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Yes the summer is heating up. The days are getting shorter and $$$MR. MARKET$$$ has another winner.
Doh! Doh! $$$MR. MARKET$$$ don’t do this to us again! Yes it is true that $$$MR. MARKET$$$ has 67 consecutive profitable trades if 15% or better. It is also true that no fewer than 6 of these 67 winners were homebuilder stocks. What is it with $$$MR. MARKET$$$ and homebuilders? For 3 years the market has been hating and undervaluing homebuilders. For 3 years, the homebuilder stocks keep going up and up. Why should little old me spoil any of the fun?
Look at this bathroom:
Picture me with a Vente Starbucks coffee, a big bran muffin and the Sunday New York times. If I had this bathroom, I would never see the light of day again. Well, maybe I can’t have a bathroom like this, but at least I can make a little jing from the company that builds these porcelain monuments.
Today I bought TOL (Toll Brothers) at 100.37. I will sell it in 4 to 6 weeks at 115.61. Here’s why I like TOL:
Toll Brothers, Inc. is the nation's leading builder of luxury homes. The Company began business in 1967 and became a public company in 1986. Its common stock is listed on the New York Stock Exchange and the Pacific Exchange under the symbol ``TOL''. The Company serves move-up, empty-nester, active-adult and second-home home buyers and operates in 21 states: Arizona, California, Colorado, Connecticut, Delaware, Florida, Illinois, Massachusetts, Maryland, Michigan, Nevada, New Hampshire, New Jersey, New York, North Carolina, Ohio, Pennsylvania, Rhode Island, South Carolina, Texas, and Virginia. The company specializes in luxury housing, a niche that's considered less sensitive to interest-rate swings than the lower-priced sector.
Toll Brothers builds luxury single-family detached and attached home communities, master planned luxury residential resort-style golf communities and urban low, mid- and high-rise communities, principally on land it develops and improves. The Company operates its own architectural, engineering, mortgage, title, land development and land sale, golf course development and management, home security, landscape, cable T.V. and broadband Internet delivery subsidiaries. The Company also operates its own lumber distribution, and house component assembly and manufacturing operations.
Look at this nice chart, up 138% over the last 12 months. It’s been clicking away at a nice 11% per month, just on pace to show me the money:
At the end of the day, this strong price momentum is a key reason why I bought this stock, but the secret is in the fundamentals. TOL’s stock keeps going up because it has to go up. TOL makes too much money. With it’s earnings growth, holding TOL’s stock down is trying to hold an empty keg of beer under water. Unless you have 19” biceps and a 385 lb bench press, you just can’t do it. For sophisticated investors, the concept is called discounting. The builders were discounting a collapse in the housing market. Anything less negative, like a stronger market, would drive the shares higher. And that is exactly what happened. Also, there was the secular market-share-gain story of the large public builders.
TOL’s PE is still a very modest 14.5. What is especially attractive is its forward PE of only 9.5.
As a general rule of thumb, growth stocks trading for PEGs of less than 1 to 1.5 are considered cheap. In other words, even if home-building revenue growth falls to 15% or 20%, as expected, the stocks still look reasonably priced. The 5 yr expected PEG for TOL is only 0.72.
Return on Assets is 13%. Return on Equity is 29%. Profit margin is 12%. Operating margin is 21% Quarterly sales growth is 51%. Quarterly earnings growth is 135%. TOL is a ridiculous value in a stock that has such great price momentum. So what’s not to like?
The tug of war that keeps the valuations on homebuilders attractive is that ANAL-ysts keep thinking that there is a real estate bubble. $$$MR. MARKET$$$ will repeat over and over. “There is no bubble”. People want to own homes because it is a good thing to do. Our country and our government will continue to encourage people to own homes. Upward price momentum has kicked into higher gear in recent years for two important reasons. First, housing is highly tax-advantaged. The 1997 tax-cut bill -- proposed by a Republican Congress and signed into law by a Democrat president, Bill Clinton -- permitted the first $500,000 of profits from the sale of a home to be tax-free. This came on top of existing law that permits mortgage expenses to be tax deductible depending on one's income bracket.
Have housing prices increased? Of course they have. Nobody cares about how much a house actually costs. All they care about is if they can afford the monthly payments. We really don't have a housing bubble that's anywhere near bursting. Current 10-year interest rates are just too low. Look at what the shift in the average interest rate for a 30-year fixed mortgage does to a home buyer's monthly payment. At today's average of 5.6%, borrowing $500,000 results in a monthly payment of $2,870. A year ago, a home buyer would have paid about the same each month, $2,847 to be exact, on a loan of $460,000.And I certainly don't see interest rates rising enough in the next year or so to burst a bubble, either.
This has nothing to do with speculation associated with buying equities or gold. There is timber and toilets behind these investments. Unlike a tech stock, a house for most people is more than an investment. It’s a place to create a home and build memories. And transaction costs are high. So there’s a natural resistance to cashing out. Contrast today's home market with the economy's last bubble -- in tech stocks. In the late 1990s the NASDAQ surged 40% a year as people threw billions of dollars into companies that had no profits or coherent business plans. That's a far cry from 2005's housing picture. The supply of housing has not outstripped demand, and price increases have been supported by gains in jobs and incomes.
