February 26, 2015 Toll Brothers Inc. NEUTRAL Current Recommendation Prior Recommendation Outperform Date of Last Change 11/05/2012 Current Price (02/25/15) $38.50 Target Price $40.00 (TOL-NYSE) SUMMARY Toll Brothers first quarter 2014 adjusted earnings of $0.44 per share surpassed the Zacks Consensus Estimate by 46.7%, and increased 76% year over year on the back of solid revenue, robust margin increase and decline in expenses. Revenues of $853.5 million beat the Zacks Consensus Estimate by 10.4% and grew 33% year over year due to aggressive pricing and higher homes closing. Solid increase in gross margin and operating margin in the quarter was driven by high priced City Living deliveries and improved SG&A leverage. Toll Brothers raised its fiscal 2015 guidance for number of homes delivered and average prices of home delivered. Nevertheless, rising building materials, labor costs and possible changes in interest/mortgage rates remain headwinds for the company. We therefore have a Neutral recommendation on the stock. SUMMARY DATA 52-Week High $39.55 52-Week Low $29.18 One-Year Return (%) N/A Beta 1.40 Average Daily Volume (sh) 2,397,265 Shares Outstanding (mil) 175 Market Capitalization ($mil) $6,738 Short Interest Ratio (days) 2.72 Institutional Ownership (%) 82 Insider Ownership (%) 11 Risk Level * Below Average Type of Stock Large-Value Industry Bldg-Rsdnt/Comr Zacks Industry Rank * 231 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Jan) (Apr) (Jul) (Oct) (Oct) Annual Cash Dividend $0.00 Dividend Yield (%) 0.00 5-Yr. Historical Growth Rates Sales (%) 21.4 Earnings Per Share (%) N/A Dividend (%) N/A using TTM EPS 19.4 using 2015 Estimate 19.3 using 2016 Estimate 14.9 2013 425 A 516 A 689 A 1,045 A 2,674 A 2014 644 A 860 A 1,057 A 1,351 A 3,912 A 2015 853 A 905 E 1,111 E 1,344 E 4,213 E 2016 961 E 4,941 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Jan) (Apr) (Jul) (Oct) (Oct) 2013 $0.02 A $0.07 A $0.38 A $0.52 A $1.00 A 2014 $0.25 A $0.31 A $0.53 A $0.71 A $1.80 A 2015 $0.44 A $0.38 E $0.56 E $0.62 E $2.00 E 2016 $0.43 E $2.58 E Zacks Rank *: Short Term 1 3 months outlook 3 - Hold Projected EPS Growth - Next 5 Years % 24 * Definition / Disclosure on last page 2015 Zacks Investment Research, All Rights reserved. www.zacks.com 10 S. Riverside Plaza, Chicago IL 60606
RECENT NEWS Toll Brothers Up on First Earnings & Sales Beat, Bright Outlook Feb 25, 2015 Toll Brothers reported strong earnings and revenue in the first quarter 2015. The company also raised its guidance for fiscal 2015. Adjusted earnings of $0.44 per share in the first quarter of fiscal 2015 beat the Zacks Consensus Estimate of $0.30 by 46.7%. Moreover, adjusted earnings increased 76% from $0.25 in the prior-year quarter. Strong earnings results were driven by solid revenue, robust margin increase and decline in selling, general and administrative (SG&A) expenses. The company reported revenues of $853.5 billion in the first quarter of fiscal 2015, beating the Zacks Consensus Estimate of $773 million by 10.4%. Revenues were up a solid 33% year over year on the back of aggressive pricing and higher home closings. Quarter Detail The number of consolidated homebuilding deliveries increased 18% year over year to 1,091 units in the first quarter of fiscal 2015. The number of homes closed increased in all the regions excluding the Mid- Atlantic. The company has been benefiting from its growing geographic diversity. Other than Washington D.C and the Boston corridor, the company is also expanding in west and south and urban centers. Its presence in the Californian market has become stronger due to coastal California land purchases and the acquisition of Shapell Homes. The average price of homes delivered was $782,300 in the quarter, up 12.8% year over year. The company ended the quarter with 258 selling communities, up 8.4% from the prior-year quarter. Toll Brothers offers homes under two segments, Traditional Home Building Product and City Living. Traditional homebuilding revenues during the quarter were $745.7 millions, up 17.7% y/y. City Living reported revenues of $107.8 million, up significantly from $10.2 million. The number of net orders signed was 1,063 units in the first quarter of fiscal 2015, up 16% year over year. Value of net orders signed during the quarter was $873.2 million, up 24% year over year. First quarter 2015 order cancellation rate was 5.6%, an improvement over 7.0% in the prior-year quarter. The company s backlog totaled 3,651 homes as of Dec 31, 2014, flat year over year. Potential housing revenues from backlog grew 2% year over year to $2.74 billion, primarily attributable to an increase in prices of backlogs. First quarter 2015 backlog cancellation rate was 1.7%, an improvement over 1.9% in the prior-year quarter. The company s homebuilding gross margin (excluding interest and write-downs) grew 290 basis points (bps) to 27.3%, driven by increased closings of higher priced of City Living deliveries during the quarter. City Living contributed a significant 300 bps to the first quarter 2015 gross margin. Moreover, margins improved 180 bps sequentially. As a percentage of revenues, selling, general and administrative (SG&A) expenses improved 270 bps to 12.5% as higher revenues improved leverage. Operating margin improved 650 bps year over year to 11.4% on the back of improved homebuilding gross margin and better SG&A leverage. Equity Research TOL Page 2
