Oh Come On! Is Toll Brothers (TOL) Serious?

Toll BrothersSo let me get this straight. Yesterday morning, Toll Brothers (TOL) reported its worst fiscal year in twenty years as a public corporation and its shares rallied as much as 15% during the day. However, eventually the shares could not fight the negative direction of the broader market, finishing up nearly 7%. With most of the major market indices falling about three percent or more for the day, you might wonder what caused the rally in TOL shares?

It was not the luxury homebuilder’s performance during the quarter that propelled the stock. On the contrary, analysts had estimated Toll Brothers would lose $.47 per share for the quarter, but the company turned in a loss of $.49 per share. Some analysts optimistically called this “a narrowing of losses” considering that TOL lost $.52 per share in the fourth quarter of 2007. I would point out that the company lost more than $300 million dollars for the year, which is not exactly inspiring. Revenue for the fourth quarter was down 40% from last year to $698 million. On November 11th Toll Brothers reported that its backlog of business has fallen 54% and that signed contracts are down 27%. To be fair, everyone knows that homebuilders–especially luxury homebuilders–are enduring one of the most dreadful operating environments in history.

So, can one attribute yesterday’s TOL rally to upbeat guidance for the year ahead? No–Toll Brothers did not offer financial guidance for 2009! I do not blame the company for its reticence given the substantial amount of uncertainty regarding the economic prospects for 2009. The company did say that it anticipates building between 2,000 and 3,000 homes in the next year with an average price of $600,000-$625,000. In comparison, the company sold 4,743 homes in the past year. Furthermore, the most recent National Association of Homebuilders’ survey showed the lowest confidence level regarding builder’s near-term prospects in the survey’s history. According to the AP, in the most recent quarter, median home prices fell 9% and 40% of all homes sold were sales on bank foreclosures.

Something must have sparked TOL’s rally and I have established that it was neither the company’s recent performance nor bright near-term prospects. So, I am left with to conclude that there must be some sort of external event causing newfound bullishness in the stock and these days that often means government is getting involved. Sure enough, word on Capitol Hill is that the government plans to artificially lower mortgage rates in order to entice new home buyers. It might be déjà-vu but I think we have seen this before and how did that work out?

The government’s imposition of a rate of 4.5% on 30-year mortgages will most definitely attract a new throng of buyers but is this really the answer to the housing crisis? The short answer is: no. As I have documented in previous posts about Toll Brothers (Home Builders: Not Finding Buyers Here and Toll Brothers CEO Warns of More Trouble Ahead), CEO Bob Toll has been asking for a government bailout for the homebuilders for about six months now. Back in June, few took Mr. Toll seriously and thought his plea was simply a diversion from his company’s woeful performance. Well mission accomplished; if this proposal is enacted, a bailout for homebuilders is exactly what we will have. All of this for a company whose stock is in positive territory thus far in 2008, meaning it has outperformed the market indices by more than 40%! That is pretty remarkable for a company that has just been through its worst fiscal year in its entire history as a public corporation. Does that sound like an industry that needs propping up? Once the government snowball starts rolling, look out below!

TOLI suspect we will be dealing with a new housing bubble down the road, as prices always seek equilibrium and will not be buoyed by governmental intervention forever. As I wait for the other shoe to drop, Ockham Research rates TOL Overvalued because I see very little compelling reasons for optimism in its crumbling fundamentals. There are far better stocks to invest in right now that actually have improving fundamentals and have been unjustly beaten down in this bear market.

For a further bearish indicator, see Jim Cramer’s interview with Bob Toll on last night’s Mad Money (link). Cramer gleefully congratulated Toll on his company’s “beautiful balance sheet” as they discussed the future of housing. They skipped over the disappointing earnings as Cramer claimed that no one looks at those numbers anymore. Then they raved about the newfound affordability in housing after legislative action to artificially lower mortgage rates (to the direct benefit of Mr. Toll) yet failed to even consider the possibility that this could all backfire down the road. What really got to me was Mr. Toll not once, but twice calling on Congress and the Fed to start marketing this mortgage rate to the public. He really must believe that the government works for him, and unfortunately he may turn out to be right.

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Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

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