Friday, November 09, 2007

Slowing Demand Takes its Toll on High-End Homebuilder

Toll Brothers, Inc. (TOL-$20.89) reported that its operating metrics continued to deteriorate for preliminary fourth quarter and fiscal year totals, with home building revenues, contracts and backlog for the period ended October 31, 2007, declining year-over year.

For the fiscal year ended October 31, 2007, home building revenues were approximately $4.63 billion and net signed contracts were approximately $3.01 billion, a decline of 24% in home building revenues and 33% in contracts compared to FY 2006’s year-end results, respectively.

The fourth quarter cancellation rate was 38.9% as a percent of current quarter contracts compared to 36.7% in the 4Q:06, with the West segment (California and Arizona) setting the pace in the high-priced point products. [Ed note. Just 11 percent of the cancellations were for mortgage-related issues.]

In addition, the nation’s leading builder of luxury homes ended FY 2007’s fourth quarter with approximately 59,300 lots owned and optioned, a 6-7 year supply based on historical pace of growth. According to analysts, however, based on expected closings over the next four quarters, the Company is sitting on about thirteen years worth of inventory.

A look at Toll’s order pace, however, suggests that a number of communities are going weeks without seeing a sale—656 net signed contracts across 315 selling communities.

The Company ended the fourth quarter with 315 selling communities, down from its peak of 325 at the end of 2Q:07, and expects to be selling from approximately 300 communities by fiscal-year-end 2008.

While Toll has not yet finalized its impairment analysis, management estimates that pre-tax writedowns in the 4Q:07 will be between $250 million and $450 million. The slowdown in new contracts signed, increases in cancellation rates (homes under contract but not yet delivered), and mortgage subsidiary exposure of more than $1.27 billion suggest to us that the recognized estimates for fourth quarter impairment charges could prove to be too conservative.

On the fourth-quarter earnings call, Robert I. Toll, chairman and chief executive officer, stated: “We continue to believe that excess supply created by cancellations, speculative buyers, and overly ambitious builders; customer concerns about selling their existing homes; and a general lack of confidence are the primary impediments to our market’s recovery. An inability to obtain mortgages does not appear to be a major factor for our buyers, although it may affect our buyers’ buyers.”

Patience is the companion of wisdom. ~ Saint Augustine (353 –430)

Albeit several quarters of poor earnings visibility has already been discounted by investors in high-end homebuilder Toll Brothers, a further weakening of demand in key markets and the risk of additional inventory impairment charges reflect our view that new monies should continue to stay on the sidelines.

Editor David J. Phillips does not hold a financial interest in Toll Brothers. The 10Q Detective has a Full Disclosure Policy.

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