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Toll Brothers (TOL) Rides on Luxury Offerings Amid High Cost

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Toll Brothers, Inc. (TOL - Free Report) has been gaining traction of late. Its shares have gained significantly in the past few months backed by robust demand for homes and limited competition in the luxury housing space. Also, accretive acquisitions and partnerships, solid land position along with robust prospects have been adding to the positives.

In the year-to-date period, shares of this Zacks Rank #3 (Hold) company have gained 47.6% compared with the industry’s 26.1% rally. The solid price performance was backed by the above-mentioned factors and an impressive earnings surprise history. Its earnings surpassed the Zacks Consensus Estimate in 17 of the trailing 19 quarters.

The positive price trend signifies bullish investors’ sentiments, indicating robust fundamentals and the expectation of outperformance in the near term. Let delve deeper.

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Growth Drivers

Luxury Housing Market a Boon: Toll Brothers is one such company that continues to display strength in several areas. The company mostly caters to luxury move-up buyers who already possess a residence but are looking to shift to larger and better homes. These homebuyers are less sensitive to price changes as it faces limited competition. Toll Brothers enjoys greater pricing power than other homebuilding companies.

The company continues to look for opportunities to expand its luxury brand to new product lines and price points in a bid to maintain leadership in the luxury segment. At the same time, the company has been strategically adding more affordable luxury communities in view of the current demographic trends, and expanding footprint as well as customer base. These communities are expected to be more capital efficient.

Recently, it announced a new strategic partnership with Equity Residential — a world-class S&P 500 company focused on luxury apartment rentals — to jointly acquire and develop sites into new rental apartment communities in key markets of metro Boston, Atlanta, Austin, Denver, Orange County, Seattle as well as Dallas. In the next three years, it expects Equity Residential to invest 75% of the equity in each selected project, while Toll Brothers’ apartment living unit will invest the remaining 25%.

Solid Housing Market Prospects: The U.S. housing market is witnessing an impressive comeback on major data points post COVID-led shutdowns, with home sales rising at a record pace, defying low inventory levels, and broad-based economic as well as public health risks. New single-family homes’ demand has seen a V-shaped recovery throughout the country. A combination of lower interest rates and rising need for more work-at-home space positively impacted the industry, thereby helping Toll Brothers deliver a solid performance.

For third-quarter fiscal 2021, home sales revenues grew 37% from the prior year. Homes delivered grew 28%, with improvement in all regions served by the company. The number of net signed contracts was also up 11% year over year, marking record third-quarter numbers. Quarter-end backlog rose 47% (55% in values) from the prior year, witnessing an all-time record high in both dollars and units. Robust demand for homes has been a boon for Toll Brothers and companies like M/I Homes, Inc. (MHO - Free Report) , Meritage Homes Corporation (MTH - Free Report) as well as Tri Pointe Homes, Inc. (TPH - Free Report) in the same industry, each sporting a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Acquisitions: Toll Brothers has secured some of the most sought-after urban locations in the country, where land is scarce and approvals are not easy to obtain. It is making use of strong liquidity position to secure the most sought-after urban locations in the country like New York City Market, Northern New Jersey, Washington DC and Philadelphia. The company’s solid land position places it well to meet the growing demand in these regions, thus giving it a competitive edge over peers who are presently facing land availability constraints.

The company has been expanding geographically via selective acquisitions. On Aug 12, it acquired a NV-based privately-held homebuilder, StoryBook Homes, thereby strengthening foothold in the Las Vegas housing market. The company’s extensive geographic footprint and deep land position will allow it to grow community count in fiscal 2021 and 2022, attributable to faster-than-anticipated sale of existing communities.

Concerns

Higher Land, Labor & Lumber Costs: Rising building materials and labor costs are growing concerns for the company’s margin. Labor shortages are resulting in higher wages due to limited availability. This is somewhat putting pressure on homebuilders’ margins. Also, fluctuation in lumber prices is likely to weigh on the bottom line. Land prices are inflating due to limited availability. This could eat into homebuilders’ margins in the forthcoming quarters. Tariff-related woes are also a pressing concern. In order to mitigate top-line woes, the company has been making investments that comprise implementation of IT system upgrades.

Supply Constraints: Several years of production deficits during the housing downturn limited the supply of both rental and new homes in the country. At present, a shortage of buildable lots, skilled labor and available capital for smaller builders are limiting home production, thereby lowering the inventory of homes, both new and existing. The labor market has also tightened with limited availability of labor, arresting the rapid growth in housing production. If the supply picture does not improve, prices could go up, thereby affecting affordability.