Reading between the lines: Toll Brothers' view of housing
Toll Brothers (NYSE: TOL) reported its first full-year loss after 22 years of profitability on the NYSE in FY2008, but the company is keeping its eye on the future. Frederick Cooper, Senior Vice President of Finance and Investor Relations, told stockholders in a letter inserted in the annual report, "With FYE 2008 liquidity of nearly $3 billion, including approximately $1.6 billion of cash and $1.3 billion under our 31-bank credit facility, which matures in March 2011, we are actively looking for opportunities that we anticipate will arise from today's challenging environment."
Let's first take a look at the challenges the company discusses in the FY2008 annual report and then explore its forward-looking statements. First the hard numbers:
- The number of homes sold dropped to 4,743 from a high of 8,601 in 2006. The company sold 35,000 since FY2003.
- FY2008 Revenues dropped 31% below FY2007 revenue.
- The number of new sales contracts dropped 46% below FY2007 contracts.
- Sales incentives needed to sell homes went up to 9.5% of contracts. In FY2007 sales incentives were 7.5% of contracts.
- Homes under contract at year-end FY2008 dropped 53% below FY2007 year end. At the end of FY2007 Toll Brothers had 3,867 homes under contract. At the end of FY2008, 2,046 homes were under contract.
Until the bottom fell out of the financial markets in September, Toll Brothers thought the market was stabilizing. It told shareholders in the annual report, "The turmoil that ensued accelerated fears of all kinds among potential buyers and precipitated a further decline in consumer confidence, a significant credit crunch, increased capital market disruption, and plummeting stock market values. These factors all contributed to reverse an improving trend and to drive our cancellations in the fourth quarter up to 233 units (about 30% of FY2008 fourth-quarter contracts) . . ."
So, how is Toll Brothers responding to these market conditions? It's reducing its land holdings from 91,200 home sites in inventory at the height of the current market on April 30, 2006 to 31,200 at the end of FY2008 on October 31, 2008. Of those 31,200 home sites, significant improvements have been completed on approximately 14,000. But the big problem is that Toll Brothers only anticipates selling 2,000 to 3,000 homes in FY2009. That's down from 8,601 homes in FY2006.
In the Management's Discussion and Analysis (MD&A) section of the report, Toll Brothers writes, "This slowdown, which we believe started with a decline in consumer confidence, an overall softening of demand for new homes and an oversupply of homes available for sale, has been exacerbated by, among other things, a decline in the overall economy, increasing unemployment, fear of job loss, a significant decline in the securities markets, the continuing decline in home prices, the large number of homes that are or will be available due to foreclosures, the inability of our home buyers to sell their current home, the deterioration in the credit markets, and the direct and indirect impact of the turmoil in the mortgage loan market. We believe that the key to a recovery in our business is the return of consumer confidence and a stabilization of financial markets and home prices."
That sums it up pretty well. In 2007 Toll Brothers blamed part of the mess on "constant media attention with regard to the potential of mortgage foreclosures, many home builder's advertising price reductions and increased sales incentives, and concerns of prospective buyers about being able to sell their existing homes. In addition we believed speculators and buyers who bought homes as an investment were no longer helping to fuel demand." They don't appear to be as hard on the media this year.
As you read through the Management Discussion and Analysis section of the report you can get a view of how the company is positioning itself for the future. This paragraph clearly lays out the strategy the company is following for its future, "When our industry recovers, we believe that we will see reduced competition from the small and midsized private builders who are our primary competitors in the luxury market. We believe that the access of these private builders to capital already appears to be severely constrained. We envision that there will be fewer and more selective lenders serving our industry at that time. Those lenders likely will gravitate to the home building companies that offer them the greatest security, the strongest balance sheets and the broadest array of potential business opportunities. We believe that this reduced competition, combined with attractive long-term demographics, will reward those well-capitalized builders who can persevere through the current challenging environment."
As the leader in the home building industry, Toll Brothers clearly is well positioned for the future. While it does predict a tough year in FY2009, the company is positioning itself for a recovery after that time, but holding tight on cash to make it through the storm and keeping its eye on future opportunities. But for now it told financial report readers that it is "reevaluating and renegotiating or canceling many of our land purchase contracts. . . . At October 31, 2008, we were selling from 273 communities compared to 315 communities at October 31, 2007. We expect to be selling from approximately 255 communities at October 31, 2009."
I do expect Toll Brothers to continue to be the leader in the home building industry when we get through this storm. Is it time to buy the stock? I'm not sure about that. The stock looks like a good buy at $19.88 (close on Feb. 6), which is a long way down from a high of $55.42 before a two for one stock split in July 2005. Shareholders who bought after that split lost about 64% of their money. The big question is with at least one more year of poor market conditions, when will the recovery come? If you do decide to jump in at this bargain price, you must be ready to hold the stock for the long term, because I doubt we'll see a recovery in 2009.
Lita Epstein has written more than 25 books including "Reading Financial Reports for Dummies" and "Surviving a Layoff: A Week-by-Week Guide to Getting Your Life Back Together."