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Avoid The Toll Brothers Trap

Posted: Dec 02, 2008 13:42 PM by Glenn Curtis

Tickers in this Article: HOV, DHI, TOL

Luxury homebuilder Toll Brothers (NYSE:TOL) has bounced nicely off its lows, and it was recently upgraded by Credit Suisse to 'neutral' from 'underperform'. However, shares are still more than 30% off their 52-week high, and investors should be reluctant to dip their toes in the murky water at his point.

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Before the Bubble Burst
Toll was a prime beneficiary of the housing boom earlier in the decade. Its revenue went from $2.76 billion in 2003 to more than $6.1 billion in 2006. It achieved this increase by selling attractive homes and lofty prices. Before things went bust in 2007, the average base price of its detached homes was $648,000, according to its 10K.

Homebuilder's Hovnanian (NYSE:HOV) and DR Horton (NYSE:DHI) took care of the lower end of the price scale. The average price of a Hovnanian home in 2007 was $338,000, while one built by DR Horton would cost you approximately $259,200 on average.

Business was booming for Toll until the bubble popped. We're still waiting on the gory details from 2008, but for 2007, overall revenue declined to $4.65 billion in 2007 from the roughly $6.1 billion in 2006. Since fiscal 2007 year end, quarterly revenue has continued to decline. (To learn more, read Why Housing Market Bubbles Pop.)

Preliminary Q4 Numbers
The company softened the blow by releasing some preliminary 2008 numbers. Toll Brothers' revenue plunged 41% in the fourth quarter. Its 2008 fourth-quarter net contracts of 539 units is an 18% drop from the 656 units it saw in 2007. In monetary terms, net contracts have plunged 27%, dropping to $266.7 million from $365.3 million in Q4 2007.

Housing prices have also dropped substantially in only a few months. In Q4 the average price of net signed contracts $495,000; in Q3 this figure was $579,000. Full fourth-quarter numbers are due out on December 4.

The Risks
The Credit Suisse upgrade to 'neutral' from 'underperform' is a nice start, but it's hardly a ringing endorsement. The recent rebound in the stock has given many investors hope that the stock has bottomed. It currently trades at $18.15, a substantial climb from the low of $13.55 it saw during intra-day trading November 21. The downside to this increase is it's a large percentage jump in a short period of time, and profit taking could set the shares back.

Investors should wait until December 4 when hopefully the company will provide more color regarding the future. Although, investors hoping for a forecast filled with sunshine will likely be disappointed anyway. In the preliminary Q4 release, CFO Joel Rassman said, "Given the significant uncertainty surrounding sales paces, cancellation rates, market direction, unemployment trends and numerous other aspects of the overall economy, we are not comfortable offering delivery, revenue or earnings guidance for the coming year."

Another disturbing trend for the future is that insider activity has been nearly nonexistent. To put it bluntly, if the executives aren't buying the stock, why should regular investors? (To learn more, read Keeping An Eye On The Activities On Insiders And Institutions.)

Bottom Line
Toll has bounced off its lows, and the shares received an upgrade, but I am still reluctant to bottom fish at current levels. A housing recovery is going to take time, and investors hoping for a quick turnaround at Toll are sure to be disappointed.

By Glenn Curtis

Glenn Curtis started his career in the 1990s as an equity analyst for a regional firm in New Jersey. There, he covered companies in the technology, entertainment, and gaming industries. Curtis has since worked as a financial writer at a series of both web and print publications, including TheStreet.com and Registered Rep Magazine. He has held his series 6,7,24, and 63 securities licenses.

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