TOL - Toll Brothers: As Good As It Gets (Rating Downgrade)

2023-05-01 09:35:17 ET

Summary

• Today, we take a deeper look at luxury home builder Toll Brothers, Inc., which had a solid first quarter but is expected to see earnings declines over the next two years.
• The stock seems cheap on a trailing P/E basis, but insider selling has picked up noticeably and order demand is falling precipitously.
• After a better than 25% return in 2023, is this as good as it gets for Toll's shareholders in 2023? An investment analysis follows in the paragraphs below.

One cannot answer for his courage when he has never been in danger .”? Francois de La Rochefoucauld.

Today, we put the spotlight on Toll Brothers, Inc. ( TOL ). The shares of this luxury homebuilder have performed well in 2023, up more than 25% year to date, despite multiple headwinds hitting the housing market. These include much higher mortgage rates, declining consumer sentiment, falling GDP growth and lower existing/pending home sales across the industry compared to a year ago.

While the stock still looks reasonable valued on a trailing price-earnings basis, there has been a noticeable uptick in insider stock sales since October. Are company officers signaling it might be time to take some chips off the table on this home building stock? An analysis follows below.

Company Overview

Toll Brothers, Inc. is headquartered just outside of Philadelphia, PA. The company is primarily known as a luxury home builder and build across the spectrum, including offerings for first-time, move-up, empty-nester, active-adult, and second-home buyers. The company also has a strategic partnership with Equity Residential to develop new rental apartment communities in the United States. The shares currently trade just below $64.00 a share and sport an approximate market capitalization of just over $7 billion. The company's fiscal year begins on October 1st.

First Quarter Results

On February 21st, Toll Brothers posted first quarter results . The company had an impressive start to FY2023. Toll Brothers had GAAP earnings of $1.70 a share, just over 30 cents a share above expectations. Revenues were down less than one percent from the same period a year ago to $1.78 billion, but that was $40 million above the consensus. Revenues from home sales rose four percent on a year-over-year basis to $1.7 billion, even as homes delivered in the quarter fell five percent. The average price of homes delivered in the quarter was $958,000. Management had this to say about the average sales price decline from the fourth quarter of last year.

About 2/3 of the $117,000 sequential decline in the average sales price of new contracts was attributable to mix. The remaining 1/3 was due to increased incentives leading to a first quarter average incentive of about 8%. Today's incentive on the next home sold is about 6.5%. Historically, our average incentive has been approximately 3% over the past 15 years . "

Adjusted gross margin was 27.5% or 50 basis points better than management's previous guidance and 190 basis points better than the same period a year ago. SG&A expense at 12.1% of homebuilding revenues was also better than previous guidance.

Digging into the details of the report should give an investor caution. Homes in Toll Brothers backlog were 7,733, down 32% from 1Q2022. Total backlog value fell 21%. New orders fell 50% from the same period a year ago to just 1,461. New order value fell 51% to $1.5 billion, showing the company is no longer benefiting from rising average home sale price. Leadership provided FY2023 guidance of an adjusted gross margin of 27% and between $8 to $9 of diluted earnings per share.

Analyst Commentary & Balance Sheet

The analyst community is currently mixed on its view around Toll Brothers. Since fourth quarter results were posted, four analyst firms including Barclays and Citigroup have reiterated Hold/Neutral ratings on the stock. Price targets proffered range from $58 to $61 a share, all below the current trading levels of the stock. Six analyst firms including Raymond James and Oppenheimer have reissued Buy/Outperform ratings over that time as well. Price targets from the optimists range from $58 to $80 a share.

Just over one percent of the outstanding float in Toll Brothers is currently held short. There was no insider activity in this stock for just over a year starting in September of 2021. That started to change noticeably in October of last year. Insiders collectively sold just over $9 million worth of stock in the fourth quarter of last year, approximately $4 million in the first quarter of this year, and around $600,000 worth of stock in April.

In February, Toll Brothers extended its $1.9 billion revolving credit facility up five years out to February of 2028. The company's net debt-to-capital ratio was 27.5% at the end of first quarter end, down from 31.9% at the end of 1Q2022. Management stated it planned to repay $400 million of senior notes when they came due in April of 2023. This will leave Toll Brothers with no meaningful debt that comes due before 2026.

Verdict

After making ten bucks a share in FY2022, the current analyst firm consensus is earnings will decline to $8.75 a share in FY2023 and $7.70 a share in FY2024. They expect overall sales to fall in the low teens this fiscal year followed by flat growth in fiscal 2024.

The company sounded upbeat during its first quarter earnings conference call . Management noted that they saw:

Improving demand in most markets across the country, including Florida, Atlanta, South Carolina, Charlotte, D.C. Metro, Pennsylvania, New Jersey, Texas Colorado and Southern California. Over the past few weeks, we have also seen signs that demand is improving in markets that struggled the most in the second half of 2022, such as Boise, Phoenix, Reno, Las Vegas and Austin ."

However, that was before the collapse of Silicon Valley (SIVBQ) and Signature Banks (SBNY) (and evidently now First Republic Bank ( FRC ) ) as well as the recent initial first quarter GDP read, that showed only 1.1% economic growth across the country. Regional banks are important sources for credit for home builders and the economy looks on the brink of recession, even before another likely 25bps rate hike from the Federal Reserve next week.

The stock does sell for only 6.4 times trailing earnings, but it trades above many analyst price targets. In addition, earnings growth is projected to decline at a decent clip in both FY2023 and FY2024. Finally, insiders are noticeably trimming their holdings in the stock. Therefore, Toll Brothers, Inc. seems like it is likely to be dead money in a best-case scenario and vulnerable to a selloff should economic conditions worsen.

And I say also this. I do not think the forest would be so bright, nor the water so warm, nor love so sweet, if there were no danger in the lakes .”? C.S. Lewis

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