Toll Brothers Can Take a Punch

The luxury homebuilder had another poor quarter, but it wasn't as bad as expected. So what's Toll doing right in a brutal housing market?

by Maya Roney

It's not easy being a homebuilder these days. Scratch that—it really, really, really stinks.

So when Toll Brothers (TOL) announced Aug. 22 that its third-quarter profit fell 85% due to price write-downs and increased cancellations, no one was surprised that the luxury homebuilder was still feeling the burn of weak demand and slower home sales.

But Wall Street, still smarting from last week's mortgage-related meltdown, had been bracing itself for an even poorer outcome. On Tuesday, Bank of America (BAC) analyst Daniel Oppenheim had downgraded Horsham (Pa.)-based Toll Brothers to "sell" from "hold," citing recent mortgage market distress. Analysts surveyed by Thomson Financial (TOC) predicted that Toll Brothers would lose 2¢ per share, vs. the reported earnings of 16¢ per share. As a result, shares of the company, which fell nearly 5% Aug. 21, rose as much as 6% after the following day's earnings announcement. The stock closed 5% higher Aug. 22, at $22.15.

Rolling with the Punches

So far, Toll Brothers has remained profitable and increased stockholders' equity since the housing slowdown began two years ago. That's more than Bonita Springs (Fla.)-based WCI Communities (WCI) can say. On Wednesday, the builder of multifamily houses reported a fiscal second-quarter loss of $33.2 million, or 79 cents per share, vs. a profit of $22.7 million, or 52 cents per share, in the year-ago period. Pulte Homes (PHM) also reported a loss last quarter, and builders D.R. Horton (DHI) and Hovnanian Enterprises (HOV) both expect to report third-quarter losses.

Considering the challenging environment, Toll Brothers seems to be making all the right moves—but what are they? For one, Toll Brothers is simply doing what homebuilders should do, considering the glut of homes on the market now. "We believe that reducing new-home production until the current oversupply is absorbed is a key step in bringing housing markets back into equilibrium," Chairman and Chief Executive Officer Robert Toll said in a statement.

The company also believes its build-to-order model has helped some. In single-family home communities, the builder says it does not typically start a home until a contract is in place and, in multifamily communities, a "significant" nonrefundable down payment, leading to fewer cancellations and freeing borrowers from tighter loan requirements from banks.

Toll is still doing a good job of creating cash, with $772 million on its balance sheet at the end of the third quarter. Inventories and receivables are also down, and the company says its debt is mostly long-term and its leverage low by historical standards.

Rough Waters

While Toll Brothers may be the least disappointing builder out there, make no mistake—the overall picture is still ugly. Toll Brothers' revenue fell 21%, to $1.21 billion, in the third quarter, and cancellations on Toll Brothers homes jumped to 24%, from 19%, in the previous quarter. "We continue to wrestle with the interrelated challenges of softer demand and excess housing supply in most markets," says Toll.

Homebuilders' insecurities are well documented. In August, the National Assn. of Home Builders/Wells Fargo Housing Market Index declined two points, to 22, its lowest level since January, 1991. Derived from a monthly survey, the index gauges builder perceptions of current single-family home sales and sales expectations for the next six months.