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Morningstar | Declining Orders Cast Doubt on Toll's 2019, but We See the Firm Still Well-Positioned Longer-Term

Toll Brothers prides itself on owning an ample supply of some of the best land in the industry. Premier land inventory, combined with luxurious, customizable designs, allows the company to charge industry-leading average selling prices. The housing market continues to recover from the 2009 bottom, albeit at a measured pace. We believe favorable demographics, coupled with the realization of pent-up demand, will drive a continued recovery through 2022, with housing starts peaking at just over 1.6 million.We see three tailwinds driving increased demand for Toll Brothers’ traditional offerings: Strong demand for entry-level homes should encourage established homeowners to sell their first homes in favor of new move-up homes; increased popularity of empty-nester homes and active-adult communities among baby boomers; and growing household wealth should put the company's products in reach of younger households.In addition to traditional homebuilding, the company has been investing in for-sale urban high-rise infill and for-rent projects to diversify revenue and leverage existing assets. Although we think these projects are riskier, we believe the firm mitigates some of this added risk by careful underwriting and joint venture partnerships. We believe these projects have generally met Toll Brothers' expectations, and we think the company has a robust project pipeline that will continue to contribute profitable growth in a healthy market.Overall, we think Toll Brothers should capitalize on an improving housing market, and we expect it to generate strong earnings growth over at least the next five years. That said, given Tolls' luxury focus and higher average selling price, we don't think the firm is as well positioned to capture demand from first-time millennial buyers as lower-priced homebuilders like D.R. Horton. While we think Toll Brothers can achieve positive economic profits with increased sales volume, we expect competition and the company's "land-heavy" land acquisition strategy to restrain the amplitude of those profits.