Bubble Fears Take Toll

The homebuilder's slide continues as a doubling of quarterly profit can't save the day.
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Toll Brothers

(TOL) - Get Report

posted another big quarter -- doubling profits -- as the luxury housing sector remained hot.

But that didn't sway the negative sentiment on homebuilder stocks, and Toll shares fell 3.8% Thursday.

Earlier Thursday, the company

posted third-quarter net income of $215.5 million, or $1.27 a share, vs. $106 million, or 66 cents a share, a year ago. Third-quarter revenue rose to $1.56 billion, up 54% from $1.01 billion last year.

Analysts surveyed by Thomson First Call had expected earnings of $1.19 a share and sales of $1.52 billion in the third quarter.

On a conference call, Robert Toll, the company's chairman and chief executive, told investors, "It's amazing that we're doing the business that we're doing in the face of this bad press."

Even though fundamentals remain solid, homebuilding stocks have taken a beating since hitting highs in late July as investors remain worried about a growing national housing bubble.

``There is a fair amount of pessimism about the group in general. People believe that the fundamentals of the group have been too good for too long," says Todd Vencil, an analyst with BB&T Capital Markets, which expects to provide investment banking services to Toll in the next three months. Vencil, however, upgraded Toll to a buy after earnings were released Thursday. He likes the stock at its current level, which represents a P/E ratio of 10 -- right around its historic level -- based on his 2006 earnings estimate for the company.

Toll said it expects earnings to grow about 20% in both fiscal 2006 and fiscal 2007, assuming demand remains sound. That is slower than the 75% rise in earnings per share the company expects for fiscal 2005.

On the call, one person questioned why investors should stick with the company, given the slowing growth in earnings. ``If I could find a place to get 20% compounded annually for a couple of years, I'd be happy," Toll replied.

But some investors question how much management actually believes in this credo. Directors and executives at the company have sold over 5.6 million shares of Toll in the past six months.

Based on its backlog of 9,490 homes -- those units that have been sold but not delivered -- Toll expects to deliver between 2,750 and 2,850 homes in the fourth quarter at an average price of $675,000 to $685,000.

The backlog at the end of the quarter was valued at $6.43 billion. Vencil expects the company to have revenue of $9 billion from now until the end of 2006. The backlog of homes already sold thus amounts to over 70% of that revenue number. Of course, things can happen and people can walk away from those homes. But on the call, Toll said cancellation rates have remained steady at just 4% over the past year.

All this makes the 2006 earnings growth of 20% very achievable, Vencil says. He also notes that Toll's management is notorious for issuing very conservative guidance and is likely very confident with that 20% growth estimate.

But several factors could impair growth in 2006 and beyond, the biggest being a material slowdown in demand for homes. This could be more likely if interest rates rise too fast without a commensurate improvement in the economy, with wages remaining stagnant.

However, things haven't slowed yet. The latest Commerce Department numbers released Wednesday show sales of new houses rose 6.5% from June to July. However, these figures are very volatile since they're based on a random sampling that doesn't evenly weigh different types of homes, based on price.

For fiscal 2006, Toll projected deliveries of 10,200 to 10,600 homes, at an average price of around $665,000, which should translate into homebuilding revenue of $6.78 billion to $7.05 billion.