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Toll Brothers (TOL)
Toll Brothers 1Q Profit Plunges 67%
It has been a tough couple of months for home builders. Between the housing bubble scare - which managed to not really materialize - and worries about interest rates, fewer Americans have been opening up their wallets to break ground on a new home. Some markets have seen a glut in housing availability, which isn't the best of news for Horsham, PA-based Toll Brothers, Inc. The company focuses on the luxury homes market, and has seen some pretty significant declines in areas which used to be booming. It announced on Thursday that its 1Q profit dropped 67%, and that new home sales might be lower than expected for 2007. What is going on in the housing market, and how does Toll Brothers plan on turning things around?
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Property is certainly more multi-faceted than just home building. Many factors - from interest rates to investment banking - influence companies like Toll Brothers, and can determine whether or not they make a profit or have to tell investors that they struck out. One major issue that has popped up in recent weeks has been the state of sub-prime lending. This type of lending focuses on customers who do not qualify for prime rates, or have damaged credit or no credit history. Sub-prime loans charge a higher interest rate in order to compensate for increased risk. Demand for these loans had increased rapidly over the last few years, and many institutions were willing to take on the added risk because of the higher rate. You can think of this as a lending company diversifying its portfolio, but to the tune of billions of dollars. The problem is that a growing number of sub-prime loan recipients aren't paying, which is what HSBC Holdings (HBC: Charts, News, Offers) and New Century Financial (NEW: Charts, News, Offers), the nation's second and third largest sub-prime lenders, discovered a few weeks ago. Regulations require that poorly-constructed loans be bought back by the lender, and the rising number of defaults has forced companies to take a major hit.
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What do sub-prime loans have to do with Toll Brothers, since its market is focused on luxury homes? As stated earlier, lending companies use sub-prime loans to diversify, often selling those loans to investment banking companies who are also trying to diversify. As this lucrative option dries up due to defaults (19% of mortgages were sub-prime in the first half of 2006), companies will have to make up for lower profits someplace. While the effects are most likely limited on Toll, the general feeling of dread could circle around the housing market and could potentially scare of new investors.
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Toll's 1Q profit dropped 67%, representing a drop from $163.9m to $54.3m. Writedowns, representing land or housing that the company doubts it could sell at a profit, jumped to $96.9m, up from $1.1m during the same period in 2006. At the same time, housing markets in the South, West and Mid-Atlantic states saw declines in new contracts, with Western states seeing a drop of 59%. Cancellations fell from 585 homes in 4Q 2006 (36.9% of contacts) to 436 homes (29.8%), though this number is still much higher than the company's historical average of 7%. Looking forward to 2007, recent trends have prompted the company to readjust the amount of homes it expects to deliver, from 6300-7300 to a newer 6000-7000. While the numbers don't look great now, they could easily become worse if the writedown rate edges up.
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Investors didn't react as poorly as some might expect when the news broke (shares were down 1.55% by noon). Despite several bad housing industry reports for the first two months of 2007, stockholders have stuck around and have even bumped Toll and its major competitors - D.R. Horton (DHI: Charts, News, Offers), KB Home (KBH: Charts, News, Offers) and Ryland Homes (RYL: Charts, News, Offers) - up by at least 5% apiece, with D.R. Horton and KB Home approaching 10%. Centex (CTX: Charts, News, Offers), another competitor, has fallen by more than 5%. Investors have eased off housing bubble fears over the last six months, which has helped Toll Brothers stock rise 30%. The stock is still far from its peak in 2005, when a share was trading at nearly $60, and has yet to bounce back to pre-April 2006 levels. Much of the company's future performance is going to depend on what the Fed does with interest rates and the performance of the overall market.
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Profile |
The Company's principal activities are the development, construction and sale of residential housing. The Company also makes arrangement of finance for single family detached and attached homes in middle and high income residential communities catering to both move-up and empty nester home buyers. The Company operates its own architectural, engineering, mortgage, title, security monitoring, landscape, lawn maintenance, insurance brokerage, cable television, broadband internet access, component assembly and manufacturing operations. It markets its homes primarily to middle-income and upper-income buyers. In 2003 the Company acquired Richard R. Dostie Inc & The Manhattan Building Company.
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