Majestic Research

The Wall Street Journal Online

Toll Brothers FY3Q Orders Fall 47.5%

By Janet Morrissey
Published: August 09, 2006

Demand for homes worsened for luxury home builder Toll Brothers Inc. (TOL) in its fiscal third quarter, as orders fell 47.5% with no signs of a rebound in sight.

The decline was bigger than Wall Street had expected, and worse than the 32% decline experienced in the fiscal second quarter.

“It appears that the current housing slowdown, which we first saw in September 2005, is somewhat unique,” said Robert Toll, chairman and chief executive of Toll Brothers, in a statement. “It is the first downturn in the 40 years since we entered the business that was not precipitated by high interest rates, a weak economy, job losses or other macroeconomic factors.”

He said the deteriorating housing conditions appear to be driven solely by an inventory glut and a decline in home-buyer confidence.

“Speculative buyers who spurred demand in 2004 and 2005 are now sellers, (and) builders that built speculative homes must now move their specs.”

At the same time, nervous buyers are canceling contracts for homes already under construction, which is exacerbating the situation, he said.

Toll said cancellations increased in a number of his company’s markets, such as Orlando, northern California, Palm Springs, Las Vegas and Phoenix. Although the company’s cancellation rate is “significantly higher” than its historical average, Toll said it’s still among the lowest in the homebuilding sector primarily because luxury homes require a bigger nonrefundable down payment than traditional homes.

In the fiscal third quarter that ended July 31, Toll’s orders totaled 1,443 units, down 47.5% from 2,746 units a year ago. The dollar value of the orders was $1.05 billion, down 45% from $1.92 billion a year earlier.

The sharp 47.5% pullback came even though the company had 21% more subdivisions than it did a year ago, noted Banc of America analyst Daniel Oppenheim, in a note. He said sales per community plummeted 57%.

“These trends are consistent with our Monthly Survey of Real Estate Agents, which has continued to show sequential deterioration, with notable weakness in pricing seen in July,” said Oppenheim.

Majestic Research analyst John Tomlinson said the 47.5% decline was far worse than the 33% to 40% decrease he was expecting.

Preliminary figures indicate that the Toll’s home-building revenue and backlog also fell in the latest quarter. Revenue slipped to $1.53 billion from $1.54 billion a year ago.  The company also indicated it would be taking write-downs in the quarter in connection with land options that it is walking away from due to slowing sales and weaker market conditions.

Toll emphasized though that his company has opted not to slash home prices in order to move sales.

“Faced with heavy discounting by many other builders, we generally have chosen to allow sales paces to slow rather than aggressively discount our home prices,” said Toll. Also, he said the company “rarely” starts construction on a single-family home without a buyer’s signed agreement and a substantial down payment.

With sales slowing and the backlog shrinking, Toll cut his guidance for the number of homes the company will deliver in fiscal 2006 to a range of 8,600 to 8,900 homes, down from previous guidance in the range of 9,000 to 9,700 homes.

Although most analysts said the order decline was worse than expected, most applauded the company for not aggressively cutting prices to move sales.

“Toll at least is not being overly aggressive in price,” said Tomlinson. “They’re not willing to get overly aggressive with pricing and incentives to move volume, and they’re letting option contracts to purchase land expire.”

UBS analyst Margaret Whelan said demand for higher priced homes has been hit harder than traditional homes during this cycle.  However, she, too, commends the company for not slashing prices.

“We view Toll’s focus on profitability over volumes favorably, and believe it will reduce both the duration and the severity of this slowdown,” Whelan said in a note.

However, Whelan lowered her 2006 earnings projection to $4.15 from $4.45, and her 2007 estimate to $3.30 from $3.60 a share.  Oppenheim cut his 2006 projection to $4.20 from $4.65, his 2007 estimate to $2.25 from $2.85, and his 2008 projection to $1.20 from $1.30.

All eyes will be on the size of the write-downs and the revised earnings guidance Toll gives later this month when it posts its fiscal third quarter results.

“The size and magnitude (of the write-downs) will give an indication of maybe what’s left to come,” and how much pricing is coming down, said Tomlinson.

Chairman Toll remains cautiously optimistic that once the inventory glut clears, demand will rebound. However, he declined to offer predictions on when this will happen.

Tomlinson and Whelan don’t hold shares in Toll, their firms have not had an investment banking relationship with the company in the past year.  Oppenheim doesn’t hold shares in Toll, but his firm has had an investment banking relationship with the company in the past 12 months.