First, home-builders know speculation works against them. It means they have to compete with speculators to make sales, which hurts their control over the markets and pricing. In contrast, during the tech bubble the people pushing tech stocks (Wall Street analysts, investment bankers and fund managers) had an interest in creating a speculative frenzy so they could sell higher. The only bubbles I see are the bubbles blown by the bathtub farts emanating from the ANAL-ysts. Sitting in those TOL bathtubs can be a relaxing and fun aromatic experience.
The current macroeconomic environment has done wonderful things for TOL vs. its competitors. TOL builds the mega Mcmansions on the golf courses. You know there has many a $$$MR. MARKET$$$ drive that has rattled off of these roofs and picture windows. As interest rates have come down, people can afford a larger house than what they used to own. They move up to TOL. “As long as the population continues to rise and affluent households continue to grow much faster than the population in general ... demand for luxury homes will continue to exceed supply”…so says Robert Toll, king TOL. The average price of a home it sells is well over $600,000. Yet TOL has plenty of potential buyers.
"We've got 16.9 million people (in the U.S.) making $100,000 or more in constant dollars compared with about 6 million 20 years ago," Toll said.
That's 15% of the U.S. population today vs. 7% 20 years ago, he says. Meanwhile, zoning and planning have become more restrictive in that time, making it more difficult and expensive to develop land. The baby boomers are getting older and wealthier. Four million more people are going to turn 45 years old on average this decade vs. last decade. That's key, because 45 is the age when most people are at or near their peak earnings potential, and when they buy their largest home.
"So what you have is tremendous increase in demand, butting up against a tremendous constraint in supply," Toll said. "What we're primarily doing is putting our net down on a stream that is full of fish.”
While the boost to the overall housing market provided by such mortgage products can only last for so long, the fundamental sales outlook is good for builders on market share opportunities, barring a significant housing slowdown. Even if housing growth cools off, TOL will continue to make a ton of money. On a national level, home prices aren't going to plunge -- they just won't rise very much. In the past 40 years, national new-home prices have fallen only twice, and both times were during a recession. Based on past history, at least, a modest rise in mortgage rates won't do the trick. Average interest rates for a 30-year fixed mortgage rose to 6.3% in May 2004 from 5.5% in May 2003 without sending housing prices sliding quickly lower. Based on the projections from the National Association of Home Builders, a future climb in mortgage rates from 5.8% in 2004 to 6.6% in 2006 wouldn't have a huge effect on sales of either new or existing homes. As mortgage rates climbed 0.8 percentage points, new-home sales would fall by 6.5% from 2004 to 2006, and sales of existing homes would decline by 5%. At worst, that's air gently escaping from any housing bubble. I’ll get to the earnings analysis later.
Going to school on homebuilding
------------------------------
As Ric Flair would say, “Whoooo! Now we go to school!”
In today's ownership society, few investments have been so lucrative for so many as homeownership. Since 2001 extremely cheap mortgage rates have fueled a record-setting level of home sales. Frenzied demand caused home prices to jump at rates not seen since the 1980s and generated 10% gains each year in housing wealth for many Americans, who quickly used refinancings or home-equity loans to convert some of the windfall into cash. Expect the macro New Home Sales growth rates to moderate, but no severe slowdown is in sight (assuming no major spikes in rates or significant job losses). For 2005 homebuilders are still optimistic about demand. There's a backlog of unfilled orders for new homes. People who compare this situation to the tech bubble are silly. Many tech stocks traded for 10 times what they were worth as businesses. Few think real estate is anywhere near that overvalued.
Demand also remains healthy. Orders, which reflect revenue two or three
quarters down the line when a home sale closes, rose 13% on average in the
quarter, estimates Merrill Lynch analyst Lorraine Maikis.
And home builders are reporting little signs of a housing crash, which many
doom-and-gloom skeptics have been predicting.
"We haven't heard of any type of slowdown out there. Interest rates are
obviously still very low, and I think some of the weather delays that were
experienced in the first half will begin to be delivered in the second half,"
Maikis said. She speculates 30-year fixed-rate mortgages would have to top the 8% mark before home builders would see a significant pullback in demand.
"We can't see much change in the headiness" in red-hot markets such as
Florida, Washington, Philadelphia and suburban New Jersey, Phoenix, and
Northern California.
Although Southern California andLas Vegas have softened from the torrid
sales pace they experienced a year ago, they still remain solid, he said. And
Reichardt said the North Carolina market has picked up from a year ago.
Raymond James analyst Rick Murray said he noticed a slowdown - but not a
decline - in orders in southern Florida. He said it's not clear if the softness
is due to a lack of supply or pullback in demand.
There is nothing clear on the horizon to break the trend. Of course, the Fed has been raising rates, but it has been doing that for almost a year now with little effect. When they raised rates in 1999 and 2000, and when they
cut interest rates drastically in 2001, there was no noticeable effect on the trend in home prices either. With the 10-year U.S. Treasury bond yielding below 4% and 30-year mortgages available at 5.1%, there isn't a housing bubble.
