The old saying is true that there is only so much land, and "God isn't making any more of it." So, over the longer run, I think demand for land and houses will flourish in a large way. However, I am not bullish on the larger homebuilders right now, and I'm particularly wary about high-end builder Toll Brothers (NYSE: TOL). Here is why.
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On a positive note, Toll Brothers' homes seem very well constructed, are attractive, and I think management generally does a good job of picking locations for its developments. So in time, the company has the reputation and the ability to grow, maybe in a big way. But right now I'm not so positive.
Thinking of the big picture, a time will come - maybe in the not-too-distant future - when the Federal Reserve decides or needs to raise rates. To be clear, I don't think we'll see any near-term dramatic moves. But I do think that almost any ratchet higher could have a negative impact on home affordability. That could have a big impact on the higher-end space that Toll is in.
But even beyond that, how many people want to, or will want to in the next few years, take on large mortgages and all the possible costs that go with owning a home? Especially a large one. If the environment doesn't improve dramatically on "Main Street," I think that middle-of-the-pack homebuilders/players will see more would-be buyers walking through their doors than the higher-end companies.
Worth A Look
Earlier in the week, Toll Brothers released some preliminary fourth-quarter data. A few positives are worth pointing out. For example, the release stated, "The company signed 822 gross contracts totaling approximately $462.0 million in FY 2009's fourth quarter, an increase of 6% and 3%, respectively, compared to the 772 gross contracts totaling $449.7 million signed in FY 2008's fourth quarter." In my mind, that is a good sign that things may be stabilizing a bit, and of possible light at the end of the tunnel. In addition, I agree with Chief Executive Robert Toll's comment in the release, "We are pleased that the home buyer tax credit was extended and that eligibility for the credit was expanded beyond those buying their first home. We believe this will help bring some reticent home buyers into the market and will also put some people back to work."
But That Doesn't Cut It
At the end of the day, and over the next year or two, the company still has a lot to prove to Wall Street. The company is expected to lose 40 cents a share in 2010, so I have trouble justifying it trading at $21.
I realize that if the U.S. economy improves in the years ahead, demand for Toll homes will likely improve. But what can the company do at this point to make it a more attractive proposition to consumers than, let's say Hovnanian Enterprises (NYSE: HOV), which is in some of the same markets? I don't see Toll's advantage. For the record, I'm not a bull on HOV either. It trades under $5, and analysts expect it to lose a lot of money in 2010.
Speaking of other players in this space, the earnings outlook almost across the aboard doesn't look inspiring. A quick look at estimate data shows that California-based KB Home (NYSE: KBH) is expected to be in the red this year and next year. Miami-based Lennar (NYSE: LEN), which also has a large and admired name, is expected to lose money in 2009 and 2010, which is hard to get inspired by.
Bottom Line
Toll Brothers is certainly a good company, and I don't want to rule out the possibility that I will become more bullish on the homebuilder in the future. But right now, the current share price just isn't a good value given the less-than-impressive near-term earnings picture and a still-shaky economy. I think consumers are likely to remain unwilling to spend large amounts of money. (For more, see Cheap Home Renovations That Pay Off.)
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