Has Toll Brothers Rally Run Its Course?

Toll Brothers NYSE: TOL shares have been on a tear since the start of 2021, up 24.5% YTD. As the leading builder of upscale homes in the United States, Toll Brothers has capitalized on the mass exodus of young professionals from the cities to the suburbs. To someone paying $3,000 a month for a tiny apartment in New York City or San Francisco, Toll Brothers’ average selling price (ASP) of $800,000+ for a spacious and beautiful house doesn’t seem so high.

With TOL shares pushing all-time highs, some fear that there is no more upside for new investors.

But that fear is misplaced as Toll Brothers is trading at just 11.5x forward earnings and could see earnings grow for each of the next few years.

Mortgage Rates Are Likely to Stay Low

The Fed is expected to keep its benchmark short-term interest rate near zero until at least 2023. The average fixed rate for a 30-year mortgage hasn’t gone above 3% since the summer, and it may spend 2+ years below that number when it’s all said and done.

 On the Q3 earnings call, CEO Douglas C. Yearley pointed out that the monthly payment is the same for someone who buys a $900,000 home with a 3% mortgage rate as someone who buys an $800,000 home with a 4% mortgage rate. All homebuilders benefit from lower interest rates, but the difference is greater for a luxury builder like Toll Brothers than it is for a lower-end builder like D.R. Horton NYSE: DHI.

You may be thinking:

Rates are starting to creep up. What if that continues?

 Obviously, higher rates are never good for homebuilding stocks. That said, it seems unlikely that rates will go up enough to move the needle. Even if mortgage rates go up 20 basis points, they will still be incredibly low compared to just about any other time in history.

College-Educated Professionals Will Continue Moving to the Suburbs

A lot of millennials bought houses in the suburbs in 2020. But this relocation trend is likely to continue into 2021 and beyond. Many college-educated professionals are waiting to pull the trigger on a permanent move until they know how their work arrangement will look in a post-pandemic world. Where they move, if anywhere, could depend on whether they’re fully remote or partly remote when we return to normal.

Toll Brothers realizes that this demographic isn’t a captive market; the company is taking steps to appeal to them. For example, Toll Brothers is expanding into Colorado Springs, which is the hottest housing market in the US. The company also has communities in several other hot markets including Boise, Salt Lake City, Las Vegas, Reno, Metro Phoenix, Denver, Austin, and Florida.

The Market Could Get Hotter

On Toll Brothers’ Q4 earnings call, management said that, “According to Redfin, in October, a record high 35% of all resales nationwide sold above asking price.”

Toll Brothers blew away expectations for the quarter, with total revenue of nearly $2.55 billion vs. analyst expectations of $2.1 billion. Net profit of $1.55 per share was well above estimates of $1.23.

For 2021, Toll Brothers is expecting new home deliveries of between 9,600 and 10,200 homes, with an ASP of between $790,000 and $810,000. But it’s not as if the company expects demand to taper off; management expects “approximately 60% of deliveries to occur in the second half of the year.”

How Should You Play Toll Brothers?

Toll Brothers is slated to release its fiscal Q1 2021 earnings next week. The numbers probably won’t be too great. On the Q4 call, management warned investors that deliveries will be low in Q1 because customized home delivery takes 9-12 months. As you can imagine, Toll Brothers didn’t make a lot of sales from March through May of 2020.

That said, a low delivery number won’t raise any eyebrows, so it’s nothing to be concerned about. Investors will be more focused on Toll Brothers’ outlook for the rest of the year. Every indication is that the outlook will be as strong or stronger than the last time we heard from management.

Bottom line: you should consider picking up some TOL shares before the market realizes that they should be trading at a higher multiple.