The fundamentals of housing -- the health of the economy and demographics -- argue against a widespread drop in demand. Faster job and income growth should help to offset the drag of higher borrowing costs. Plus, even though a record 69.1% of Americans owned their homes at the end of 2004, demand will still be supported by baby boomers and immigrants. Immigration is another trend that will help housing coast to a soft landing.
Immigrants accounted for one-third of the new households formed in the 1990s, and these families are entering the housing market.
What we're seeing in the housing market is monetary inflation. Pure and simple. Economic theory says that when more money chases a limited quantity of goods, the price of those goods increases. So nationally, cheaper money drives up the price of houses -- which does lead home builders to increase supply at higher prices.
The Federal Reserve has effectively mopped up excess cash and calmed inflation expectations. That's why bond rates are hovering around 4 percent, with most mortgage rates about a point higher.
TOL will make a ton of money
----------------------------
Toll Brothers, has been chosen by their peers as the First Place Winner for Innovative Product Design in the Big Builder Apex Awards. The selection was made using a national survey of the home building community, sent out to readers of Builder and Big Builder magazines; the award was created by Hanley Wood, publisher of these and other publications. Toll Brothers was also honored for Leadership and Management, and for Operational Excellence and Efficiency. In addition, Toll Brothers was named as one of the Most Admired Big Builders of the Year, based on an overall ranking of Builders 100 companies in various categories.
Nearly 600 people attended the awards luncheon, which was held at the Mandalay Bay Hotel and Casino in Las Vegas, Nevada. Most of them were horrified at the site of a dozen Wharton MBA’s consuming mass quantities of alcohol by the pool and then placing bets at the sports book while they ran around shouting “Johnny Walker Blueeeeeeeeeeeeee”.
Toll Brothers is the only publicly traded national home building company to have won all three of the industry's highest honors: America's Best Builder from the National Association of Home Builders, the National Housing Quality Award and Builder of the Year.
"People just keep buying anyway .... I've never seen anything like this in almost 40 years in the business." Robert Toll, the CEO of Toll Brothers
TOL recently reported fiscal second-quarter results, and its numbers continue to astound. It generated net income of $170.1 million, or $2.01 /share up 135% from last year's $72.4 million, or $0.89 per share. That easily topped the average estimates of $1.79 per share. Revenue was also up significantly, jumping 52% to $1.25 billion.
The future continues to look bright for Toll Brothers, with no evidence of a slowdown in sight. The company's second-quarter contracts and backlog of $5.87 billion were the highest for any quarter in its history. Through its first two quarters, Toll Brothers has signed accounts on 5,354 homes. At that pace, it should easily top its previous forecast of 8,050 to 8,400 homes for the year.
The company also managed to increase by 10,000 the number of home sites it controls to 68,000. TOL increased its full-year guidance, now predicting a 70% increase in net income over last year. Even with the increase, the company still expects to generate a 20% jump in fiscal 2006 over those 2005 results. Toll Brothers should close on nearly 8,900 homes in FY 05 (Oct.), almost a 35% increase from last year, and its average home price should advance 10%.
Like $$$MR. MARKET$$$ has said before, if yields on the 10-year bond rise, they will go up because of economic strength – strength that creates more jobs. That will fuel more demand for housing, offsetting any negative impact from higher rates.
Next, interest rates are so low, it’s not clear they will go up enough to kill off the housing market. Even if yields on the 10-year bond go up 1.5 to two percentage points to hit 5.5% to 6% over the next year or more, that would take the 30-year mortgage rates -- recently around 5.5% -- up to about 7.5%. If history is any guide, that’s not enough to cool off the housing market. The last three housing market slowdowns -- in 1995, 1997 and 2000 -- didn’t happen until mortgage rates moved into the 8.4% to 9.4% range. Joel Rassman, the finance chief at Toll Brothers says “There is so much demand, if we stay in the 6% to 7% plus range, housing will continue to boom. “ Robert Toll confirms, “"We had a field day in 1995 when mortgage rates went up to 9.1%," he said.” Toll Bros. also kept growing in 1997 and 2000, when interest rates were at 8.1% and 8.75%, respectively.
TOL noted that it’s buying more land now than a year ago. Increased land buying is occurring in many areas, including NE (NY, CT, NJ); West (AZ, LV, lesser degree CA); FL (E & W coasts). It’s great that management is using cash flow to fuel growth. In most cases, the money is being made on the land appreciation. Before TOL drives their first nail, they’ve already made money on a house. On the supply side, there are land shortages in key metropolitan areas and greater obstacles to using land for housing. Meanwhile, demand will get a boost from new immigrants, baby boomers buying second homes and so-called echo boomers buying first homes.
TOL’s debt-to-capital at quarter end was 42.1%, down from the 2Q04 level of 49.3%. TOL’s return on capital continues to expand, at 17.7% from 11.9% in 2Q04, driven by increased asset efficiency, profitability and leverage. TOL’s 68,000 lots controlled represents approximately a 7-8 year supply of lots based on next twelve month projected closings.