Second Quarter Outlook During the fiscal second quarter 2015, average price of homes delivered is expected to be in the range of $720,000 to $740,000. Though City Living contributed significantly to the first quarter 2015 gross margin, the segment will have very few deliveries in the second quarter. 2015 Outlook Based on the increasing momentum of the housing industry, Toll Brothers raised its guidance for fiscal year 2015. The company increased its guidance for number of homes delivered and average prices of home delivered, while maintaining the guidance for community count. Management expects to deliver 5,200 and 6,000 homes, higher than the prior expectation of 5,000 and 6,000 homes in fiscal 2015. The average price of homes delivered is expected to range between $725,000 and $760,000, compared to prior expectation of $710,000 and $760,000. The company expects community count to range between 270 and 310 in fiscal 2014. Fiscal 2015 gross margin is expected to be about 26%, which is flat year over year. Gross margin is expected to reach its low point in the second quarter, thereafter gaining upward progression in third and fourth quarter. Equity Research TOL Page 3
VALUATION Toll Brothers current trailing 12-month earnings multiple is 19.4x, representing a premium of 24.4% to the industry average of 15.6x. Currently, the shares of Toll Brothers are trading at 19.3x our fiscal 2015 earnings estimate of $2.00, representing a premium of 29.5% on the industry average of 14.9x. The P/B multiple of the stock is approximately 1.8x, a premium of 20.0% over the industry average of 1.5x. Overall, the stock is steeply priced as it carries a trailing 12-month ROE of 8.9% against an industry average of 10.6%. Our target price of $40.00 is based on approximately 20.0x our 2015 earnings estimate. On a P/B basis, the price target is based on a P/B multiple of approximately 1.9x. Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low Toll Brothers Inc. (TOL) 19.3 14.9 24.0 19.2 19.4 N/A 17.4 Industry Average 14.9 11.3 8.2 17.1 15.6 N/A 13.5 S&P 500 16.8 15.7 10.7 15.3 18.5 19.4 12.0 NVR, Inc. (NVR) 16.3 13.6 10.0 18.4 21.1 32.6 16.2 PulteGroup, Inc. (PHM) 17.1 14.2 11.0 16.8 18.7 N/A 12.1 Taylor Morrison Home Corporation (TMHC) 11.2 9.6 5.0 46.8 9.3 17.3 8.0 Ryland Group Inc. (RYL) 12.7 11.0 N/A 9.8 14.6 N/A 9.9 TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA Toll Brothers Inc. (TOL) 1.8 2.1 0.9 8.9 0.8 0.0 18.0 Industry Average 1.5 1.5 1.5 10.6 0.7 0.7 30.5 S&P 500 5.3 9.8 3.2 25.5 2.1 Equity Research TOL Page 4
Earnings Surprise and Estimate Revision History Equity Research TOL Page 5
DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of TOL. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1126 companies covered: Outperform - 15.3%, Neutral - 75.8%, Underperform 8.1%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. NOTE YET. THIS IS A NEWS-ONLY UPDATE; THE REST OF THIS REPORT HAS NOT BEEN UPDATED OVERVIEW Based in Horsham, PA., Toll Brothers Inc. builds single-family detached and attached home communities; master planned luxury residential resort-style golf communities; and urban low, mid, and high-rise communities principally on the land it develops and improves. The company operates in 19 states in the U.S including Arizona, California, Florida, Delaware, Maryland, Pennsylvania, and South Carolina. As of Oct 31, 2014, the company had 263 communities. Toll Brothers offers homes under two segments, Traditional Home Building Product and City Living. Traditional Home Building Products include detached and attached homes for move-up, empty-nester, active-adult, age-qualified, and second-home buyers. Within Traditional Home Building Products, Toll Brothers operates in four geographical segments, North, Mid Atlantic, South and West. City Living includes homes in urban infill markets in New York City market. Toll Brothers is also building homes for rental apartment projects. Toll Brothers Apartment Living and Toll Brothers Campus Living are rental apartment projects in lucrative markets like metro-boston and metro-washington, D.C. corridor. Equity Research TOL Page 6
The company also invests in distressed real estate properties through its subsidiary, Gibraltar Capital and Asset Management LLC ( Gibraltar ). The company also operates through a number of joint ventures, such as, Land Development Joint Ventures, Home Building Joint Ventures, Rental Property Joint Ventures. On Feb 4, 2014, Toll Brothers completed the acquisition of the single family homebuilding business of CA-based Shapell Industries, Inc. for $1.49 billion; which is expected to largely boost its presence in the upscale Californian housing market. REASONS TO BUY Steady Recovery in the Housing Market: The housing market has made a steady comeback from the lows witnessed in mid-2006 due to severe and widespread downturn. Though interest rates started increasing from May 2013, they are below historical levels and housing is still affordable. In addition, accelerating job growth, increasing consumer confidence, improving economy and unlocking pent-up demand is boosting demand for new homes. Supply, however, remains limited by low home inventories, both for new and existing ones. Shortage of land and labor is restricting the production of homes both single-family and multi-family. Home prices, thus, started moving up with market demand gaining momentum but