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Mike Lapsa

TOL AT A GLANCE

P/E ► -4.86   EV/EBITDA ► -15.1   ROA ► -11.2% AVG ROE ► -24.5% AVG Debt to Equity ► 1.19 AVG Current Ratio ► 3.70 AVG Interest Coverage Ratio ► -22.0 AVG

 

 

 

 

 

 

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 $688K ^[1]. The majority of Toll Brothers’ customers (60-70%) are considered move-up buyers, who are previous homeowners interested in purchasing a larger residence ^[2]. 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. However, in 2004, Toll Brothers expanded into urban markets in New York City and Philadelphia, through several high-rise projects targeted at young professionals. The company decreases unit dwelling costs by offering the same home designs in similar communities. In 2006, Toll Brothers was building in nearly 400 communities that together contain nearly 32,000 homesites ^[3].

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 over the summer of 2007. Its 2007 revenue and contracts fell 24% and 33% respectively from the year before. Contracts cancellations were also up as ^[4] potential buyers were unable to sell their current homes. ^[5]

Business Financials

As the graph below suggests, Toll Brothers experienced considerable revenue growth from 2004-2005, driven primarily by a 32% nationwide increase in traditional home closings^[6]. Operating income grew along with revenue during this period.

Revenue growth remained positive in 2006, despite a nearly 2% decrease in closings^[7]. Growth numbers were kept in positive territory by a rise in the average closing price per home. 2006 operating income declined from year prior levels due to an 11% increase in the unit cost of constructing each home^[8].

An 11/07 company announcement suggests a significant 24% decline in revenue for 2007, brought on by both a reduction in contracts and a decrease in closing price per unit. Profit numbers have not yet been released^[9]

On 12/07, the company recorded its first quarterly loss ($81.8 million) in 21 years. CEO and Chairman Robert Toll cited 2007 as, "the most challenging of the forty years that Toll Brothers has been in business." Moreover, the company did not issue further earnings guidance, citing sustained volatility in the housing market. ^[10]

^[11]

^[12]

Key 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: If the Democratic nominee emerges victorious in the 2008 U.S. Presidential election, there is a possibility that marginal tax rates on income will be raised. 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:

While it is clear from the table that Toll Brothers sells homes at a considerably higher price than the companies listed, most analysts still consider these four homebuilders to be TOL’s closest competitors. The rationale here is that these are all national homebuilders with similar market capitalizations. Moreover, there are no national luxury homebuilders other than Toll Bothers, so competitor analysis is focused on those companies that compete with Toll on the high end of their market, which is the low end of Toll’s market. Toll faces competition in its high/medium end from more local builders, but since these vary by market and have limited public financial information, it doesn’t seem possible to include them in the above table.

Market Share

Toll Brothers is the fourteenth largest homebuilder in the United States, capturing approximately 0.75% of the nationwide residential building market by 2006 unit closings^[18]. The top fifteen U.S. homebuilders by unit market share are listed below:

Notes

1. ↑ TOL 2006 10K, Item 1, pg. 2
2. ↑ TOL 2006 10K, Item 1, pg.3
3. ↑ TOL 2006 10K, Item 1, pg. 2
4. ↑ Toll Brothers Press Release November 18, 2007
5. ↑ "Blame for Poor Sales? It's the Press a Builders Says", The New York Times, November 11, 2007
6. ↑ TOL 2006 10K, Item 1, pg. 5
7. ↑ TOL 2006 10K, Item 1, pg. 5
8. ↑ TOL 2006 10K, Item 8, F4
9. ↑ Toll Brothers Press Release November 8, 2007
10. ↑ http://biz.yahoo.com/ap/071206/earns_toll_brothers.html
11. ↑ TOL 2006 10K, Item 8, F4
12. ↑ TOL 2006 10K, Item 1, pg. 5
13. ↑ TOL 2006 10K, Item 1, pg. 2
14. ↑ Centex 2006 10K, Item 1, pg. 5
15. ↑ Pulte 2006 10K, Item 1, pg. 4
16. ↑ D.R. Horton 2006 10K, Item 1, pg. 1
17. ↑ Lennar 2006 10K, Item 1, pg. 2
18. ↑ BUILDER Online, Builder 100 Listing 2006
19. ↑ BUILDER Online, Builder 100 Listing 2006