Toll Brothers Inc (TOL) and Housing Market Dynamics

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Whether we are looking at the residential spending part of the latest GDP report, new home sales, existing home sales, or the decline in foreclosure inventory, we see signs of a slightly improving real estate market.  The recent Toll Brothers Inc (NYSE:TOL) earnings announcement suggests continuation of this trend.  But there are developments that raise flags and give investors reason to continue to approach this arena with trepidation.  While more-aggressive investors might find opportunities in recent stock-price weakness, more risk-averse investors might want to sit on the sidelines for a bit longer.  Here are some things to consider.

Toll Brothers Inc (NYSE:TOL)Examining earnings

Toll Brothers announced its first-quarter earnings on February 20.  In the three months ended January 31, the company posted a per-share profit of $0.03, marking a significant improvement from the loss of $0.02 per share in the year-earlier period.  The EPS gain came amid a 32% increase in revenue (both in terms of volumes and dollars).  The results are solid, even if the company reportedly missed analyst estimates.  Further, conditions look relatively rosy going forward.  Douglas C. Yearley, Jr., Toll Brothers Inc (NYSE:TOL)’s CEO, is quoted in the earnings announcement stating: “Demand has increased. With our first quarter contracts up 49%, and contracts for the first three weeks of our second quarter up 40% versus comparable periods in FY 2012, it appears that momentum is building.”

That’s the good news.  The part that concerns me about the overall housing market came in the next paragraph: “We are continuing to gain market share and see little competition from local private builders.”  That’s good for Toll Brothers Inc (NYSE:TOL), but this brings several questions to mind, and we will have to see how other developers’ earnings come in before we can answer them.  After all, Toll Brothers operates in 19 states, covering the southwest, south central, north central, and much of the east coast.  To get a better picture of other markets, we will need to wait to hear from other companies.  For example, builders KB Home (NYSE:KBH) and Hovnanian Enterprises, Inc. (NYSE:HOV) report earnings in March.  KB Home is one of the oldest home-building companies.  It is well-positioned in ten states, primarily in the south, and the southern parts of both the east and west coast.  Toll Brothers also operates in nine of these states.  By comparison, Hovnanian is positioned in 16 states, all but four overlap with Toll Brothers.

As a general thought, I would like to know how much of Toll Brothers’ recent business comes from market share gains and how much comes from actual strengthening in the housing market.  Admittedly, Toll Brothers operates in the more affluent spectrum of the market, so its earnings report really doesn’t tell us too much about the rest of real estate.  I can’t help but be a bit concerned about the part that they aren’t seeing too much competition from private builders.  For that reason, it is a good idea to take a look at the economic statistics that cover more of the real estate market.

What the statistics tell us

The latest housing statistics continue to show that the real estate market is improving, but it isn’t great.  Still, there are signs to be somewhat hopeful down the road.

According to the government, new single-family home sales in December 2012 were up 8.8% from the year-earlier period, but were down 7.3% from November.  (The government releases January’s statistics on February 26.)  Similarly, new housing starts in January were up considerably from the prior-year level (23.6%), but were down on a month-to-month basis (8.5%).

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