Toll Brothers (TOL)

TOP CONTRIBUTORS

Mike Lapsa

Alan Ibrahim

Toll Brothers (NYSE: TOL) is the largest luxury homebuilder in the United States, operating in 6 regions and 21 states. The company designs, constructs, and finances single family homes with an average closing price of $626K. The majority of Toll Brothers’ customers (60-70%) are considered move-up buyers, who are previous homeowners interested in purchasing a larger residence. The remaining sales are split between empty nesters, active adults, and second home buyers. The homebuilder operates primarily in affluent planned suburban communities with easy highway access to major metropolitan areas. The company decreases unit dwelling costs by offering the same home designs in similar communities. Toll Brothers builds in nearly 400 communities that together contain nearly 32,000 homesites.^[1]

Toll Brothers' national scope and its focus on the luxury end of the homebuilding spectrum give it some protection from fluctuations in the U.S. economy and U.S. housing market, but it is far from immune to these factors. The company was severely affected by the collapse of subprime lending and the U.S. Housing Market. The company suffered it's second straight year of negative earnings, losing $756 million in 2009.^[2]

Company Overview

Homes^[3]

The company builds many kinds of homes in different price ranges:

• Detached Homes
  • Move-Up - $235,000 to $1,037,000
  • Executive - $265,000 to $977,000
  • Estate - $340,000 to $1,911,000
  • Active-adult, age-qualified - $286,000 to $596,000
• Attached Homes

  Contents 1 Company Overview 1.1 Homes[3] 2 Business Growth 2.1 FY 2009 (ended October 31, 2009)[2] 3 Trends and Forces 4 Competitors 5 Notes

  • Flats - $229,000 to $700,000
  • Townhomes/Carriage Homes - $180,000 to $840,000
  • Active-adult, age-qualified - $257,000 to $497,000
  • Mid-rise - $200,000 to $603,000

By geographic segments:

• North - 68 communities
• Mid-Atlantic - 72 communities
• South - 52 communities
• West - 59 communities

Business Growth

FY 2009 (ended October 31, 2009)^[2]

• Net sales fell 44% to $1.76 billion. The company attributes the loss to the weak U.S. Housing Market. The value of net contracts signed was 81.8% lower than the value of net contracts signed five years ago.
• The company incurred a net loss of $756 million which was worse than the net loss of $298 million it incurred in the previous year. In addition to lower revenue, the company was negative impacted by $458 million of valuation allowances recognized against the company's deferred tax assets.

Trends and Forces

• Excessive Land Holdings: As a planned community homebuilder, Toll Brothers is forced to acquire and improve land several years prior to selling to homebuyers. As a result, during downturns in the housing market, Toll Brothers and other construction companies are faced with excess land inventory. Toll Brothers has the largest land bank (relative to sales) in the industry, and will face pressure if housing demand remains depressed.

• Interest Rates: While high income homebuyers are not directly affected by reductions in subprime, the contagion from constrained subprime lending could decrease luxury home sales. Move up buyers will experience difficulty selling their current homes as potential purchasers prove unable to obtain the necessary financing. With fewer buyers able to purchase luxury homes, Toll Brothers’ revenue will decrease. Higher interest rates will also threaten the company’s ability to obtain financing for operations. Anticipated future debt issuances will be costly if undertaken in a high interest rate environment. Moreover, interest payments on Toll Brothers’ revolving bank credit facility are tied to changes in short-term interest rates.

• Increases in Marginal Tax Rates: Toll Brothers operates in a more affluent sector of the market where wealth, and thus demand for luxury housing, is quite dependent on personal tax bills. As a result, in a higher tax environment, potential buyers will have less discretionary income to spend on housing.

• Aging Baby Boomers: Much of Toll Brothers growth during the past decade has been fueled by purchases from the oldest of the baby boomers. These individuals reached the peak of their earning power and thus had the discretionary income to purchase the luxury home product offered by Toll Brothers. The company should continue to see growth from the baby boomer demographic, as the younger half of the baby boomers is just now reaching its highest earning years.

• Expanding Government Regulations: When developing new communities, Toll Brothers is forced to comply with numerous local governmental regulations. While the company buys land on option to reduce the risk that a development project might be squashed by government resistance, prolonged legal and regulatory battles contribute to higher costs that reduce overall project profitability. The housing industry has recently faced an increase in local resistance to land development, suggesting that Toll Brothers could face increased government regulations in the future.

Competitors

Toll Brothers faces competition from both regional and local homebuilders. The flexibility of small custom construction companies can often be more consistent with the varied tastes of luxury homebuyers. To compete against these custom builders, Toll Brothers has been forced to develop a diverse product line. The company also faces competition from sales of existing homes.

Toll Brothers’ closest competitors include the following:

• Centex

• Pulte Homes

• D.R. Horton

• Lennar

Notes

1. ↑ TOL 2009 10-K "Genera" pg. 1-2
2. ↑ ^{2.0 2.1} TOL 2009 10-K "Selected Financial Data" pg. 24
3. ↑ TOL 2009 10-K "Our Homes" pg. 5-6