Toll Brothers (TOL) can offer good returns despite tough environment

The housing market is witnessing a surprise-boom at a time when the economy is going through one of the worst phases. The primary contributor to the growth is historically low interest rates, a trend that is expected to continue this year. Also, more and more people are purchasing new homes to take advantage of the favorable resale market.

Unexpected Boom

The recent performance of luxury home builder Toll Brothers (NYSE: TOL) underscores the emerging trend in the housing industry. The company is seeing record high demand, despite the pandemic-related disruption, and is busy adapting to the changed market conditions. The new strategy includes hike in prices across communities with the aim of increasing profitability and driving growth, besides moderating the pace of sales. It has been particularly successful in communities where the company has good pricing power.

From Toll Brothers’ Q4 2020 earnings conference call:

“We strategically moderated the sales pace in the second half of the quarter by increasing prices in nearly all of our communities and limiting lot releases in about 15% to 20% of our communities. What this means is that for these communities, we put in place a monthly allocation of homes to sell. We employed a strategy in some of our hottest-selling communities, where there is a limited finished lot supply or extended delivery times due to prior strong sales.”

Shares of the Fort Washington, Pennsylvania-based real estate firm has been on an upward trajectory since early last year, but look overvalued at the current price. The recent performance signals an imminent pullback, as indicated by the average target price that represents a 4% downturn. Market watchers are pretty cautious in their recommendations.

Upbeat Start to FY21

The company’s earnings rose to $1.55 per share in the fourth quarter from $1.41 per share a year earlier. Revenues increased 7% annually to $2.55 billion as demand conditions remained elevated. The results also came in above the consensus forecast. A moderation in home prices in certain markets and a decrease in SG&A expenses also contributed to the top-line growth. Net signed contracts climbed 68% to 3,407 residential units.

Read management/analysts’ comments on Toll Brothers’ Q4 report

As far as the influence of the pandemic is concerned, the remote work phenomenon is driving demand due to an increase in relocations, since people now have the option to live where they want, rather than where the office is located. The management believes the bullish trend continued in the early months of fiscal 2021, with estimated deliveries of about 1,675 homes and average prices in the range of $780,000 to $800,000.

Stock Performance

Last year, Toll Brother’s stock plunged to the lowest level in nearly a decade when stock markets were battered by the virus outbreak. But it made a quick recovery and bounced back to the pre-crisis levels. The shares closed Tuesday’s trading around $55, close to the record highs seen about 15 years ago.