One of the more unexpected trends that have resulted from the pandemic is the increase in the demand for new single-family homes. At first, many believed that the pandemic would cause an economic crisis that would decimate the real estate market. However, that hasn’t exactly been the case for residential real estate thus far. As people look to head out of the major cities and into the suburbs, companies that build homes and suburban communities have experienced strong performance in the stock market as of late.
The leading U.S. builder of luxury homes, Toll Brothers (NYSE:TOL), is the perfect example. The company recently reported earnings and seems to be benefitting from increased demand and people leaving high-rises in urban markets in favor of the suburbs. The stock has been performing very well lately and is up 13% in September. Let’s take a deeper look at what might be driving the stock price higher and decide whether or not Toll Brothers is a buy at this time.
Leading Builder of Upscale Homes
Now, more than ever, people view their house as one of the most important investments they will ever make. This narrative is playing well for Toll Brothers, which is the leading builder of upscale homes in the United States. The company currently has 328 active selling communities with the majority of its homes located along the East Coast. Since Toll Brothers caters to wealthy buyers, many of its customers are financially secure and either pay with cash or make large down payments, which is certainly advantageous. Its customers also tend to splurge on upgrades, as the average Toll Brothers homebuyer added roughly $178,000 in upgrades in FY 19. With an average selling price of $805,000 per house in Q3, this is a home builder that generates substantial revenue when the housing market is hot.
What’s interesting about Toll Brothers is that it controls or purchases the land for building its houses through options, as it starts construction after the sales agreements have been executed and it uses subcontractors to handle the construction work on a fixed-price basis. This makes a lot of business sense because it allows the company to boost its return on capital and avoid putting a lot of debt on its balance sheet. Toll Brothers has a history of making key acquisitions and just announced that it is expanding into Colorado Springs, the #1 Hottest US Housing Market according to USA Today, by acquiring Keller Homes. These are the types of moves that investors love to see, especially during a period with so much uncertainty.
We mentioned earlier that the pandemic has caused many to consider making the move out of cities and into suburban single-family homes, which is great news for Toll Brothers. There are also more people working remotely than ever before which has detracted from the allure of expensive urban living. Additionally, recent protests and disorder have left many city-dwellers looking for a more peaceful way of life, which is another positive for this company.
Perhaps the biggest impact of the pandemic for Toll Brothers is the action taken by the Federal Reserve with interest rates. The housing market has seen a lot of demand thanks to record-low interest rates that consumers view as a good opportunity to buy a house and lock in a mortgage. With that said, there are some negative pandemic impacts on Toll Brothers to keep in mind as well. For example, supply chain issues have caused the price of lumber to increase and there’s still the risk of a prolonged recession which could lead to lower demand for luxury homes.
Q3 Earnings Beat
Back in August, Toll Brothers reported its Q3 earnings that proved the company is handling the pandemic well. The company reported better than expected revenue, EPS, and Q3 sales numbers that have proved to be a positive catalyst for the stock. The company saw homebuilding revenue decrease by 7% year-over-year to $1.63 billion but reported home deliveries of 2,022, up 1% year-over-year.
It’s reassuring for investors to see that in Q3, Toll Brothers reinstated its financial guidance and ended the quarter with $2.3 billion in liquidity. That tells us that the company is confident in its backlog for the remainder of the year and that it is in a good financial position to deal with any short-term cyclical risks. Finally, new contracts were up 26% year-over-year in Q3 to 2,833, which is a number that all but confirms the demand for Toll Brothers homes remains strong at this time.
Toll Brothers stock is certainly one of the best home builders to consider adding to your portfolio at this time. The pandemic has reinforced the idea that having a safe home that provides a place to relax, work, and live comfortably is essential. If you are bullish on the housing market and think that the economy will rebound sooner rather than later, this is a stock that is worth a look if the price dips significantly in the coming weeks. However, there are undeniable risks for the housing market such as a prolonged recession, high unemployment rates, and high lumber costs that could impact the company in the short-term and should not be ignored.
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