EUR 850.00 For Business Accounts Only

Morningstar | Toll Brothers' Stock Jumps in Reaction to Strong 3Q Results; Maintaining $49 FVE

Toll Brothers' stock rallied almost 14% on Aug. 21 in response to the no-moat homebuilder's strong fiscal third-quarter results. Revenue grew 27% year over year to $1.9 billion, which beat the consensus estimate by 6%. Home delivery volumes during the third quarter increased 18%, and the average selling price of homes delivered increased about 8%. GAAP EPS of $1.26 was 45% higher than the year-ago quarter and easily beat the $1.03 consensus estimate. Prior to the earnings release, Toll Brothers' stock was down 28% year to date as investors fretted over homeowner affordability and rising input costs. Clearly, Toll Brothers' strong results assuaged some of these concerns. After reviewing Toll Brothers' third-quarter results, we didn't materially change our key valuation assumptions, and we're therefore maintaining our $49 per share fair value estimate.

Demand for Toll Brothers homes remained strong during the quarter; new order volume increased 7% year over year to 2,316 units. However, this growth rate doesn't tell the whole story as Toll Brothers operated out of fewer communities versus the year-ago quarter (301 at the end of third-quarter 2018 versus 312 last year). New orders per community grew at a more robust 18% year over year pace to 8.1 units per community. In terms of community count, management expects to finish fiscal 2018 with 315 selling communities and continue to grow community count in 2019. In our view, Toll Brothers has plenty of land to accomplish this goal. Year-to-date, the homebuilder has spent $810 million for 8,110 lots versus $491 million for 4,677 lots last year. Toll Brothers ended the third quarter with 53,604 lots versus 47,840 at the end of the year-ago quarter. Given that Toll Brothers is sitting on a backlog valued at $6.5 billion, up 22% year over year, and typically only about 40% of that backlog is delivered in the fourth quarter, the company is well-positioned for another year of growth in fiscal 2019.

Management typically provides quarterly guidance for six key metrics: home deliveries; average selling price of home deliveries; adjusted gross margin; selling, general, and administrative expenses as a percentage of sales; other income and unconsolidated income, and effective tax rate. Actual third-quarter results across each of these metrics topped management's guidance.

While third-quarter adjusted gross margin of 24.3% was down 70 basis points year over year, it was above management's 23.4% guidance even after excluding a 60-basis point benefit from litigation settlements realized during the quarter (23.7% excluding this benefit). Management noted that third-quarter gross margin benefited from lower than expected costs and favorable product mix. SG&A as a percentage of sales was 9.1% during the quarter, 50 basis points better than guidance.

We viewed Toll Brothers' third-quarter results as overwhelmingly positive, however, bears may point at a 4% decline in new orders in California (32% of third-quarter revenue) as a cause for concern. Management addressed this concern on the call saying, "while California is not as hot as it was a year ago, it is still one of our stronger markets." California sales pace of 10 new orders per community during the quarter topped the company average of 8.1 new orders per community. We also note that Toll Brothers' California backlog value of $2.3 billion is 55% higher than the year-ago quarter.

Toll Brothers continues to repurchase shares at prices below our $49 per share fair value estimate, which we see as a good use of capital. The firm purchased 3.7 million shares during the third quarter at an average price of $37.24 per share. Year to date, Toll Brothers has purchased 10.2 million shares at an average price of $43.05 per share.