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Bear of the Day: Toll Brothers (TOL)

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Toll Brothers, Inc. (TOL - Free Report) is feeling the strain as home buyers are balking at high housing prices. This Zacks Rank #5 (Strong Sell) has increased incentives which is going to hit gross margins this year.

Toll Brothers builds luxury homes for move-up, empty-nester, active-adult and second home buyers. It also builds urban and suburban rental properties.

The company operates in 22 states including Arizona, California, Colorado, Connecticut, Delaware, Florida, Georgia, Idaho, Illinois, Maryland, Massachusetts, Michigan, Nevada, New Jersey, New York, North Carolina, Oregon, Pennsylvania, Texas, Utah, Virginia and Washington, as well as in the District of Columbia.

Expanding Into Hot Markets

In May 2019, Toll announced it was entering the metro Atlanta market by acquiring Sharp Residential. Sharp was one of Atlanta's largest private home builders.

Atlanta was also the largest US housing market that Toll did not have a presence.

Sharp focused primarily on the area’s northern suburbs with homes ranging from first-time to luxury at price points from the $300,000s to the $900,000s. At the date of acquisition, the Company had approximately $65 million in backlog consisting of 125 homes with an average price of $520,000.

Toll also acquired approximately 900 lots owned and controlled in the Atlanta MSA in the deal.

Terms of the deal were not disclosed.

In the fiscal second quarter, Toll also expanded organically into two other hot markets: Salt Lake City and Portland, Oregon, with the opening of their first communities.

Toll said buyer interest had been "healthy."

Toll Beats Again in the Fiscal Second Quarter

On May 21, Toll Brothers reported its fiscal second quarter results and beat on the Zacks Consensus by 10 cents. Earnings were $0.87 versus the consensus of $0.77.

It was the 6th consecutive earnings beat.

Revenue was up 7% to $1.71 billion as deliveries rose 1% to 1,911.

But the problem was that net signed contract value fell 16% to $2 billion and contract units were down 9% to 2,424.

Also backlog value at the end of the quarter fell 11% to $5.66 billion.

The company struggled in California, a large luxury home market.

The level of incentives to get buyers to sign the contract jumped 13.3% from the first quarter and was 55% higher than the second quarter of last year. In 2018, it was giving average incentives of $22,000 but this year it had jumped to $34,000.

This increase hits gross margins directly.

Analysts Cut Estimates for F2019 and F2020

The high end of the housing market is feeling the pinch, even with mortgage rates dropping again.

Analysts are bearish about earnings due to the higher incentives and hit to gross margins. They've been cutting since the earnings announcement.

6 analysts cut their full year 2019 estimates in the last month, pushing the Zacks Consensus down to $3.91 from $4.38 during that time.

Toll made $4.71 in fiscal 2018 so that's an earnings decline of about 17%.

6 analysts also cut fiscal 2020 estimates pushing the consensus down to $4.29 from $4.51. But that's at least 9.5% earnings growth compared to 2019.

Is the Rally Over?

The home builder stocks got crushed in 2018 as Wall Street feared rising rates would mean slowing sales.

Toll Brothers stock bottomed out in October 2018 and then staged a furious rally.

But the earnings report put a damper on the party. While Toll is still up 7.7% year-to-date, it's well off its recent highs.

Could it retest those October lows again this year?

Shares look cheap with a forward P/E of just 9. Toll also pays a dividend yielding 1.2%.

But with incentives rising on weaker demand, it might be too early to jump back in.

If you really want to own a home builder, check out those that are Zacks Rank #1 (Strong Buys). Those include PulteGroup (PHM - Free Report) , NVR (NVR - Free Report) and Taylor Morrison (TMHC - Free Report) .

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