Key Issues for TOL’s 4Q Results on Wednesday
SEE LAST PAGE OF THIS REPORT FOR IMPORTANT DISCLOSURES
Dan Oppenheim , CFA
November 30th 2018
- Can Toll Brothers pull off a 17th straight quarter of year/year order growth? It’ll be a close call, as worsening conditions in California will impact 4Q18 orders. We expect most regions will see modest order growth, with a slight decline in the West and a more significant decline in California (probably down approximately 20%). Overall, we would not be surprised to see orders come in flat to a low single-digit decline on a year/year basis. Given the weak housing stats as of late, we don’t think orders at that level ought to be a surprise.
- How will the order trends impact the backlog going into 2019? Even if orders are essentially flat in 4Q18, we expect the year-end backlog value to be 16% higher than the backlog value at the end of 2017, pointing to solid, but slower revenue growth in 2019.
- Does the decline in orders in California mean that the overall backlog will have less from California, and what does that mean for margins? Weexpect the California to represent 31% of the total backlog value, up from 29.5% at the end of 2017. This mix of backlog would not point to lower margins in 2019. However, we expect declining margins in California, given the falling absorption/orders and price pressure in the markets. We think overall gross margins will likely fall 150 basis points in 2019 relative to 2018, leaving adjusted gross margins (ex capitalized interest and impairments) around 22.5%.
- How significant was the share repurchase during 4Q18? We expect that Toll was likely active with the repurchase in the fourth quarter, especially in October, when the stock closed as low as $29. The company acquired $136 million of stock in 3Q18, and the seasonally-higher level of closings and revenue likely led the company to repurchase approximately $150 million of stock during the quarter.
- How much guidance will Toll provide for 2019, given the slowing and uncertain conditions? Toll has visibility into the first half of 2019, given its backlog, longer construction cycle, and significant deposits from its homebuyers (leading to a low cancellation rate on its orders). Other companies have limited their commentary on expectations for 2019, but we expect Toll will provide guidance for the key issues of volume and margins, likely noting that margins will have a downward trajectory given that California will be less significant over the course of 2019 due to the declining orders.
- How will the stock react? The stock is now trading at less than 1.1x year-end tangible 2018 book value, at the bottom end of where the stock has historically traded, aside from during the housing downturn. As such, we would not be surprised to see a positive reaction to the earnings release.
- Any risks that could cause greater concern? We see the biggest potential risks being a) a sharper-than-expected decline in orders in California in 4Q18, b) more cautious 2019 gross margin commentary, or c) any comments about trends in November in California, as the fires and poor air likely led to a much lower level of orders in California in the first month of fiscal 2019.
- We continue to favor the rental sector (REITs) over homebuilders and home centers. We believe the ongoing slowdown in housing turnover and sharp deceleration in price appreciation will present challenges for homebuilding and home center stocks, although we believe homebuilders reflect far more of the slowing than home centers do, and we see risk to both Home Depot and Lowe’s. We believe the multi-family and single-family REITs will benefit from the lower turnover via higher occupancy and pricing power, along with reduced expenses related to move-outs.
|Exhibit 1: SSR’s Preferences Among Housing-Related Sectors|
|Source: SSR Analysis|
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