It’s Not Time To Buy Toll Brothers, Inc Yet

Key Points

• Toll Brothers Q1 was better than expected but the growth outlook has evaporated. 
• The signed contract volume is down 50% and will fall further as interest rates rise. 
• Long-term fundamentals are intact but near-term headwinds will pressure home builders in 2023. 

Toll Brothers NYSE: TOL Q1 results were better than expected and have the market for shares higher, but savvy investors should wait for the next shoe to drop. While the company’s results were better than expected due to improved consumer sentiment, the strength will likely be fleeting.

The Q1 period coincided with the same time frame in which inflation appeared to cool, the FOMC backed off its rate-hiking pace, and the average rate on a 30-year mortgage pulled back from over 7.5% to under 5.5%. Those times are over because inflation is accelerating, the outlook for FOMC interest rates is worsening, and the average rate on a 30-year mortgage is back in the 7.5% range.

In this light, it should be expected that slowing in the industry will resume and that Q2 and perhaps Q3 results won’t be so rosy. 

Toll Brothers Results Overshadowed By Outlook

Toll Brothers had a good quarter, but the takeaway is the same as reported by others earlier in the reporting cycle. The company’s strength is driven by dwindling backlogs and the forecast for the year isn’t great. The $1.78 billion in revenue is already down -0.6% compared to last year and the contraction will grow over the next few quarters.

The revenue beat by 220 basis points and comes with wider margins, but that won’t matter much when revenue shrinks by double-digits. Internally, revenue was driven by a 4% increase in sales and a 5% decline in deliveries. The margin improved by 200 basis points and delivered robust results on the bottom line. The $1.70 in GAAP EPS beat the consensus by $0.31.

The details that investors should pay attention to are the signed contracts and backlog. The backlog is down 20% in value, 32% in volume due to a 50% decline in signed contracts. This suggests that backlogs will continue to dwindle and undercut operations in 2023. 

Value Trap, Watch Out, Here It Is 

Toll Brothers stock and others in the home building group offer value for investors, but this is a trap. These stocks had retreated to this valuation well before the pandemic began because the industry is so visible. There are only so many buildable lots in the US, and these guys are on track to buy them up and build houses on all of them.

The takeaway is that Toll Brothers trades at roughly 7X earnings compared to more than double that for the S&P 500 and it is improbable to improve without some new growth avenue the market has not yet seen. There is a dividend to consider, but even that may not be enough to keep investors interested. The payout is safe and should continue to grow, but at only 1.45%, the yield isn’t all that attractive. 

The analysts have been supporting the stock until now, but that may change. There has been zero activity since the better-than-expected report was released which may be telling. If the analysts change their tune, it is doubtful this stock will continue to move higher. As it is, the Marketbeat.com consensus estimate assumes the stock is fairly valued at its current price levels. 

The Technical Outlook: Toll Brothers Hits A Peak, A Pullback Is Coming 

The price action in Toll Brothers peaked before the Q1 results were announced and now it may move lower. The post-release action shows support at the $55 level, but this is a tenuous level of support. If the market can not sustain this price level, the stock could fall back to the 150-day EMA near $50 or lower.