Homebuilders across the U.S. were poised to have a great year before the COVID-19 crisis hit. During the height of the shutdown, the pandemic caused many builders to put projects on hold and to wait and see how the economy would respond.
But instead of curbing demand for housing, COVID-19 appears to have had the opposite effect: It served as an impetus for people to leave cramped and crowded apartment complexes in big cities and move to the suburbs where there is more space and it's easier to social distance.
One of the biggest beneficiaries of this real estate trend should be Toll Brothers (NYSE: TOL), which just reported earnings on Wednesday. How did the luxury homebuilder fare in its fiscal 2020 third quarter and how might it take advantage of the current housing situation?
Strong -- and surprising -- Q3 earnings for Toll Brothers
While most homebuilders have been reporting strong demand for housing this spring and summer, it is surprising to think that they would be reporting record gains. Yet Toll Brothers said that the quarter ending July 30 was a record quarter for signed contracts. On the earnings conference call, CEO Douglas Yearley explained:
Our third-quarter net signed contracts of 2,833 homes and $2.2 billion were up 26% in units and 18% in dollars compared to one year ago, the highest third quarter ever in both units and dollars. Our contracts per community in the third quarter at 8.5 were the highest third quarter in 15 years. As for monthly cadence, May's contracts were down 21%, June's were up 76%, and July's were up 31% versus one year ago.
During the third quarter, Toll delivered 2,022 homes and generated $1.63 billion in revenue. Revenue was down 7.4% from a year ago, which was largely driven by a drop in average selling prices (ASPs) from $881,000 to $805,000. The drop in ASPs was due to a higher concentration of sales in the affordable luxury segment, which sits in the $300,000 to $600,000 price range. This was Toll's strongest segment in the quarter, followed by luxury, which constitutes price points from $600,000 to $3 million.
During the conference call, it was also noted that the age-targeted and above-55 segments, reported together, were unsurprisingly slower simply because those customers are the demographic most exposed to COVID-19, and therefore least likely to break social distancing guidelines. That said, the COVID-19 crisis has made the Reno, Nevada, age-targeted markets extremely hot, especially to San Francisco Bay Area residents, management explained.
Interest rate drop and the coronavirus create tailwinds
Toll Brothers has several tailwinds helping to boost orders. The COVID-19 crisis has made fundamental adjustments to what people consider when evaluating a home purchase. The prospects of working from home and social distancing are encouraging people to leave urban apartments and move to the suburbs. Toll Brothers' homes tend to be positioned in attractive suburbs of major coastal cities. The homes it produces are largely built-to-order and the company saw a record number of customers asking for upgrades.
Moreover, the dramatic decrease in interest rates has improved affordability. Mortgage rates have dropped over 1% so far this year. The monthly payment for an $800,000 mortgage at 4% and a $900,000 mortgage at 3% are roughly the same. Finally, Toll Brothers' primary demographic is college-educated professionals, who have largely weathered the coronavirus crisis better than the population as a whole.
Toll Brothers took steps to preserve liquidity during the quarter, pausing land spend and investments in the urban apartment sector. In fact, the company's inventory in New York urban apartments is at a 10-year low. As of now, the company has no plans to invest further there. Toll repaid its borrowings on its revolving line of credit and ended the quarter with $2.34 billion of liquidity between its $559 million in cash and $1.78 billion in availability from those credit lines. Toll has no significant debt maturities until 2022.
When asked about buybacks (which the company suspended) Toll was non-committal, although it said the board and management are always considering the idea. Finally, Toll projected it would end the fiscal year with 320 communities, and it anticipates 10% growth in community count for 2021.
The takeaway on Toll Brothers
The U.S. Census Bureau reported that new home sales rose 36% year over year to a seasonally adjusted annual rate of 900,000. This is the highest annual rate since December 2006.
The tailwinds for Toll Brothers also extend to the entire home building and construction sector. Toll Brothers trades at 14.7 times expected 2020 earnings per share, a discount to luxury builder NVR, which trades at 19.4 times. The more diversified builders like D.R. Horton and PulteGroup trade with P/E ratios in the lower double digits.
Toll Brothers' homes may be a touch on the expensive side, but it has a different customer base and it is possible that established college graduates may do better economically than the typical first-time homebuyer for a while. That bodes well for the stock of this luxury home builder.
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Brent Nyitray, CFA has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends NVR. The Motley Fool has a disclosure policy.
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