Toll Brothers (NYSE:TOL) reported a solid set of third quarter results as the outlook for the fourth quarter deliveries and selling communities disappointed the investment community. Lower order intake also resulted in the fact that the company is eating into its order backlog, which is disappointing.
I continue to shun the shares amidst a fairly demanding valuation, quite some leverage on the balance sheet and fairly solid economic conditions for luxury home builders to operate in currently. I remain on the sidelines amidst those concerns.
Third Quarter Highlights
Toll Brothers posted third quarter sales of $1.06 billion, a 53% increase compared to the year before. Analysts anticipated that Toll would post sales bellow the billion mark, anticipating revenues of some $978 million.
The homebuilder more than doubled its earnings on the back of the sales growth with reported earnings coming in at $97.7 million which is nearly a 110% increase versus last year.
GAAP earnings more than doubled as well, coming in at $0.53 per share on a diluted basis, thereby comfortably beating consensus estimates at $0.45 per share.
Looking Into The Results
Revenues were aided by the fact that the company simply sold more homes with the number of deliveries having increased by 36% to 1,444 units. Growth resulted from the housing recovery and the acquisition of Shapell Homes. The remainder of growth was aided by an average of 12% increase in average selling prices which totaled $732,000 for the quarter.
Adjusted gross margins, which excluded interest and write-downs, improved to 26.8% of sales which was a 170 basis points improvement versus the corresponding quarter last year. At the same time, selling, general and administrative expenses dropped by 250 basis points to 10.4% of sales. This adjusted metric excludes $5.1 million costs which have been incurred related to the acquisition of Shapell Homes.
While the reported sales growth, higher average pricing and solid operating leverage in the business model are encouraging there was some bad news as well. Total net signed contracts fell by 4% to $949 million, resulting in a dollar book-to-bill ratio of little below 0.90, indicating that the company is eating into its current backlog.
CEO Yearley remains optimistic despite the lower signed contracts amidst healthy traffic. Throughout the quarter Yearley saw more contracts being signed not showing up in the current report yet. He also notes that pricing power is fading a bit amidst the recovery in home prices. Despite this trend, the company is not offering incentives to a greater extent, keeping margins intact as it feels comfortable with the current inventory position.
As Toll Brothers is currently ¨eating¨"into its backlog, the total inventory backlog position still totaled $3.1 billion which was actually up 9% versus last year.
For the current year total home deliveries are seen between 5,300 and 5,500 homes to be sold for an average between $710,000 and $725,000. This translates into full year targeted sales of $3.76 to $3.99 billion.
The fourth quarter is typically seasonally strong with the results so far this year indicating that sales for the final quarter are seen between $1.20 and $1.43 billion. This compares to last year's earnings of $1.05 billion for the corresponding period.
At the end of the quarter, Toll Brothers held nearly $390 million in cash and equivalents. At the same time the nature of the business which is quite capital-intensive, given the lot acquisition policies and past acquisitions, resulted in $3.4 billion in debt. This results in a net debt position of about $3 billion at the moment.
It should be noted that the access to credit lines and other financing options give Toll access to almost one and half billion in liquidity.
With 186 million shares outstanding at the moment, which are trading at around $34 per share, equity in the business is currently being valued at about $6.3 billion.
Based on the full year revenue outlook, equity is valued at around 1.6 times anticipated sales. Trailing reported earnings came in at around $300 million, valuing shares at some 21 times earnings. Note that full year earnings for this year could come in a bit higher as fourth quarter earnings are expected to rise as well on an annual basis.
Long Term History, Dominated By The Recession
Of course investors and the company have suffered big time from the financial crisis and subsequent recession which of course hit a builder, and a luxury home builder in particular, very hard.
With sales peaking at $6.1 billion in 2006 shares fell to paltry $1.5 billion in 2010 and 2011, resulting in a 75% drop in sales which is simply astonishing. Despite the fat margins on the building of luxury homes the company was forced to post four years of consecutive losses. Despite these terrible results, management must be credited for keeping the total share count rather stable, with cumulative dilution over the past decade only amounting to 10-15%.
The recovery is now apparent with sales approaching $4 billion again this year. Margins have recovered as well to about 8% on an after-tax basis, after peaking at levels above 10% in the years ahead of the recession.
While investors like the reported results, the investment community is not very happy with the outlook which the company gave. While gross margins being guided are appealing, the numbers in terms of deliveries and selling communities have been disappointing a bit.
At the start of June, I last had a look at the prospects for the business. At the time shares traded around $36 per share and they have fallen slightly ever since. Despite the upbeat conditions, although the housing market remains far from a peak, shares trade at twenty times earnings amidst quite some leverage on the balance sheet.
As the company caters the very luxury end of the housing market, which is being aided by strong performance of major asset classes and is impacted by less credit availability and mortgage rates to a lesser degree, I fail to see additional drivers going forwards. Of course the housing market should be able to show continued improvements, but I would not anticipate an acceleration of the multi-year trend.
As a matter of fact last year's $1.6 billion deal to acquire Shapell Homes to add more exposure to the high end of the market and California only increased the concentration risks, although Toll anticipates to divest some $500 million of that company's assets.
All in all I don't fancy paying an-above market multiple for a homebuilder with a struggled past amidst a leveraged balance sheet. While shares might offer value if the housing market accelerates, especially given the large holdings of construction lots for the future, the risk-reward is not necessarily appealing at current levels in my opinion.
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The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.