Toll Brothers: Bulls vs. Bears
The luxury homebuilder is down, but can it come back? Two top analysts face off.
NEW YORK (Fortune) -- As the spring buying season begins, luxury homebuilders are not anticipating a fresh start.
That leaves shares of the country's biggest luxury homebuilder at their lowest point since mid-2003
Now investors are worried about upcoming land write-downs (Toll owns nearly six times as much land as the average homebuilder) and its exposure to falling prices in the Wall Street-heavy northeast.
But with plenty of cash on hand to weather a long downturn and a history of shrewd land buys, does Toll have what it needs to pull out of the current slump? We posed the question to two top analysts covering the Pennsylvania-based builder.
"Toll is very out of favor right now for two reasons: it's a luxury homebuilder and it owns a lot of land. When everyone hates it, you make the most money.
"First, home buying is more a function of income and cash flow than net worth. It's not clear that declines in the stock market will disproportionately hurt Toll. Their customer makes $160,000 a year, so these aren't the laid-off Wall Street guys.
"Second, even though home sales are going to be terrible through 2010, Toll will be able to buy land at great prices. They've been very good at that. After the savings and loan crisis, Toll traded at a 75% premium to other homebuilders after picking up cheap assets. As this cycle turns, they'll do that and create a lot of net income and book value.
"Right now Toll's trading at 0.8 times book value, which is almost a 5% discount to the homebuilding group. It's very rare that Toll trades at a discount. In the past year it's traded at a 20% premium. We know Toll is no longer a darling, and that's why we call it a buy."
"I have a sell on Toll because there is a recipe for Wall Street to be very surprised by their operating losses and customers' woes.
"The luxury move-up market is discretionary and much more impacted by the wealth effect. Their potential buyers are losing 20% to 40% of their wealth in the stock market, not to mention the loss of home equity.
"In the first quarter, Toll only had one home order per development - or 266 homes. That's horrendous, and down from a total of 3,000 in 2008. Also, a third of Toll's communities are in the northeast markets, which are now declining faster than the rest of the country. Jumbo prime loans behind on payments by 60 days or more just reached a historical high of 2.57%.
"Toll controls a massive amount of land - 38,000 lots, or 15 years worth - that they haven't significantly marked down. Before markdowns, there's a good chance that at the operating profit line, they won't be profitable for the next eight quarters. Investors aren't expecting that.