Although the company does not provide specific earnings per share guidance, it did raise its fiscal 2005 outlook to approximately 70% net income growth versus its prior guidance of at least 60% growth. Additionally, despite the higher base earnings in 2005, anagement believes it can still achieve earnings growth of approximately 20% in fiscal 2006.
With valuations improving for nearly all builders due to evidence of ongoing strength in operating performance and greater visibility into 2006. TOL’s stock price would hit $120 based on about a 13.3X P/E multiple applied to our First Call 05 EPS forecasts, which is well past my sell price.
My earnings estimate, which is based on net income growth of 90%, incorporates 50% homebuilding revenue growth and 430 basis points of operating margin expansion to 22.8%. $$$MR. MARKET$$$ sees earnings at $10/share, which would mean the stock will probably go over 133.
There’s not a lot more I can say about this stock. If you think “bubble” is not going to burst, there is absolutely no reason to NOT own TOL’s stock. If you are fearful of the "bubble", then this is not a stock for you.
For the first time, I have run out of things to say, so I’ll let the TOL bosses lay this on you:
Robert I. Toll, chairman and chief executive officer, stated: “We owe our excellent results to the tremendous perseverance and intensity of our associates. No one in our industry has a harder working, more dedicated team!
“With increasing numbers of communities in lot-constrained markets, our growing brand name and our broadening diversity of luxury new home product lines, we continue to produce record results.
“We expect to end fiscal 2005 with approximately 240 selling communities compared to 220 at FYE 2004. We believe our expertise in securing land and opening communities in highly-regulated, upscale markets gives us a competitive advantage, both today and in the future. We now control approximately 68,000 home sites, compared to 58,000 one year ago. These sites, which are in communities currently open for sale or wending their way through the approval process, represent a five-to-six year supply based on our historic pace of growth.”
Joel H. Rassman, chief financial officer, stated: “Our record earnings, contracts and backlog reflect the strong demand and accompanying pricing power we have enjoyed over the past twelve months. Based on these results and our record $5.87 billion backlog of homes under contract, we are increasing our earnings expectations for FY 2005. We now believe net income will grow approximately 70% in FY 2005 compared to FY 2004. Based on our backlog and expected community growth, even with this increased projection, we still believe net income will rise approximately 20% in FY 2006 over FY 2005.”
Toll Brothers’ financial highlights for the three-month and six-month periods ended April 30, 2005 (unaudited):
• The Company’s FY 2005 second-quarter net income of $170.1 million grew 135% versus FY 2004 second-quarter net income of $72.4 million. Second-quarter earnings of $2.01 per share diluted increased 126% compared to second-quarter 2004’s earnings of $0.89 per share diluted, the previous second-quarter record.
• FY 2005 six-month net income of $280.3 million grew 129% versus FY 2004 six-month net income of $122.5 million. Six-month earnings of $3.34 per share diluted rose 121% versus FY 2004’s same period earnings of $1.51 per share diluted.
• FY 2005 second-quarter contracts of $2.20 billion (3,181 homes), grew 38% over FY 2004’s second-quarter contracts of $1.60 billion (2,595 homes), the previous second-quarter record. In addition, in second quarter 2005, unconsolidated entities in which the Company had an interest signed contracts of $85.2 million (123 homes).
• FY 2005’s six-month contracts of $3.65 billion (5,354 homes), grew 46% over FY 2004’s total of $2.50 billion (4,107 homes), the previous six-month record. In addition, in the six-month FY 2005 period, unconsolidated entities in which the Company had an interest signed contracts of $100.7 million (159 homes).
• FY 2005 second quarter-end backlog of $5.87 billion (8,561 homes), the highest in the Company’s history, increased 57% over FY 2004’s second-quarter-end backlog of $3.73 billion (6,211 homes), the previous second-quarter record. In addition, at the end of second quarter 2005, unconsolidated entities in which the Company had an interest had a backlog of $111.7 million (183 homes).
• FY 2005 second-quarter revenues of $1.25 billion increased 52% versus FY 2004’s second-quarter revenues of $819.5 million. In FY 2005, second-quarter home building revenues of $1.23 billion (1,912 homes), increased 51% over FY 2004’s second-quarter home building revenues of $814.3 million (1,463 homes), the previous second-quarter record. Revenues from land sales totaled $9.8 million for FY 2005’s second quarter, compared to $2.0 million in the second quarter of FY 2004.
• FY 2005 six-month revenues of $2.25 billion increased 59% versus FY 2004’s six-month revenues of $1.42 billion, the previous six-month record. FY 2005 six-month home building revenues of $2.22 billion (3,502 homes) increased 58% over FY 2004’s six-month home building revenues of $1.40 billion (2,548 homes), the previous six-month record. FY 2005 revenues from land sales for the six-month period totaled $11.0 million compared to $8.0 million in the same period in FY 2004.
If I keep putting a string of these stocks together, a Toll Brothers home is right around the corner for $$$MR. MARKET$$$.
