Investors Take a Shine to Toll

The homebuilder's battered shares rose Wednesday after the company said it's poised to ride out the current slowdown

by Karyn McCormack

Toll Brothers' (TOL) latest sales numbers confirm what many other homebuilders have been saying: The housing slump still has legs. Still, the beaten-down shares headed higher as the company tried to assure investors that it has enough liquidity to survive the downturn. Other homebuilding stocks rallied as well.

The luxury homebuilder said on Aug. 8 that preliminary third-quarter (ended July 31) revenues came in at around $1.21 billion, down 21% from a year ago but up 3% from the April quarter. Third-quarter backlog was $3.67 billion, down 34%, while net signed contracts were $727.1 million, falling 31% from year-ago levels. (The company will announce third-quarter earnings results on Aug. 22.)

“We are now in the twenty-third month of a down housing market. Hesitant customers remain on the sidelines, unsure of whether home prices have bottomed," said Robert I. Toll, chairman and CEO of Toll Brothers in a release.

The CEO of the Horsham (Pa.)-based company said he believes "significant pent-up demand is building" given a "decent economy," but warned that "the pace of home sales could slow further until the credit markets settle down." Toll said that "tightening credit standards for borrowers should reduce the pool of potential buyers: Liquidity and affordability issues may impede some customers from closing, while others may find it more difficult to sell their existing homes."

Along with dropping sales and homeowners defaulting on subprime and other mortgage loans (see BusinessWeek, 8/13/07, "Bonfire Of The Builders"), many homebuilders are also writing down land they own that's dropped in value. Toll Brothers figures that its pretax write-downs will be $125 million to $175 million for the fiscal third quarter ended July 31. Given the uncertainty in the market, the company said it will no longer provide EPS guidance for fiscal year 2007 (ending October).

However, the company believes that it can survive the downturn. Toll Brothers said it has reduced its land position and postponed the opening of new communities in weak markets, and begun to lower its community count. It finished the quarter with over $700 million in cash and more than $1.1 billion available under a bank credit facility, with no major debt due before 2011, the company said. "We believe we are well-positioned to weather the current slowdown and take advantage of opportunities that may arise," it said.

Investors bid up the depressed stock by 6% to $24.33. Just last week, on Aug. 1, the stock hit a new 52-week low of $18.85. That day, rumors swirled that Beazer Homes (BZH) was facing liquidity problems and might file for bankrupcty, which the company denied (see BusinessWeek.com, 8/1/07, "Bankruptcy Buzz Bugs Beazer").

"Concerns about liquidity for the moment have been put aside, and concerns about bankrupcties in the group may have been taken off the table today," said Standard & Poor's equity analyst Ken Leon in an interview.

Eric Landry, an equity analyst at Morningstar, said in an interview that Toll's report was not unexpected and the CEO's comments were not new. Although fundamentals for homebuilders are not getting any better, he thinks the stocks are "extremely cheap."

Landry believes that last week's heavy sell off could mark a bottom for the stocks, which are discounting the tough times. "There was so much short interest and the stocks had gone down so much that they were spring loaded, so to speak," he said.

Leon at S&P kept a hold opinion on Toll Brothers shares, given its strong balance sheet compared with its peers. He also said he is positive on the company's focus on reducing overhead instead of trying to stimulate a weakening real estate market. "Despite sales that may be weak well into '08, we would hold the shares, given TOL's strong competitive position," he said in a note.

Still, Leon said he continues to see problems for the industry. "Current trends point to further weakness in the housing market as evidenced by TOL's net signed contracts decline of 31% from a year ago, as well as July-quarter cancellations rising to 24%, from the second quarter's 19%," Leon wrote in a note Aug. 8.

Leon reiterated his negative fundamental outlook for the homebuilding industry on Aug. 8, saying he expects new home sales to remain weak through the first half of 2008 as credit conditions tighten, customer cancellation rates rise, and homebuilder inventories remain high. He added that selling prices for new homes are likely to trend flat to lower until excess inventories come down, and that writedowns of land values should continue at record levels throughout 2007. (S&P, like BusinessWeek, is owned by The McGraw-Hill Companies (MHP).)

McCormack is senior producer for BusinessWeek.com's Investing channel.