Sizing Up The Homebuilders: Chapter 1 - Toll Brothers

| About: Toll Brothers (TOL)

Summary

Through this article series, I will systematically analyze the homebuilding industry's strategic landscape and share key highlights with the Seeking Alpha community through a minimalist writing style.

National homebuilders are well positioned to benefit from the macroeconomic and demographic trends in the United States.

My goal is to build a deep and complete fundamental understanding of the players before I position my portfolio to benefit from these trends.

Click to enlarge

Can you say beautiful...

First, check out my article Homebuilders: Stars Are Lining Up for an overview of the macroeconomic and demographic backdrop.

An investor should consider an appropriately modified set of metrics when analyzing different industries; and for this series, the following metrics matter the most: description, management, size, footprint, revenue growth, backlog, gross margin, price-to-book ratio, and use of excess capital. I may also discuss any company-specific topics towards the end.

Please note that this article presents a brief overview of my analysis, which in full, extends deeper into regulatory filings, earnings calls, company presentations, and where appropriate and feasible, discussions with customers, suppliers, analysts, and management. I intend to soon start a Seeking Alpha PRO subscription service through which I will share my full analysis on each company.

Description

Toll Brothers (NYSE:TOL) is the nation's leading homebuilder for people who don't mind dropping upwards of a million dollars on a house, but hey, to each their own. No judgments here.

The company was founded in 1967 and is based in Horsham, PA.

Management

Bob Toll founded the company and it seems that he still runs the show, not just in the company, but also across the industry. He owns ~10% of the company (excluding options), which currently makes up approximately a quarter of his more than billion-dollar net worth. He's built an expansive management team, which is as capable as it comes. And just for flavor, here's my favorite analyst question of all time, asked by THE housing analyst Ivy Zelman to Bob Toll during the F4Q06 conference call, right after the peak of the housing boom and just before the crisis spread:

Which Kool-aid are you drinking because I want some

The back-and-forth exchange is worth reading.

It's also worth noting that the whole management team attends the company's earnings calls: 10 members of the management team and 12 sell-side analysts attended the last earnings call. Compare that to Amazon's earnings calls in which the CFO (not Jeff Bezos) is the only executive fielding questions from a swat team of 15+ analysts. I don't know which one is a better approach. Maybe Bob Toll is sending a message to shareholders. Anyway, let's move on.

Size

LTM revenue was $4.5 billion, which makes the company the fifth largest homebuilder behind D.R. Horton (NYSE:DHI), Lennar (NYSE:LEN), PulteGroup (NYSE:PHM), and NVR (NYSE:NVR). If we redefine the space as "luxury homebuilder," however, the company is The Player, which is an important consideration for valuation (more on this later).

Footprint

In FY15, the company generated ~$2.0B of revenue in the Northeast (incl. city living), ~$1.5B in the West (incl. California), and $1.0B in the South. In short, the company is geographically diversified with greater exposure to the Northeast. This is important because housing is local and it's important to consider a builder's geographical exposure as trends evolve.

Revenue growth

Following the dip in 2011, the company (along with other homebuilders) has been growing its top-line at ~25-30% CAGR driven by both pricing and units. Note that the company's growth rates can be slightly more volatile than other homebuilders due to its focus on a niche market with significantly higher ASP.

This is very positive for the company and the industry, and it's a sign of what's ahead as the housing picks up more steam (have you read my macro article yet?).

Backlog

Backlog is generally a good indicator of a homebuilder's near-future revenue. As of October 31, 2015, the latest fiscal year-end (it's always baffled me why some companies choose odd fiscal year-ends), the company's backlog was $3.50 billion (4,064 homes, $862k ASP), up 29% YoY from $2.72 billion (3,679 homes, $739k ASP). About one-third of the increase in backlog was driven by an increase in number of communities and two-thirds by ASP. I expect this trend to continue for the foreseeable future.

Of the 4,064 homes in backlog, management expected 96% to be delivered within the next 12 months. As of April 30, 2016, backlog had increased YoY by 20% to $4.19 billion (4,940 homes, $849k ASP), which pointed to continued revenue growth at the current pace for the foreseeable future.

Gross margin

From 1990 to 2003, the company's GAAP gross margin generally ranged from mid-20s to high-20s, which compares favorably when stacked against peers. This is a function of the company's dominance of the niche luxury market and brand value, and it's important for valuation.

The gross margin ticked up even higher in 2004 and 2005, before tumbling to negative levels in 2009 due to impairments, and subsequently recovering steadily to 22% for the LTM period ended April 2016. There's more room to go as the housing market picks up steam in the coming years.

P/B ratio

The company's p/b ratio was 1.10 as of June 17, 2016, which compared favorably to D.R. Horton's 1.83, Lennar's 1.70, Pulte's 1.38, and unfavorably to KB Home's 0.74. This generally favorable comparison is further supported by the company's dominance of the niche luxury housing market, a durable competitive advantage. Toll Brothers undeniably has a strong reputation and brand recognition in this market. Further, the company's p/b ratio is currently closer to the lower end of its five-year range of 0.88 to 2.27.

Use of excess capital

During FY15, FY14, and FY13, the company repurchased $57 million, $91 million, and $15 million worth of shares, respectively. During the six-month period ended April 30, 2016, the company increased the pace of its repurchases to $230 million (~5% of market cap) from $7 million during the same period in the previous fiscal year. Management has committed to being opportunistic with share repurchases.

Bottom line: The company is a strong player in an improving housing market. It is led by a capable and shareholder-friendly management team. The company's valuation is low compared to its peers and history.

Disclosure: I am/we are long TOL.

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.