Toll Brothers rebounding faster than other US homebuilders in housing recovery, benefiting from strategy of focusing on up to US$2M homes, which are less impacted by shifts in consumer sentiment

Allison Oesterle

NEW YORK , November 14, 2013 (Thomson Reuters Corp.) – * Company's well-heeled customers shrug off higher interest rates

* Expensive homes account for bigger portion of overall U.S. sales

* Toll's orders rose in latest quarter, while lower end of market stalled

Most American homebuilders faced a sudden drop in demand from first-time buyers during a quarter blighted by the U.S. government shutdown and a two-year peak in interest rates.

Toll Brothers Inc stands out as the exception.

The country's largest builder of luxury homes is expecting a 65 percent jump in revenue in its just-ended fourth quarter that would take it across the $1 billon threshold for the first time since 2007.

It has also reported a preliminary 6 percent rise in orders, in contrast to the drop in orders just reported by top U.S. homebuilder D.R. Horton Inc and No. 2 PulteGroup Inc .

D.R. Horton and PulteGroup cater mainly to first-time buyers or those upgrading to a bigger property for the first time. Both groups were sidelined in the latest quarter by rising mortgage rates and policy squabbles in Washington.

For Toll Brothers, which targets a different demographic with homes that can retail for up to $2 million, the change in consumer sentiment has had less of an impact.

"You have a lot more cash, so the luxury end of the market is not as fickle," said David Williams, who follows U.S. builders for Dallas-based brokerage Williams Financial Group.

Industry data bear out a shift toward more expensive homes.

David Crowe, chief economist at the National Association of Homebuilders, said 12 percent of houses sold in the United States this year to date cost $750,000 or more. Last year, the number was 9 percent.

Announcing its preliminary fourth-quarter results on Nov. 7 - final results will follow in early December - Toll Brothers said it expected its average selling price to have risen 21 percent to $703,000 in the three months to Oct. 31.

"Six years of pent-up demand is just beginning to return to the market," Chief Executive Douglas Yearley said on a call with analysts to discuss the preliminary results.

Homebuilders report quarterly results at different times. D.R. Horton reported its fourth-quarter results on Nov. 12 and PulteGroup its third-quarter results on Oct. 24.

Their orders for the quarter ended Sept. 30 fell 2 percent and 17 percent respectively.

LAND BANK

Toll Brothers has accumulated a larger land bank than most of its peers - enough to last more than 12 years, compared with an average 7.4 years for the top five U.S. homebuilders, according to data supplied by Tri Pointe Homes.

The company has also reported some of the lowest cancellation rates among the leading U.S. builders. It said about 5.5 percent of homes ordered were canceled in the fourth quarter; D.R. Horton reported a 31 percent cancellation rate.

Toll Brothers' shares have fallen 10 percent since interest rates began rising in May, while the Dow Jones Home Construction index has fallen by slightly more than 20 percent..

At just over $32, the company trades at 21.9 times 12-months forward earnings and is expensive compared with the top five homebuilders, which trade at an average of 12.4 times, according to Thomson Reuters StarMine data.

But analysts at brokerage Keefe, Bruyette & Woods said they believed the shares warrant a premium.

"We view Toll Brothers' luxury focus, geographic footprint and long land position as attractive, particularly given land scarcity in Toll's affluent markets," they wrote in August.

Thirteen analysts have a "buy" or "strong buy" on Toll Brothers' stock, according to Thomson Reuters data. The average price target of all 23 analysts covering the company is $36.83.

Eight analysts rate the stock a "hold" and two a "sell".

Analysts say Toll Brothers' national footprint gives it an edge over other luxury U.S. homebuilders, which tend to be small or mid-sized private builders that are constrained for capital.

Until July, Toll was the only publicly listed luxury homebuilder in the United States. Smaller peer WCI Communities Inc went public on July 25, but analysts say others are too small to tap the stock market.

Toll Brothers is also one of the few builders with a strong presence in downtown Manhattan, and is extending its presence in California - the state at the forefront of the housing market recovery, where the average price of the company's finished homes topped $1.2 million in the latest quarter.

Toll Brothers said last week it would pay $1.6 billion for Shapell Homes, its biggest acquisition to date, in a deal that will give it access to 5,200 lots in California's affluent real estate markets.

While analysts are concerned that too much exposure to California could be risky for lower-end builders, they said the spotless credit records of Toll Brothers' customers would help to safeguard the company against any slowdown.

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