1 Home Builder Ready to Weather a Volatile Housing Market


Toll Brothers might not look like the ideal long-term investment at the moment based on housing market volatility, but this is a company with a long-term mind-set and implemented strategies that give it the potential to reward investors and outperform its peers over the long haul.

Toll Brothers makes a strong case
According to Toll Brothers, its position and potential in the market are strong. It states that the housing recovery began in early 2012, fueled by a reduction in unemployment and an improvement in consumer confidence. Combined with low supply and extremely favorable mortgage rates, the gradual recovery led to pent-up demand. But, you're probably wondering how this trend is sustainable. This is where Toll Brothers makes an interesting case for itself.

Toll Brothers mostly targets consumers who have remained employed through the recent economic drought. However, many of these potential buyers have been hesitant to act due to concerns about the direction of the economy, the ability of the potential home buyer to sell his or her current home, and future job security. The good news is that since these are potential home buyers, ones that haven't acted yet, there's still growth potential for Toll Brothers.

The bad news: Toll Brothers admits that the industry is largely dependent on the sustainability of the financial markets and the economy in general. Therefore, if you're looking to invest in a resilient company that's at least partially unfazed by economic slowdowns, then you might want to look elsewhere.

More good news
According to the U.S. Census Bureau, the average annual number of housing starts from 1970-2007 was 1.26 million. From 2008-2012, that number plummeted to just 0.70 million, indicating declining demand for new homes. The average family desiring a new home just isn't as interested as in the past.

The good news is that the number of households earning $100,000 or more has tripled since 1980. As of Sept. 12, 2012, 17.3% of U.S. households brought in at least $100,000. It's often stated that we're in the midst of a 5% recovery, which means that only the top 5% of the population (in terms of wealth) has enjoyed a recovery. This is a positive situation for a company like Toll Brothers because it primarily focuses on luxury residential properties.

Other positives for Toll Brothers include the ownership of difficult to obtain land in Boston and Washington, D.C., not being overexposed to the overbuilt Southeast and West, and increased market share opportunities thanks to smaller companies going bankrupt due to their inability to access capital.

Recent results
For the nine months ended July 31, 2013, on a year-over-year basis, revenue increased 30.4%, with Toll Brothers delivering 22.8% more homes, and the average price of those homes having increased by 6.2%.

It is evident that demand has remained intact for Toll Brothers, which ties into the aforementioned 5% recovery. Better yet, the surprise announcement by the Federal Reserve not to taper quantitative easing led to a recent dip in the average 30-year fixed mortgage rate, which now stands at 4.3%, compared to 4.5% last week. This could lead to increased demand for homes.

Peer comparisons
Toll Brothers seems poised for continued long-term success, but it's possible that one of its peers presents a better long-term investment opportunity.

If you're considering an investment in either PulteGroup or Lennar , then you won't find much disparity on the top line. Despite different target markets, consider the similarity in revenue trends over the past decade:

PHM Revenue TTM Chart
PHM Revenue TTM Chart

PHM Revenue TTM data by YCharts

However, Toll Brothers has outperformed its peers on the bottom line:

PHM EPS Diluted TTM Chart
PHM EPS Diluted TTM Chart

PHM EPS Diluted TTM data by YCharts

As Toll Brothers sees continued demand, PulteGroup has purposely slowed down its sales in several markets -- including Arizona, Nevada, and Southern California -- due to lack of available land. PulteGroup is now more focused on price increases, opposed to volume.

Lennar's third-quarter revenue jumped 53% year over year, with new home orders increasing 14%, but demand declined sequentially. However, Lennar's diluted earnings per share improved to $0.54, compared to $0.40 in the year-ago quarter, which should be at least somewhat comforting to bottom-line investors.

Though mortgage rates have declined recently, they will eventually increase, which will decrease demand for homes. Therefore, you want to invest in a company that has outperformed its peers over the long haul, in good times and bad, which indicates superior management:

PHM Chart
PHM Chart

PHM data by YCharts

The bottom line
Presently, a lot is up in the air with the housing market, which will lead to continued volatility. That said, Toll Brothers is likely to be a long-term winner considering its target market, ownership of difficult to obtain land, access to capital, strong balance sheet, proven management, and established brand.

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The article 1 Home Builder Ready to Weather a Volatile Housing Market originally appeared on Fool.com.

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