Has Toll Brothers Bottomed Out?

Includes: KBH, PHO, TOL
by: Yaser Anwar

Despite reporting lower earnings and a lowered guidance, shares of Toll Brothers were on the rise Tuesday morning, climbing roughly 2.5% to end the day up 1.74%.

The lowered earnings still came in above expectations. Other home builders, including Pulte Homes (NYSE:PHM) and KB Home (NYSE:KBH) were also up on the news. Profits for the third quarter were down 19% & Revenues were down 1%. In a conference call with analysts, Robert Toll said, "The speculative buyers of 04 and 05 are now sellers," and added, "Builders that built speculative homes are trying to move them by offering large incentives and discounts and some anxious buyers are canceling contracts for homes already being built." Commenting on a "continuing malaise" in the housing market, he said, "This overhang in supply and the aggressive discounting of many builders is undermining consumer confidence and keeping buyers on the sidelines as they continue to worry about the direction of home prices."

Investors should be concerned about lack of earnings visibility over the next 12 to 18 months. Until equilibrium between supply and demand is better established, investors should keep away from the homebuilders. YTD the S&P Homebuilding Index was down 36.4% versus a rise of 1.2% in the S&P 1500. With its sluggish stock price, TOL has stepped up its share repurchase program. Still, its continued investments in land, combined with slower sales, suggest that inventories will rise close to 30% in 06.

After nearly a decade of steady volume advances and relatively large price gains, there is strong evidence that this homebuilding boom is over. Investors should factor the strong possibility that new home demand will continue to worsen before it improves again.

Answering my question, if TOL has bottomed out: The stock rising on abysmal earnings (bad news) could be an indication of its bottom but investors should keep in mind that, according to S&P estimates, if TOL's current book value of approximately 1.5 is factored into 06 forecasts, the stock price comes around $22 (higher than the closing price on August 22nd 06).