Toll Brothers Sees Buyers Returning for Spring Selling Season

Toll Brothers’ TOL stock traded higher on Feb. 22 after the no-moat-rated luxury homebuilder reported fiscal first-quarter results (ended Jan. 31) that mostly exceeded guidance and management issued cautiously optimistic commentary on the state of the United States housing market. We’ve increased our fair value estimate approximately 5% to $69 per share due to the time value of money and our revised near-term inventory turnover outlook.

Management said demand for its homes increased in January and that trend has persisted so far in February. As such, the homebuilder has been able to reduce its reliance on sales incentives to stoke demand. According to management, sales incentives as a percentage of selling price is now around 6.5% compared with an 8% average during the fiscal first quarter. However, incentives are still elevated compared with the 3% 15-year average. The U.S. homebuilding industry has seen a surge of cancellation rates over the last three quarters, but Toll Brothers has been much less affected by cancellations due to its more-affluent base of customers who make substantial nonrefundable deposits.

That’s not to say that the very strong demand environment witnessed during 2021-22 is back. In fact, new orders for Toll Brothers’ homes declined 50% year over year during the first quarter following two preceding quarters with 60% declines. Toll Brothers’ backlog is still sizable (7,733 units worth $8.6 billion), which will support solid profit margins in 2023 even as industrywide pricing power subsides. Recently, we’ve seen more commentary from industry insiders asserting that demand for new homes may have bottomed as homebuilders have become more willing to lower prices and offer greater incentives to improve affordability. Even so, we maintain our near-term cautious stance, and we project Toll Brothers will see two consecutive years of declining revenue and earnings before growth returns in 2025.