I am HUGE!!
Doh! Doh! $$$MR. MARKET$$$ don’t do this to us again! Yes it is true that $$$MR. MARKET$$$ has 67 consecutive profitable trades if 15% or better. It is also true that no fewer than 6 of these 67 winners were homebuilder stocks. What is it with $$$MR. MARKET$$$ and homebuilders? For 3 years the market has been hating and undervaluing homebuilders. For 3 years, the homebuilder stocks keep going up and up. Why should little old me spoil any of the fun?
Look at this bathroom:
Picture me with a Vente Starbucks coffee, a big bran muffin and the Sunday New York times. If I had this bathroom, I would never see the light of day again. Well, maybe I can’t have a bathroom like this, but at least I can make a little jing from the company that builds these porcelain monuments.
Today I bought TOL (Toll Brothers) at 100.37. I will sell it in 4 to 6 weeks at 115.61. Here’s why I like TOL:
Toll Brothers, Inc. is the nation's leading builder of luxury homes. The Company began business in 1967 and became a public company in 1986. Its common stock is listed on the New York Stock Exchange and the Pacific Exchange under the symbol ``TOL''. The Company serves move-up, empty-nester, active-adult and second-home home buyers and operates in 21 states: Arizona, California, Colorado, Connecticut, Delaware, Florida, Illinois, Massachusetts, Maryland, Michigan, Nevada, New Hampshire, New Jersey, New York, North Carolina, Ohio, Pennsylvania, Rhode Island, South Carolina, Texas, and Virginia. The company specializes in luxury housing, a niche that's considered less sensitive to interest-rate swings than the lower-priced sector.
Toll Brothers builds luxury single-family detached and attached home communities, master planned luxury residential resort-style golf communities and urban low, mid- and high-rise communities, principally on land it develops and improves. The Company operates its own architectural, engineering, mortgage, title, land development and land sale, golf course development and management, home security, landscape, cable T.V. and broadband Internet delivery subsidiaries. The Company also operates its own lumber distribution, and house component assembly and manufacturing operations.
Look at this nice chart, up 138% over the last 12 months. It’s been clicking away at a nice 11% per month, just on pace to show me the money:
At the end of the day, this strong price momentum is a key reason why I bought this stock, but the secret is in the fundamentals. TOL’s stock keeps going up because it has to go up. TOL makes too much money. With it’s earnings growth, holding TOL’s stock down is trying to hold an empty keg of beer under water. Unless you have 19” biceps and a 385 lb bench press, you just can’t do it. For sophisticated investors, the concept is called discounting. The builders were discounting a collapse in the housing market. Anything less negative, like a stronger market, would drive the shares higher. And that is exactly what happened. Also, there was the secular market-share-gain story of the large public builders.
TOL’s PE is still a very modest 14.5. What is especially attractive is its forward PE of only 9.5.
As a general rule of thumb, growth stocks trading for PEGs of less than 1 to 1.5 are considered cheap. In other words, even if home-building revenue growth falls to 15% or 20%, as expected, the stocks still look reasonably priced. The 5 yr expected PEG for TOL is only 0.72.
Return on Assets is 13%. Return on Equity is 29%. Profit margin is 12%. Operating margin is 21% Quarterly sales growth is 51%. Quarterly earnings growth is 135%. TOL is a ridiculous value in a stock that has such great price momentum. So what’s not to like?
The tug of war that keeps the valuations on homebuilders attractive is that ANAL-ysts keep thinking that there is a real estate bubble. $$$MR. MARKET$$$ will repeat over and over. “There is no bubble”. People want to own homes because it is a good thing to do. Our country and our government will continue to encourage people to own homes. Upward price momentum has kicked into higher gear in recent years for two important reasons. First, housing is highly tax-advantaged. The 1997 tax-cut bill -- proposed by a Republican Congress and signed into law by a Democrat president, Bill Clinton -- permitted the first $500,000 of profits from the sale of a home to be tax-free. This came on top of existing law that permits mortgage expenses to be tax deductible depending on one's income bracket.
Have housing prices increased? Of course they have. Nobody cares about how much a house actually costs. All they care about is if they can afford the monthly payments. We really don't have a housing bubble that's anywhere near bursting. Current 10-year interest rates are just too low. Look at what the shift in the average interest rate for a 30-year fixed mortgage does to a home buyer's monthly payment. At today's average of 5.6%, borrowing $500,000 results in a monthly payment of $2,870. A year ago, a home buyer would have paid about the same each month, $2,847 to be exact, on a loan of $460,000.And I certainly don't see interest rates rising enough in the next year or so to burst a bubble, either.
This has nothing to do with speculation associated with buying equities or gold. There is timber and toilets behind these investments. Unlike a tech stock, a house for most people is more than an investment. It’s a place to create a home and build memories. And transaction costs are high. So there’s a natural resistance to cashing out. Contrast today's home market with the economy's last bubble -- in tech stocks. In the late 1990s the NASDAQ surged 40% a year as people threw billions of dollars into companies that had no profits or coherent business plans. That's a far cry from 2005's housing picture. The supply of housing has not outstripped demand, and price increases have been supported by gains in jobs and incomes.
