Toll Brothers 1Q14 earnings report: Margins keep expanding (Part 4 of 4)
Management’s view on the all-important spring selling season
Toll Brothers commented:
“The freezing, snowy weather of the past two months has impacted our business in the Northeast, Mid-Atlantic, and Midwest markets, where about 50% of our selling communities are located. While it is still too early to draw conclusions about the Spring selling season, we remain optimistic based on solid affordability, attractive interest rates, growing pent-up demand and an industry that is still under-producing compared to both historical norms and current demographics.”
It’s important to remember that housing starts are still highly depressed compared to historical norms. From the late 1950s through 2002, we averaged 1.5 million starts a year. During booms, it would top 2 million and during the depths of recessions, it would hit maybe 900,000. We recently had housing starts of an annualized pace of 880, and have not seen normal housing start numbers since 2007–2008.
Valuation and outlook
With the acquisition of Shapell, Toll Brothers looks well-positioned for growth going forward. The secular (long-term) story for the builders is fantastic—we have underbuilt for over a decade and household formation has been depressed. The low household formation numbers of the post-bust environment weren’t due to fertility rates 25 years ago. They were due to young graduates who have been unable to find a job in this economy. As we’ve seen from the recent economic data, the labor market is turning around—albeit slowly. This represents pent-up demand that will unleash. In previous upturns, we’ve seen housing starts over 2 million units a year. It’s not inconceivable that housing starts could triple over the next few years. That’s a lot of growth.
What’s the catch? Toll is trading at a very high multiple of 27x earnings. That multiple is discounting a lot of growth. One thing to remember with builders is that they’re very cyclical. During boom times, they’ll trade at mid to high single-digit price-to-earnings ratios. So an investor could end up being absolutely correct about future earnings only to find that multiple compression negates that growth as the stock goes nowhere.
To learn more about investing in homebuilders, see the Market Realist series January home sales, starts, permits, and prices: Key takeaways.
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