means that the trailing results continue to understate the real forward revenues and earnings, of course aided by the Shapell deal.

The solid demand allowed Toll to boost prices while higher mortgage rates and restrictive lending has not impacted the business much with many of its customers paying for their homes in cash.

While the company remains upbeat about the prospects, earnings will have to show a continued increase to justify the current valuation. Shares continue to trade below their all time highs of $55 set in 2005, yet shares trade comfortably above the levels in many of the good years before the financial crisis.

I find the valuation still a bit steep despite the strong backlog and the further anticipated recovery of the housing market. I remain on the sidelines.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.