First, home-builders know speculation works against them. It means they have to compete with speculators to make sales, which hurts their control over the markets and pricing. In contrast, during the tech bubble the people pushing tech stocks (Wall Street analysts, investment bankers and fund managers) had an interest in creating a speculative frenzy so they could sell higher. The only bubbles I see are the bubbles blown by the bathtub farts emanating from the ANAL-ysts. Sitting in those TOL bathtubs can be a relaxing and fun aromatic experience.
The current macroeconomic environment has done wonderful things for TOL vs. its competitors. TOL builds the mega Mcmansions on the golf courses. You know there has many a $$$MR. MARKET$$$ drive that has rattled off of these roofs and picture windows. As interest rates have come down, people can afford a larger house than what they used to own. They move up to TOL. “As long as the population continues to rise and affluent households continue to grow much faster than the population in general ... demand for luxury homes will continue to exceed supply”…so says Robert Toll, king TOL. The average price of a home it sells is well over $600,000. Yet TOL has plenty of potential buyers.
"We've got 16.9 million people (in the U.S.) making $100,000 or more in constant dollars compared with about 6 million 20 years ago," Toll said.
That's 15% of the U.S. population today vs. 7% 20 years ago, he says. Meanwhile, zoning and planning have become more restrictive in that time, making it more difficult and expensive to develop land. The baby boomers are getting older and wealthier. Four million more people are going to turn 45 years old on average this decade vs. last decade. That's key, because 45 is the age when most people are at or near their peak earnings potential, and when they buy their largest home.
"So what you have is tremendous increase in demand, butting up against a tremendous constraint in supply," Toll said. "What we're primarily doing is putting our net down on a stream that is full of fish.”
While the boost to the overall housing market provided by such mortgage products can only last for so long, the fundamental sales outlook is good for builders on market share opportunities, barring a significant housing slowdown. Even if housing growth cools off, TOL will continue to make a ton of money. On a national level, home prices aren't going to plunge -- they just won't rise very much. In the past 40 years, national new-home prices have fallen only twice, and both times were during a recession. Based on past history, at least, a modest rise in mortgage rates won't do the trick. Average interest rates for a 30-year fixed mortgage rose to 6.3% in May 2004 from 5.5% in May 2003 without sending housing prices sliding quickly lower. Based on the projections from the National Association of Home Builders, a future climb in mortgage rates from 5.8% in 2004 to 6.6% in 2006 wouldn't have a huge effect on sales of either new or existing homes. As mortgage rates climbed 0.8 percentage points, new-home sales would fall by 6.5% from 2004 to 2006, and sales of existing homes would decline by 5%. At worst, that's air gently escaping from any housing bubble. I’ll get to the earnings analysis later.
Going to school on homebuilding
------------------------------
As Ric Flair would say, “Whoooo! Now we go to school!”
In today's ownership society, few investments have been so lucrative for so many as homeownership. Since 2001 extremely cheap mortgage rates have fueled a record-setting level of home sales. Frenzied demand caused home prices to jump at rates not seen since the 1980s and generated 10% gains each year in housing wealth for many Americans, who quickly used refinancings or home-equity loans to convert some of the windfall into cash. Expect the macro New Home Sales growth rates to moderate, but no severe slowdown is in sight (assuming no major spikes in rates or significant job losses). For 2005 homebuilders are still optimistic about demand. There's a backlog of unfilled orders for new homes. People who compare this situation to the tech bubble are silly. Many tech stocks traded for 10 times what they were worth as businesses. Few think real estate is anywhere near that overvalued.
Demand also remains healthy. Orders, which reflect revenue two or three
quarters down the line when a home sale closes, rose 13% on average in the
quarter, estimates Merrill Lynch analyst Lorraine Maikis.
And home builders are reporting little signs of a housing crash, which many
doom-and-gloom skeptics have been predicting.
"We haven't heard of any type of slowdown out there. Interest rates are
obviously still very low, and I think some of the weather delays that were
experienced in the first half will begin to be delivered in the second half,"
Maikis said. She speculates 30-year fixed-rate mortgages would have to top the 8% mark before home builders would see a significant pullback in demand.
"We can't see much change in the headiness" in red-hot markets such as
Florida, Washington, Philadelphia and suburban New Jersey, Phoenix, and
Northern California.
Although Southern California andLas Vegas have softened from the torrid
sales pace they experienced a year ago, they still remain solid, he said. And
Reichardt said the North Carolina market has picked up from a year ago.
Raymond James analyst Rick Murray said he noticed a slowdown - but not a
decline - in orders in southern Florida. He said it's not clear if the softness
is due to a lack of supply or pullback in demand.
There is nothing clear on the horizon to break the trend. Of course, the Fed has been raising rates, but it has been doing that for almost a year now with little effect. When they raised rates in 1999 and 2000, and when they
cut interest rates drastically in 2001, there was no noticeable effect on the trend in home prices either. With the 10-year U.S. Treasury bond yielding below 4% and 30-year mortgages available at 5.1%, there isn't a housing bubble.