supply remaining limited. In 2014, demand for new homes reflects stable to moderately improved trends with improvement in both the economy and employment. The stabilizing interest/mortgage rate acted as a further stimulus. Though higher than the average rate in 2013, mortgage rates are still below historical levels, making housing affordable. Moreover, though home prices have been rising in calendar 2014, the rates have moderated since the last year as new homes became less affordable to some buyers and due to increase in supply. The low mortgage rates and moderating home prices are expected to give homebuyers the much needed confidence paving the way for higher home demand in 2015. Moreover, with the economy looking better in 2014 than last year, the housing outlook for 2015 is stable to slightly better. Large homebuilders like Toll Brothers with significant land positions, broad geographic and product diversity, and better capital positions are better placed to capitalize on the housing recovery. Limited Competition in the Luxury Housing Market: Toll Brothers mostly offers luxury homes and its communities are located in prosperous suburban areas with easy access to major cities. Luxury homes generally face limited competition in the market. The company mostly caters to luxury move up buyers, who already posses a residence and are looking for a shift to larger and better homes. These homebuyers are less sensitive to price changes. Toll Brothers enjoys greater pricing power than other homebuilding companies. Significant Land Positions: Given the significant pent up housing demand, Toll Brothers has secured some of the most sought after urban locations in the country, where land is scarce and approvals are not easy to obtain. Toll Brothers is using its strong liquidity position to secure the most sought-after urban locations in the country like New York City Market, Northern New Jersey, Philadelphia and Washington D.C. The company s solid land position places it well to meet growing demand, thus giving it a competitive edge over peers who are facing land availability constraints. Equity Research TOL Page 7
With the present demand supply gap in the housing market, Toll Brothers strong land position is expected to help it garner increased market share. Shapell Acquisition: On Feb 4, 2014, Toll Brothers completed the acquisition of the single family homebuilding business of CA-based Shapell Industries, Inc. for $1.49 billion; which is expected to largely boost its presence in the upscale Californian housing market. Though demand in the homebuilding market is gaining traction, the supply side is still weak. Following the acquisition, Toll Brothers has gained control over Shapell's entire land portfolio in the California market. It has provided the company additional lots and homes for future sales, thereby strengthening its supply side. REASONS TO SELL Supply Constraints: A shortage of buildable lots and skilled labor and a lack of available capital for smaller builders are limiting the production of homes, thereby lowering inventory of homes, both new and existing. As a result, neither current nor pent-up demand can be met. If the supply picture does not improve, home prices could shoot up further, causing many homebuyers to put their purchase decisions on hold. Rising Labor, Land and Material Costs: Rising building materials and labor costs are an increasing margin headwind. As housing starts accelerate, both labor and construction material costs continue to drive prices higher. This could eat into the margins of the homebuilders in the forthcoming quarters. Slow Economic Recovery: Sustainable revival in housing and housing demand for the long term will require the overall economy to strengthen. This means further job growth, improving household income, rising consumer confidence and easing of credit availability. The economy though on the mend with all these factors showing signs of improvement is far from a complete recovery. Despite moderate improvement in economic growth, consumers are spending only modestly, as a surge in job growth this year is yet to translate into significantly higher wages. The lending environment is still overly restricted for first-time buyers. High down payments and strict underwriting standards are restricting the access to the mortgage markets. Until there is a more robust economic recovery, new home sales would continue to lag historical levels. Federal Government Actions: The federal government s actions related to economic stimulus, taxation, borrowing limits could affect consumer confidence and spending levels which, in turn, could hurt the economy and the housing market. Currently, there is a high probability of a rise in short-term interest rates in 2015 considering the fact that the Fed has ended its six-year long quantitative easing program in October. Though the Fed had earlier assured that the key interest rate will be kept at the record low level for a considerable time, investors have started speculating about the timing of the planned rate hike. It may well be sooner than expected in 2015. Higher interest/mortgage rates has a moderating effect on housing demand and pricing. Equity Research TOL Page 8
Research Analyst Lead Analyst QCA Copy Editor Content Ed. Reason for Update Sarmistha Roy Chowdhury Kinjel Shah Kinjel Shah Shikha Kansal Shikha Kansal Analyst note Equity Research TOL Page 9