Homebuilders have a reason to be optimistic as of late. Not only has the SPDR S&P Homebuilders ETF (XHB) firmed up, but Toll Brothers (TOL) released strong fundamental news, helping to buoy the industry.
Toll Brothers operates at the high-end of the homebuilding industry. Its average home price, for example, has historically been ~$650,000 compared to ~$300,000 for its publicly-traded peers. As a result, we’d view Toll’s main competitors as small private builders catering to luxury demographics, not necessarily the large public builders. The firm’s performance, however, is worth watching as yet another data point with respect to the industry’s health.
Pent up housing demand has been accruing for years, and new home inventory is limited, which makes for an environment conducive to driving housing price improvements (as a result of simple supply/demand dynamics). Toll’s preliminary fiscal fourth-quarter results, released Monday, showed a company benefiting from this dynamic. Fiscal fourth-quarter revenue advanced 29% in dollars thanks to a 22% increase in units. The firm’s average price of homes delivered in the quarter surged to $747,000, compared to ~$700,000 in the fourth quarter of last fiscal year (and the ~$650,000 historical mark). Net signed contracts rose 16% in dollars and 10% in units. The company ended fiscal 2014 with a backlog of ~$2.72 billion, an increase of 3%. Toll Brothers’ quarterly performance was excellent, by any measure.
Though we acknowledge the concept of ‘shadow inventory’—sellers currently without a ‘for sale’ sign in their front yard—overall inventory trends continue to move in the right direction. Toll estimates that the total estimated shortfall of housing starts from the period 2008-2013 was 5.1 million. That equates to an annual shortfall in production of ~850,000 new homes, providing significant future opportunities for the homebuilding group as a whole. With interest rates still near historical lows, it’s difficult for us to say that such pent-up demand will not be realized by the industry in coming years, even as threats of higher rates loom.
Toll Brothers is trading roughly in-line with our estimate of its intrinsic value, though we note that peers Ryland (RYL) and Meritage (MTH) are trading below our estimates of their respective fair value ranges. Still, we’d be very cautious putting any money to work in the homebuilding industry. The recent meltdown in housing, for one, is a prime example of the extreme cyclicality of the industry’s fundamentals. Housing market health is also determined by a number of variables outside of a builder’s control: consumer confidence, employment, household formation, replacement demand (natural disasters), inventory (existing/shadow), interest rates, lending standards, and housing prices themselves. One doesn’t have to look much further than the Great Recession to see a number of builders wiped from the map. Owning a homebuilder, in our view, is merely a speculative economic bet that we’re not comfortable taking.
Homebuilders: DHI, GFA, JOE, KBH, LEN, MDC, MTH, NVR, PHM, RYL, SPF, TOL