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Toll Brothers (TOL) Gains from Solid Demand, Rising Costs Hurt

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Strong housing demand and lack of competition in the luxury new home market are favoring Toll Brothers Inc (TOL - Free Report) . Overall fundamentals of the housing market were strong in 2017 and are expected to improve further in the rest of 2018. Steady job and wage growth, recovering economy, moderate home price gains, rising rentals, rapidly increasing household formation and a limited supply of inventory indicate consistent strong demand through 2018.

Again, less competition in the luxury new home market is beneficial for Toll Brothers. The company mostly caters to luxury move up buyers, who own a residence and are planning to shift to larger homes. These homebuyers are less sensitive to price changes. Thus, the company enjoys an edge over other homebuilding companies, resulting in increased home deliveries, earnings and revenue backlog growth.

In fiscal 2017, total revenues of $5.82 billion rose 12% and deliveries of 7,151 units increased 17% from the prior-year period. The company delivered double-digit growth in earnings, revenues, contracts and backlog in fiscal 2017. The trend continued in the first six months of fiscal 2018, with the company registering double-digit growth in revenues (up 21%), contracts (up 25% in dollars) and backlog (up 27% in value). This reflects the health of the luxury new home market.

Moreover, considering the pent-up housing demand, the company secured some of the most sought-after urban locations in the country, where land is scarce and approvals are not easy to obtain. The company’s solid land position places it well to cater to growing demand in these regions and provide it a competitive edge over peers who are facing land-availability constraints.

Constraints

Rising building materials and labor costs are growing concerns for the company’s margin. Land prices are inflating due to limited availability. This can dent homebuilders’ margins in the forthcoming quarters. Moreover, the recently imposed tariff on imported steel and aluminum raises concern. An increase in import tariff will escalate raw material cost for home builders, who are already grappling with higher cost, thanks to the recent imposition of lumber tariff.

Again, a shortage of buildable lots and skilled labor is exerting pressure on the margins of Toll Brothers and other homebuilders like PulteGroup (PHM - Free Report) , KB Home (KBH - Free Report) and D.R. Horton Inc. (DHI - Free Report) . In fact, the company’s adjusted gross margin declined 80 basis points in fiscal 2017 and 180 basis points in the last quarter.

Notably, shares of the company have lost 5.6% in the past year compared with the industry’s 4.8% rally.



Bottom Line

Unhindered by the persistent issues, analysts are optimistic about Toll Brothers. Earnings estimates for this Zacks Rank #3 (Hold) company have moved up 3 cents for 2018 and 11 cents for 2019 over the past 60 days. This indicates analysts’ optimism surrounding the company’s future earnings potential.

You can see the complete list of today’s Zacks #1(Strong Buy) Rank stocks here.

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PulteGroup, Inc. (PHM) - free report >>

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