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Toll Brothers 1H17 Performance Solid, Materials Costs High

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On May 24, we issued an updated research report on Toll Brothers Inc. (TOL - Free Report) – the nation's leading builder of luxury homes.

Strong housing demand and lack of competition in the luxury new home market are doing the trick for Toll Brothers. However, we are concerned about the escalating building material and labor costs that are proving to be a drag on margins.

Toll Brothers came up with a stellar show in the recently reported second quarter of fiscal 2017, with both earnings and revenues surpassing analysts’ expectations. Adjusted earnings rose 43.1%, while revenues were up 21.4% year over year. Second-quarter net income grew 40%, deliveries increased 26% in units, and contracts rose 23% in dollars and 26% in units, compared to the prior-year quarter, defining the best spring selling season for Toll Brothers in over ten years.

Notably, Toll Brothers’ shares have gained 31.4% in the last one year, outperforming the Zacks categorized Building-Residential/Commercial industry's gain of 22.2%. Meanwhile, estimates for the current year and the next have moved up by 1.3% and 2.1% over the last 60 days.


 
First-Half Fiscal 2017 Performance

Toll Brothers reported adjusted earnings of $1.15 per share in the first half of fiscal 2017, highlighting an increase of 26.4% from the prior-year period on the back of higher revenues.

In the first half of fiscal 2017, total revenues of $2.28 billion rose 12% and deliveries of 2,828 units increased 19% from the prior-year period.

The company’s net signed contracts worth $3.26 billion and for 4,033 units show an increase of 19% in dollars and 24% in units.

Key Positives

Toll Brothers mostly offers luxury homes and its communities are located in prosperous suburban areas with easy access to major cities. Luxury homes generally face limited competition. The company mostly caters to luxury move up buyers, who are less sensitive to price changes. Thus, Toll Brothers enjoys greater pricing power than other homebuilding companies.

The 2017 outlook for the U.S. homebuilding industry is quite compelling given the affordable interest rates and tight inventory indicating pent-up demand. Also, an improving economy, modest wage growth, low unemployment levels and positive consumer confidence raise optimism about the sector in 2017.

Concerns

Rising building materials and labor costs are growing concerns for the company. Specifically, rising lumber/timber costs raise concern, as timber and related products are required for building new houses. The U.S. government has announced plans to impose a tariff of up to 24% on imports from the Canadian softwood lumber industry. This may lead to an uptick in lumber prices, making imports from Canada costlier. And domestic lumber companies may also be able to charge some price premium in the face of lesser foreign competition.

Toll Brothers’ valuation looks a little stretched when compared to the industry average. With a trailing 12-month P/E ratio of 17.02, the stock is relatively overvalued right now compared to its peers, as the Building-Residential/Commercial industry’s average over the past five years is 13.95. Moreover, the company’s ROE of 9.71% compares unfavorably with the ROE of 12.47% for the industry, reflecting this Zacks Rank #3 (Hold) company’s inefficiency in using shareholders’ funds.

Stocks to Consider

Better-ranked stocks in the industry include Lyon William Homes , M/I Homes, Inc. (MHO - Free Report) and KB Home (KBH - Free Report) .

Lyon William and M/I Homes sport a Zacks Rank #1 (Strong Buy). Full-year 2017 earnings for Lyon William are expected to increase 38.4%, while that of M/I Homes is likely to rise 36.2%. You can see the complete list of today’s Zacks #1 Rank stocks here.

KB Home, a Zacks Rank #2 (Buy) stock, is expected to witness 43.3% growth in fiscal 2017 earnings.

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