The fundamentals of housing -- the health of the economy and demographics -- argue against a widespread drop in demand. Faster job and income growth should help to offset the drag of higher borrowing costs. Plus, even though a record 69.1% of Americans owned their homes at the end of 2004, demand will still be supported by baby boomers and immigrants. Immigration is another trend that will help housing coast to a soft landing.
Immigrants accounted for one-third of the new households formed in the 1990s, and these families are entering the housing market.
What we're seeing in the housing market is monetary inflation. Pure and simple. Economic theory says that when more money chases a limited quantity of goods, the price of those goods increases. So nationally, cheaper money drives up the price of houses -- which does lead home builders to increase supply at higher prices.
The Federal Reserve has effectively mopped up excess cash and calmed inflation expectations. That's why bond rates are hovering around 4 percent, with most mortgage rates about a point higher.
TOL will make a ton of money
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Toll Brothers, has been chosen by their peers as the First Place Winner for Innovative Product Design in the Big Builder Apex Awards. The selection was made using a national survey of the home building community, sent out to readers of Builder and Big Builder magazines; the award was created by Hanley Wood, publisher of these and other publications. Toll Brothers was also honored for Leadership and Management, and for Operational Excellence and Efficiency. In addition, Toll Brothers was named as one of the Most Admired Big Builders of the Year, based on an overall ranking of Builders 100 companies in various categories.
Nearly 600 people attended the awards luncheon, which was held at the Mandalay Bay Hotel and Casino in Las Vegas, Nevada. Most of them were horrified at the site of a dozen Wharton MBA’s consuming mass quantities of alcohol by the pool and then placing bets at the sports book while they ran around shouting “Johnny Walker Blueeeeeeeeeeeeee”.
Toll Brothers is the only publicly traded national home building company to have won all three of the industry's highest honors: America's Best Builder from the National Association of Home Builders, the National Housing Quality Award and Builder of the Year.
"People just keep buying anyway .... I've never seen anything like this in almost 40 years in the business." Robert Toll, the CEO of Toll Brothers
TOL recently reported fiscal second-quarter results, and its numbers continue to astound. It generated net income of $170.1 million, or $2.01 /share up 135% from last year's $72.4 million, or $0.89 per share. That easily topped the average estimates of $1.79 per share. Revenue was also up significantly, jumping 52% to $1.25 billion.
The future continues to look bright for Toll Brothers, with no evidence of a slowdown in sight. The company's second-quarter contracts and backlog of $5.87 billion were the highest for any quarter in its history. Through its first two quarters, Toll Brothers has signed accounts on 5,354 homes. At that pace, it should easily top its previous forecast of 8,050 to 8,400 homes for the year.
The company also managed to increase by 10,000 the number of home sites it controls to 68,000. TOL increased its full-year guidance, now predicting a 70% increase in net income over last year. Even with the increase, the company still expects to generate a 20% jump in fiscal 2006 over those 2005 results. Toll Brothers should close on nearly 8,900 homes in FY 05 (Oct.), almost a 35% increase from last year, and its average home price should advance 10%.
Like $$$MR. MARKET$$$ has said before, if yields on the 10-year bond rise, they will go up because of economic strength – strength that creates more jobs. That will fuel more demand for housing, offsetting any negative impact from higher rates.
Next, interest rates are so low, it’s not clear they will go up enough to kill off the housing market. Even if yields on the 10-year bond go up 1.5 to two percentage points to hit 5.5% to 6% over the next year or more, that would take the 30-year mortgage rates -- recently around 5.5% -- up to about 7.5%. If history is any guide, that’s not enough to cool off the housing market. The last three housing market slowdowns -- in 1995, 1997 and 2000 -- didn’t happen until mortgage rates moved into the 8.4% to 9.4% range. Joel Rassman, the finance chief at Toll Brothers says “There is so much demand, if we stay in the 6% to 7% plus range, housing will continue to boom. “ Robert Toll confirms, “"We had a field day in 1995 when mortgage rates went up to 9.1%," he said.” Toll Bros. also kept growing in 1997 and 2000, when interest rates were at 8.1% and 8.75%, respectively.
TOL noted that it’s buying more land now than a year ago. Increased land buying is occurring in many areas, including NE (NY, CT, NJ); West (AZ, LV, lesser degree CA); FL (E & W coasts). It’s great that management is using cash flow to fuel growth. In most cases, the money is being made on the land appreciation. Before TOL drives their first nail, they’ve already made money on a house. On the supply side, there are land shortages in key metropolitan areas and greater obstacles to using land for housing. Meanwhile, demand will get a boost from new immigrants, baby boomers buying second homes and so-called echo boomers buying first homes.
TOL’s debt-to-capital at quarter end was 42.1%, down from the 2Q04 level of 49.3%. TOL’s return on capital continues to expand, at 17.7% from 11.9% in 2Q04, driven by increased asset efficiency, profitability and leverage. TOL’s 68,000 lots controlled represents approximately a 7-8 year supply of lots based on next twelve month projected closings.
