Luxury homebuilder Toll Brothers (NYSE:TOL) delivered its Q3 earnings August 21. It was a mixed bag with both positives and negatives in its report. Management has an upbeat view of the future housing market. Investors have to be torn.

Should you buy or sell on the news? Here are my thoughts on the subject.

The Negatives


  • While Toll Brothers saw revenue increase 24% year-over-year to $689.2 million, analysts were expecting Q3 revenue of $695.8 million. A slight miss but a miss nonetheless.
  • Order growth in Q3 was 26%; its worst increase in 2013.
  • Earnings per share declined by $0.10 or 28% to $0.26.
Flawed Information
As I personally go through its earnings release I have a hard time finding any negatives in its report. The points I've mentioned above were all mentioned in an August 21 article at Fox Business. Both the headline and some of the content seems to suggest Toll Brothers third quarter was less than stellar when in fact its business is doing just fine thank you very much.

For starters, the 10-cent decline in earnings per share included a tax benefit in Q3 2012 of 11 cents or $18.7 million. On a pre-tax basis, Toll Brothers' earnings actually increased by 59% to $68.3 million. I'd take that everyday and twice on Sunday. As for its order growth (by units) slowing, there's no denying it was smaller at 26% than its Q2 2013 growth rate of 36% and 49% in Q1 2013. However, if you consider the selling process Toll employs, you'll see that 26% isn't necessarily a bad number despite being lower than the first two quarters of the year.

SEE: Making Money In Residential Real Estate

In this case, the prospective buyer signs a binding agreement of sale providing the company with a downpayment that averages 7% of the purchase price. Only when the company also signs the agreement of sale is it considered backlog. At the end of the third quarter Toll Brothers had a backlog of 4,001 units, an increase of 56% year-over-year. Sequentially, its backlog in the third quarter increased by 346 homes, up 9.6% from the backlog in the second quarter. That's the critical number. When combined with a higher average price for a delivered home (up 6% in Q3 to $612,000), you know the company's moving in the right direction.

The Positives
CEO Douglas Yearley stated in its Q3 press release: "Sales volumes and pricing power both increased this quarter from one year ago…We believe the recovery is real and we are in the early stages of the rebound." The head of America's largest luxury homebuilder has every reason to be optimistic. Lennar (NYSE:LEN), KB Homes (NYSE:KBH), Ryland Homes (NYSE:RYL) and many of the other major homebuilders are reporting healthy revenue and earnings growth. Consumer sentiment is better than it's been in quite some time and yet inventory levels remain historically low. This train is moving from the station—are you going to be on board?

Guidance provided by CFO Martin Connor suggests Toll Brothers will deliver at least 3,925 homes in fiscal 2013 generating revenue of at least $2.46 billion, 31% higher than in fiscal 2012. It expects to deliver 19% more houses in 2013 at an average price of $675,000, 18% higher than the year before. Very early on in the cyclical recovery, Toll Brothers looks ideally situated to benefit from an improving economy. All four of its regions appear to be doing well; no more so than in the South where its home building revenue in the first nine months of the year was $418 million, up 63% from a year earlier on a 49% increase in units. Only its North region had a decline in units delivered in the first nine months of the year but even there its revenue in dollars increased marginally. In terms of its 4,001 home backlog, the potential revenue is spread evenly between all four regions. Unless I'm missing something—that's a very healthy indicator.

Bottom Line
If you compare Toll Brothers revenue and profits today to its zenith in 2005 there's no comparison. In 2005 it generated $5.8 billion in revenue along with $1.3 billion in operating income. This year it won't even get to half that revenue and operating income will be about one-sixth as big. So sure, if you look at it from that perspective its current numbers are nothing to write home about.

However, the entire industry has been digging itself out of a giant pit. It's the direction that counts not the relative numbers. In March U.S. housing starts hit the one-million mark on an annualized basis for the first time since June 2008. RBC Economics analyst David Onyett-Jeffries suggests this number will hit 1.4 million by the end of 2014. If most of the major builders are showing growth—just as Toll Brothers is—than this number seems very realistic over the next 16 months.

SEE: Economic Indicators: Housing Starts

Toll Brothers hit an all-time high of $55.42 in July 2005. It makes sense given the numbers it was putting up. Can it get back there? While it's got a lot of ground to cover I think it can. Most of its stock's recovery came last year. Year-to-date it's down 2.1% through August 21. Over the past year its residential construction peers have achieved a 26% return while it lay dormant. It's time to reawaken.

Its third quarter numbers are anything but mixed. If you own already—keep holding. If you don't—you should buy.

Disclosure - At the time of writing, the author did not own shares of any company mentioned in this article.



Tickers in this Article: TOL, LEN, KBH, RYL,

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