Evaluating Toll Brothers vs. KB Homes

Includes: KBH, TOL
by: ClearFish Research

Both Toll Brothers Inc. (TOL) and KB Home (KBH) are big house manufacturers. We talked about some of the housing market background earlier. Over the last five years, the stocks of these two companies have almost perfectly tracked each other, until late 2005 when KBH recovered somewhat and TOL continued to deteriorate. Since then the gap between them has once again narrowed, but has not completely filled. We'll bet that gap will close, so the question is whether the sector will go up, or drop. From a technical perspective, looking only at TOL indicates the most likely thing is a further price drop (head and shoulders formation). But looking only at KBH indicates something different - a long term trend that has met resistance and is now in a range bound pennant - it could just as well go up as down. Even if it stays range bound, that's a $20 possible price move.

So, from current housing stock patterns it is not at all clear that the sector is dead. Then the WSJ reports on the pattern of UK housing stocks, ahead of us in the interest rate cycle, where fundamentals slowed but stocks recovered due to better management. KB Home reports quarterly results today after the market closes. Toll Brothers filed quarterly results on 10 Mar 2006 for the period ending 31 January 2006. Q/Q stockholder equity increased 6% despite some significant asset shifts and some minor liabilities changes. Y/Y revenue increased 29% ($1,278M/$989M), operating income increased 36% ($237M/$175M), and net income increased 49% ($163M/$110M). Quarterly Y/Y EPS increased 48% ($0.98/$0.66), showing a tiny bit of share dilution. That gives them a Y/Y slight OP margin increase from 18% to 19% (from $175M/$989M to $238M/$1278M).

The short story is that their model is better this year than last year - no sign of slowing - and their stock is half what it was. As far as we can tell, the stock decline is based on sentiment over the housing sector - fuzzy stories - rather than the cold hard numbers. We'll look for confirmation or contradiction of that from KB Home after today's close.