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by Mike McDermott

Luxury homebuilder Toll Brothers (TOL) announced fiscal fourth quarter earnings yesterday morning – offering a positive perspective for the home construction industry…

For the fourth quarter (ending October 31), the company reported earnings of 9 cents per share, beating analyst expectations of 5 cents. Revenue was up 6.3%, hitting $427.8 million – also above the consensus target. Toll Brothers closed on 757 homes for the quarter, which represents an 8% increase over last year.

Toll Brothers signed 644 contracts for new homes during the quarter – up 15% over last year. The average price for these contracts came in at $606,000 per home, well above the average price last year of $565,000

The cancellation rate is an especially important figure to track, as this gives us a good barometer for how committed customers really are to taking delivery of homes. For the quarter, the cancellation rate came in at 7.9% versus 8.8% last year. So in the luxury homebuilding space, customers are increasingly likely to find financing and close on their purchases once the home is completed.

Looking forward to next year, management expects to deliver between 2,400 and 3,200 homes at an average price of $550,000 to $575,000. Toll Brothers currently has a backlog of 1,667 homes ordered but not yet delivered, representing a total value of $981 million.

The positive fundamental data backs up the improving technical picture that has been evolving for homebuilders over the past few months. In early October, the broad industry hit a low point – and since that time, investors have been accumulating exposure. The iShares DJ US Home Construction (ITB) ETF is now up 44% from the October low, and if other homebuilders continue to see positive demand, the run could continue for some time.

The Increasing Divide Between “Standard” and “Luxury”

If you look at broad indices tracking home demand, unit prices, or even existing home sales, you will see that the trends are improving. When tracking homebuilders, it is important to pick out an appropriate benchmark – and our ETF Scorecard on homebuilders outlines the difference between ITB and the other primary homebuilder ETF.

The SPDR S&P Homebuilder (XHB) proxy has a much higher concentration in home furnishing retailers which can distort the picture for the industry focused on actually “building homes.

But even focusing on companies that are in the business of constructing and selling new homes, there is significant differentiation between individual companies.

Toll Brothers offers a premium product at a premium price point. Sure, the overall prices have dropped since the speculative peak last decade. But the company still focuses on houses that cost more than a half million – which means that the company is selling to an affluent consumer.

As we’ve seen for more traditional retailers, the high-end consumer is still relatively healthy. Retailers offering premium products at premium prices are doing just fine. Ironically, the retailers serving the lower-income consumers are also doing well – because a larger portion of the US population is now falling into this category.

But retailers “in the middle” – offering quality products at a reasonable mark up – these retailers are seeing the size of their target demographic shrink.

To see this concept demonstrated for the new-home market, take a look at the stock chart for Toll Brothers, versus a chart for Beazer Homes (BZH). Beazer offers homes at price points that are 1/2 to 1/3 of Toll Brothers homes – and the company continues to struggle with losses and bloated inventories. Click to enlarge:

When looking at the two business models, Beazer homes has much more direct competition with existing homes still on the market. Consumers shopping for houses in the $200k range are likely to be more interested in distressed properties sold at a discount by banks, or attractive homes offered by by attractive existing homeowners.

But the $600k house shopper is often looking for that “new home” status symbol – and has little interest in finding a deal that needs additional work necessary to improve the property.

Today’s market environment is looking a bit overbought – with plenty of headline risk looming. But if we get a consolidation or pullback and the homebuilding sector remains relatively stable, both ITB and TOL look very attractive as buy candidates.

Disclaimer: This content is general information only, not to be taken as investment advice or invitation to buy or sell securities. As active traders, we may or may not have positions in securities mentioned. For full disclaimer click here

Source: Toll Brothers Raises Hopes For Homebuilders