Toll Brothers: Scraping The Bottom?

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The colorful CEO of luxury homebuilder Toll Brothers (TOL), Robert Toll, stepped forward on Dec. 5 with the claim that some housing markets might be stabilizing. His comments came as a slight disconnect from the company's quarterly news: Profits plunged, customers canceled more orders, and the company took a deep hit on its property holdings.



Most analysts and builders are bracing themselves for further tough times in the housing market, noting that the pain has yet to go around -- especially as homebuyers stomach steeper mortgage rates and monthly payments -- or, at best, hemming and hawing about what happens next.



The London-based banking giant, HSBC Holdings (HBC) came out the same day noting that its revenue growth had slowed due in part to weak results from its U.S. mortgage lending and the advent of higher delinquency rates. "This slowdown in growth of the Mortgage Services portfolio will of itself lead to higher reported delinquency percentages as the portfolio seasons and will constrain revenue growth," the bank said in a statement. That could easily spell trouble for similar large lenders across the Atlantic [see BusinessWeek.com, 11/17/06, "Housing: The Riddle of Rates and Prices].



"A New Man"

And, make no mistake, the quarter's numbers were decidedly dreary for Toll compared with a year ago: net income down more than 40%, revenue off 10%, asset writedowns up to $115 million from just $1.4 million, mostly for its real estate holdings. Profits fell 44%, to $173.8 million, or $1.07 per share, from $310.3 million, or $1.84 per share in 2005. The latest period's results included the pretax property writedowns. Toll, the nation's biggest builder in the luxury-home category, has been taking losses on properties, and its customers have grown nervous and far more likely to abandon new contracts on houses as prices retreat. Toll signed only $706 million of contracts during the quarter, compared with a record $1.59 billion in the same period of 2005.



Even so, the Horsham [Pa.]-based company dared put its optimism into the public arena. Toll's CEO said the metro D.C. suburbs of northern Virginia, the first market in which he saw activity slow, seems to have stabilized, although at levels much lower than in the past few years. He also sees the market stabilizing in the Maryland-D.C. suburbs, a more lot-constrained region where builders built fewer spec homes and where there were fewer speculative buyers. "Fifteen months into the current slowdown we may be seeing a floor in some markets where deposits and traffic, although erratic from week to week, seem to be dancing on the bottom or slightly above," Toll said.



The change in tone struck several analysts in the Dec. 5 conference call, which came less than a month after the company's last briefing [see BusinessWeek.com, 11/7/06, "How Deep Housing's Decline"]. "You seemed like a very I guess broken man last time. And here you are a new man," Ivy Zelman, an analyst at Credit Suisse First Boston, told Toll Tuesday. "I'm wondering which Kool-Aid you're drinking because I want some. No one else in the industry is willing to stick their neck out."



Normal Levels

Toll responded that he was merely making a statement with regard to what he had witnessed in the market. "I made the statement many moons ago that things stink and we're getting chopped," Toll said. "But I don't think I made a statement with respect to the future."



The comments helped to spark a minirally for the sector Dec. 5. Toll shares gained 3%, to close at $32.87 per share on the New York Stock Exchange Dec. 5. Hovnanian Enterprises (HOV) rose 3.4%, to $37.39; Beazer Homes USA (BZH) 2.6%, to $46.34; Lennar (LEN) 2.6%, to $53.53; Centex (CTX) 1.7%, to $56.76; and KB Home (KBH) 1.5%, to $52.17. Homebuilding stocks in the Standard & Poor's 1500 have shed 20.2% of their value in the year to date to trade at 699.38, making them one of the weakest performing sectors in the index.

UBS analyst Margaret Whelan said in a Dec. 5 note that most of Toll's recent profitability slide was spurred by its losses on land. She continues to expect those losses to remain elevated and cut her fiscal 2007 earnings estimate to $1.60 per share from $2.49 EPS. But she thinks the company will gain market share once demand returns to normal levels, and hiked her price target on the stock to $38, from $35 per share. S&P analyst William Mack also hiked his target price on the stock to $36, from $30 per share, citing rising inventories and book value. [S&P, like BusinessWeek, is a unit of The McGraw-Hill Companies.]



Demand Boost

The current decline, however long it lasts, has already proved to be persistent. In September, UBS Investment Research, for example, concluded that the housing market peaked in the third quarter of 2005, when housing prices stopped increasing at their torrid double-digit pace of recent years. The investment firm also made the point that the subprime market -- loans to people with poor credit -- peaked in 2003 and has been on the decline in recent years. UBS said Nov. 7 that the subprime market continues to deteriorate for newer loans, and at a faster rate in recent months. The company said vintage subprime mortgages are going bad this year at a 50% higher frequency than loans originated in 2005.



"Demand from second-home buyers and speculators, which drove record revenue and margins in 2005, is turning into a torrent of supply. Unit orders are off more than 50%, and how long it will take to burn off the excess is anybody's guess," Morningstar analyst Eric Landry said in a research note Nov. 27. He added the caveat that the ordeal may be shorter than some think, given trends such as the growth of the affluent baby boomer demographic.



Toll maintains that in Washington, D.C., one of his company's largest markets, the unemployment rate is close to zero. He thinks the turnover in Congress will also give a minor boost to demand, as new political staffers move into the city and buy homes there. "We don't think it's illogical to assume that pent-up demand is building," Toll said in a conference call. "That's all we're saying."



"Chutzpah"

The last major downturn, in the late 1980s and early 1990s, provided a springboard for Toll Brothers to expand into northern Virginia, the New York City suburbs, southern Connecticut, metro Los Angeles, and San Francisco. The company took its first major steps to becoming the national brand for luxury new homes during those tough times.



During the first quarter of fiscal 2007 Toll now expects to deliver 1,600 to 1,900 homes, up from the 1,500 to 1,800 homes forecast in Nov. 7. Toll had also said on that grimmer day in November that he expected to deliver 6,300 to 7,300 homes for fiscal year 2007, compared with previous guidance of 7,000 to 8,000 deliveries. He maintained that full-year estimate on Dec. 5.



"I want to give you a congrats to have had the nerve or chutzpah to put out an estimate -- and we know the problems -- but you have at least put it out. And you're the only one that has," said Timothy Jones of Wasserman & Associates in the conference call.



Toll's reply? He said he wouldn't have done so if he'd known he was the only one.