Although the company does not provide specific earnings per share guidance, it did raise its fiscal 2005 outlook to approximately 70% net income growth versus its prior guidance of at least 60% growth. Additionally, despite the higher base earnings in 2005, anagement believes it can still achieve earnings growth of approximately 20% in fiscal 2006.
With valuations improving for nearly all builders due to evidence of ongoing strength in operating performance and greater visibility into 2006. TOL’s stock price would hit $120 based on about a 13.3X P/E multiple applied to our First Call 05 EPS forecasts, which is well past my sell price.
My earnings estimate, which is based on net income growth of 90%, incorporates 50% homebuilding revenue growth and 430 basis points of operating margin expansion to 22.8%. $$$MR. MARKET$$$ sees earnings at $10/share, which would mean the stock will probably go over 133.
There’s not a lot more I can say about this stock. If you think “bubble” is not going to burst, there is absolutely no reason to NOT own TOL’s stock. If you are fearful of the "bubble", then this is not a stock for you.
For the first time, I have run out of things to say, so I’ll let the TOL bosses lay this on you:
Robert I. Toll, chairman and chief executive officer, stated: “We owe our excellent results to the tremendous perseverance and intensity of our associates. No one in our industry has a harder working, more dedicated team!
“With increasing numbers of communities in lot-constrained markets, our growing brand name and our broadening diversity of luxury new home product lines, we continue to produce record results.
“We expect to end fiscal 2005 with approximately 240 selling communities compared to 220 at FYE 2004. We believe our expertise in securing land and opening communities in highly-regulated, upscale markets gives us a competitive advantage, both today and in the future. We now control approximately 68,000 home sites, compared to 58,000 one year ago. These sites, which are in communities currently open for sale or wending their way through the approval process, represent a five-to-six year supply based on our historic pace of growth.”
Joel H. Rassman, chief financial officer, stated: “Our record earnings, contracts and backlog reflect the strong demand and accompanying pricing power we have enjoyed over the past twelve months. Based on these results and our record $5.87 billion backlog of homes under contract, we are increasing our earnings expectations for FY 2005. We now believe net income will grow approximately 70% in FY 2005 compared to FY 2004. Based on our backlog and expected community growth, even with this increased projection, we still believe net income will rise approximately 20% in FY 2006 over FY 2005.”
Toll Brothers’ financial highlights for the three-month and six-month periods ended April 30, 2005 (unaudited):
• The Company’s FY 2005 second-quarter net income of $170.1 million grew 135% versus FY 2004 second-quarter net income of $72.4 million. Second-quarter earnings of $2.01 per share diluted increased 126% compared to second-quarter 2004’s earnings of $0.89 per share diluted, the previous second-quarter record.
• FY 2005 six-month net income of $280.3 million grew 129% versus FY 2004 six-month net income of $122.5 million. Six-month earnings of $3.34 per share diluted rose 121% versus FY 2004’s same period earnings of $1.51 per share diluted.
• FY 2005 second-quarter contracts of $2.20 billion (3,181 homes), grew 38% over FY 2004’s second-quarter contracts of $1.60 billion (2,595 homes), the previous second-quarter record. In addition, in second quarter 2005, unconsolidated entities in which the Company had an interest signed contracts of $85.2 million (123 homes).
• FY 2005’s six-month contracts of $3.65 billion (5,354 homes), grew 46% over FY 2004’s total of $2.50 billion (4,107 homes), the previous six-month record. In addition, in the six-month FY 2005 period, unconsolidated entities in which the Company had an interest signed contracts of $100.7 million (159 homes).
• FY 2005 second quarter-end backlog of $5.87 billion (8,561 homes), the highest in the Company’s history, increased 57% over FY 2004’s second-quarter-end backlog of $3.73 billion (6,211 homes), the previous second-quarter record. In addition, at the end of second quarter 2005, unconsolidated entities in which the Company had an interest had a backlog of $111.7 million (183 homes).
• FY 2005 second-quarter revenues of $1.25 billion increased 52% versus FY 2004’s second-quarter revenues of $819.5 million. In FY 2005, second-quarter home building revenues of $1.23 billion (1,912 homes), increased 51% over FY 2004’s second-quarter home building revenues of $814.3 million (1,463 homes), the previous second-quarter record. Revenues from land sales totaled $9.8 million for FY 2005’s second quarter, compared to $2.0 million in the second quarter of FY 2004.
• FY 2005 six-month revenues of $2.25 billion increased 59% versus FY 2004’s six-month revenues of $1.42 billion, the previous six-month record. FY 2005 six-month home building revenues of $2.22 billion (3,502 homes) increased 58% over FY 2004’s six-month home building revenues of $1.40 billion (2,548 homes), the previous six-month record. FY 2005 revenues from land sales for the six-month period totaled $11.0 million compared to $8.0 million in the same period in FY 2004.
If I keep putting a string of these stocks together, a Toll Brothers home is right around the corner for $$$MR. MARKET$$$.
I am HUGE!!
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